In his recent message to the Yale community, President Richard C. Levin articulated the principles and priorities that will guide the University in the decade ahead. The focus of this letter is on the financial strategy that will undergird the University's efforts during these years. Our planning is predicated on two strongly held beliefs. First, the quest for fiscal strength is not a goal in itself but, rather, a fundamental means of promoting the institutional mission of creating, transmitting, and preserving knowledge. Second, since this quest will repeatedly engage the wisdom and participation of the whole community, it is important that we set out with a shared sense of the magnitude and nature of the challenges and opportunities ahead of us and the soundness of the strategies we will employ to meet them.
This letter builds upon the reports published in the Yale Bulletin & Calendar during the Spring of 1995 and incorporates information presented in the Yale University Financial Reports for 1994-95 and 1995-96. Long-range planning is necessarily a work in progress, better suited to regular updates than grand plans or definitive pronouncements, and this letter should be read in that spirit.
Institutional goals
The President has written of Yale's high institutional aspirations. Much of our effort over the coming decade will be directed toward reaffirming and renewing the excellence that is characteristic of Yale, an effort requiring a steady focus on our highest priorities. We must continue to attract and retain the very best faculty and staff to lead and serve the University's education and research mission by remaining competitive in our compensation and support. We are firm in our belief that a Yale College education should be available to outstanding students regardless of their financial means, and that the education we offer them should remain among the very best in the world. We will maintain the rich diversity of education and the research strength that derive from the presence of the Graduate and Professional Schools, which continue to attract outstanding scholars and future leaders. We will safeguard the remarkable collections that nourish Yale's educational and research endeavors. We celebrate Yale as an interconnected community, a community of windows rather than walls, and we recognize the importance of our New Haven community, the host of contributions made to the life of this City by students, faculty, and staff, and the richness of experience and opportunity that the City offers Yale.
We are confident that we can maintain our distinction and achieve our aspirations over the coming decade with the resources that we anticipate being available. In an age of rapid change, however, it is critical that we be able and willing to act boldly and decisively while managing those resources prudently, wherever possible generating new sources of funding, making more efficient use of current resources, and reallocating existing support as our priorities determine.
The foundations of financial planning
In order to support its broad goals, the University must pursue a financial strategy that will enable it to achieve and maintain financial equilibrium, a balance among our resources and expenditures that is stable over the long term. In a state of financial equilibrium, the real value of the University's endowment is preserved, the operating budget is kept in balance, and the operating and capital budgets provide annual funds sufficient to sustain the quality of existing programs and facilities and to permit the pursuit of new opportunities.
Since 1992, Yale has made significant strides in implementing this financial strategy by progressively reducing the structural deficit in the operating budget. We have steadily reduced the deficit each year, to the point where the 1996-97 budget will show a deficit of only $4 million, and the 1997-98 operating budget will be in balance. This has been achieved through sustained and substantial operating budget reductions, including a phased 5 percent decrease in the size of the Faculty of Arts and Sciences, significant reductions in administrative and library staff, and a modest scaling-back of certain employee benefits. But we have further to go in order to reach true financial equilibrium.
Understanding the present challenge requires understanding the University's financial structure: Yale's substantial assets and major sources of income, and the categories of expense included in the operating and capital budgets. Only when all of these components are in a balance that can be sustained over time can the University be said to have achieved financial equilibrium. I will now test your patience but also, I hope, engage your interest, by presenting an overview of the University's financial structure.
The operating budget. The operating budget represents the annual income and expenses associated with running the entire University. There are several major sources of income to the annual operating budget: 1. student tuition, room, and board payments; 2. income from the endowment; 3. gifts from alumni and friends; 4. grants and contracts -- both direct expenditures for sponsored research and support for the indirect costs of that research; 5. medical services income -- generated primarily by clinical faculty in the Medical School; and 6. other income, such as application fees. The expenditures in the operating budget include the annual costs -- salaries, benefits, goods and services -- of all of Yale's programs and people, including the "self-supporting" professional schools and self- endowed units like the Beinecke Library and British Art Center, whose revenues cover all of their expenditures and also pay their share of central University costs and functions.
