Financials

Harvard Business School’s economic model performed well in fiscal 2014. Driven primarily by revenues in Harvard Business Publishing (HBP) and Executive Education, as well as philanthropic income from gifts, HBS was solidly cash flow positive, extending a record that began more than a decade ago.

This cash flow enabled HBS to fund its core educational programs, spur innovation in teaching and research, and invest in strategic opportunities. HBS also used internally generated cash from operations to increase its capital investment in the campus, without taking on new debt, while still ending fiscal 2014 with a strong balance of unrestricted reserves. These reserves are crucial in providing the School with sufficient liquidity to execute on its mission and sustain the campus through economic cycles over the long term.

One of our key financial planning goals for HBS is to serve as a living model of a well-run organization—consistent with the skills, tools, and frameworks taught across the School’s educational programs each year. Achieving this goal starts with transparency. To that end, the School’s fiscal 2014 financial results are explained in detail in the Supplemental Financial Information section that begins on page 22. The balance of this letter will speak to the School’s financial condition in the context of strategic changes taking place at HBS, looking at both the past year’s results and our plan for fiscal 2015.

Fiscal 2014 in Review

The HBS economic model starts with a faculty whose research brings them into contact with leaders and managers of organizations around the world. That contact generates new ideas meant to transform the practice of management. Executive Education and HBP transform the resulting ideas into new programs and materials that reach, increasingly, many thousands of students, academics, and managers worldwide.

Executive Education and HBP revenues result in margin contributions that fund the faculty’s research and enable them to stay close to practice, thus completing the cycle and allowing it to begin anew. Revenues from Executive Education and HBP also help cover costs associated with strategic initiatives across the School.

Fiscal 2014 marked the first year of significant investment in the School’s online learning platform, HBX. Launched publicly in spring