The 1996-97 operating budget exceeds $1 billion. However, nearly two thirds of that budget represents restricted research funds and the revenues and expenditures managed by the self-supporting schools and units. Approximately $350 million in unrestricted funds is available to support the Faculty of Arts and Sciences, Yale College, the Graduate School, the University Library, some of the professional schools, and most of the central services and systems that keep the institution running.
This year, the annual operating budget contains a gap between income and expenses of $4 million, which is reduced from the $8 million budgeted in 1995-96 and even larger deficits in prior years. These deficits were planned and budgeted so that the structural gap between income and expenses could be closed gradually rather than by making drastic cuts in expeditures with the resulting damage to ongoing programs. The reduction of the deficit has been achieved despite the impact of several new financial burdens. Some of these we have chosen to assume, such as the investment in information network technology, but others have been imposed upon us, such as new federal regulatory requirements, and new pressures on traditional revenue sources, especially federal funding and fees for medical services.
After eliminating the operating deficit, we intend to keep the operating budget in balance for the long-term future. As a fraction of Yale's $1 billion operating budget, eliminating a $4 million deficit appears to be a relatively minor challenge. Remember, however, that the $4 million must be removed from the approximately $350 million in expenses that compose the unrestricted portion of the central budget. At the same time, moreover, we must make room to absorb further declines in some revenues and absorb additional costs as we invest selectively in some new undertakings.
The capital budget. Each year Yale spends a significant amount of money on capital projects, which include the construction of new buildings, the purchase of equipment with a very long life, and the renovation and renewal of existing facilities -- capital maintenance--
. These expenditures are represented in the capital budget. In contrast to the operating budget, the primary sources of funding to support capital projects are currently gifts -- 30 percent-- and debt -- 60 percent-- . The 1996-97 Capital Budget includes $222 million in new authorizations and $173 million in capital disbursements to be spent during the year, on projects such as the Sterling Memorial Library renovation, residential college renovations, and the replacement of the central power plant.
While the deficit in the operating budget is no stranger to any of us, less widely recognized, perhaps, is the presence of what can reasonably be portrayed as a facilities deficit. This deficit has resulted from an annual consumption of our facilities not funded in any budget and, thus, postponed for later generations to address. The level of deferred maintenance on campus today that we have unfortunately inherited is substantial. We believe that it is our responsibility, to ourselves and to subsequent generations, to bear the full cost of the gradual wear on the buildings in which we live and work. Furthermore, we believe that we must pay a share of the cost of prior deterioration. Consequently, in 1995-96 we embarked on a ten-year effort to build into Yale's annual capital budget $50 million -- in 1995-96 dollars-- for capital maintenance, drawn from direct allocations out of the operating budget -- $35 million-- and from targeted gifts -- $15 million-- . We are making progress toward this goal, beginning with an allocation of $3.5 million from the 1995- 96 operating budget and adding another $3.5 million for a total of over $7 million from 1996-97. This allocation will be increased each year until the level of $35 million -- in 1995 dollars-- is reached, and progressively less debt will be needed to top up the fund for capital maintenance.
It may be asked if $50 million is the right amount to commit to capital maintenance annually. One way of answering this question is to review a building-by-building inventory of current maintenance needs. Alternatively, a formal estimate of the necessary level of investment can be derived from a calculation of the initial or replacement cost of buildings spread over their anticipated lifetime. Both methods indicate that $50 million is a level of spending that should allow us to keep up with ongoing depreciation while making steady, albeit slow, progress in addressing prior years' deferred maintenance. It is crucial to this effort, of course, that these funds be expended wisely, efficiently, and effectively -- on the right projects at the appropriate cost.
Recognizing that facilities cannot be viewed in isolation from the activities they support, the University has adopted a long-term facilities renewal strategy that incorporates the needs of the programs associated with existing facilities and proposed new facilities. We are working to link this strategy with other University planning initiatives, and in 1996-97 the University Budget Committee will coordinate more closely the planning by reviewing both the capital and operating budgets together.
Financial equilibrium. Our goal, then, is not just a balanced operating budget but true financial equilibrium, where the levels of income and expense in both the operating and capital budgets are matched and stay in balance. More specifically, financial equilibrium means that in the operating budget the annual expenditures required to achieve our programmatic priorities will remain matched to available income. It means that spending from the endowment will continue to supply a significant and reliable stream of income to the operating budget without eroding the real value of each dollar invested. Financial equilibrium in the capital budget means that we will annually reinvest in our facilities at approximately the rate at which we "consume" those facilities. Only when all this has been achieved can we feel assured that we will maintain over time the value of all three of Yale's great assets -- its people and programs, its endowment, and its facilities, including the buildings that house students, programs, the library, and other collections that enrich those programs.
Alternatives to the pursuit of financial equilibrium certainly exist, but they are dismal at best -- dysfunctional facilities unable to support core programs, operating funds inadequate to preserve current quality, or a diminished endowment unable to assure future excellence -- in short, a future punctuated by episodes of crisis and disarray. Yale can and must do better than this. It is in this spirit that we have made it our goal to achieve financial equilibrium over the next decade.
Achieving Financial Equilibrium
Our planning assumptions are based on a careful analysis of our current situation and the trends we are likely to see in the major components of our budget in the future. We have no crystal ball, and we cannot project the University's revenues and expenses over a decade with any precision. Quite small variances in projections can yield quite large dollar "swings." Accordingly, long-range projections must be constantly scrutinized and revised as conditions change. That said, a long-range projection is nonetheless an important tool to give us a useful first approximation of the financial challenges ahead.
Our long-range projections are embodied in a model that presents a view of Yale's current programs and policies extrapolated over the next decade, using assumptions about the way in which revenues and expenses will grow. In practice, we have concentrated our efforts on the three-to-five year horizon, where we can be more confident about trends. The resulting projections indicate that we face significant but surmountable challenges in trying to reach our goal of achieving and maintaining financial equilibrium. Growth in the University's primary sources of revenue will not soon return to the rates experienced in the 1980s. An increasing portion of our revenue base is subject to adverse external pressures and influences, such as the leveling off of Federal research funding, the decline in medical service reimbursement rates, and moderation in the growth of tuition rates. On the other hand, the costs of many of the goods and services on which we rely continue to increase at rates greater than inflation.
The challenges are real, but we are exploring every possible way of achieving our goal of financial equilibrium, confident that the goal can be met without compromising the principles enunciated by President Levin. Our strategy is focused upon a persistent and rigorous review of our resources, our operations, and our opportunities. We must be creative in identifying and gaining access to new sources of revenue, such as technology transfer and innovative educational offerings. We must work together to realize shared economies and efficiencies in the operation of administrative systems and academic programs. We must have the courage and wisdom to recognize efforts that are less productive or distinguished, and modify their direction or scope. While ever conscious of the need to contain costs, we must continue to make investments in programs and in systems that promise long-term gains in quality or efficiency. And we must always remember that if they are to thrive in the long- term, programs need and deserve excellent facilities.
The path ahead
Yale has achieved excellence and special distinction, often achieving them with a resource base smaller than our peers. We are mindful that if the proud tradition of doing more with less turns into doing too much with too little, that excellence and special distinction will dissipate. The strategy we have chosen to achieve financial equilibrium is neither glamorous nor dramatic, but we are confident that it is appropriate for us. The University is not in a state of fiscal crisis, and a radical change in Yale's educational philosophy or "mix" of programs and schools is neither needed nor, we believe, desirable. We must make choices and invest selectively. But there is ample room at Yale for excellence across a wide range of disciplines and schools. We foresee a decade in which Yale's greatness is maintained and renewed, while new undertakings are pursued with energy and effectiveness.
There is always the danger that in a time of challenge, each entity within the University will retreat behind a defensive wall and struggle to maintain its own status quo. But in these very same times we will all be best served by coming together as stewards of our exploding universe of ideas and aspirations. Universities are called communities of scholars. A hackneyed phrase, to be sure, but it rings as true today as ever. What does it mean to be a community of individuals, founded on free inquiry in the pursuit of new knowledge, free expression, and the open exchange of ideas? It means bringing together every bit of vision, courage, dedication, and forebearance that we can muster. This letter is a step in a dialogue that must continue among faculty, staff, students, Corporation Fellows and alumni, in the formal settings of University Committees and in informal gatherings alike. I hope to encourage an open and welcoming response to carefully considered change, a renewed sense of what it means to be a community, a continued commitment to excellence, and an abiding recognition that there is great strength in our midst.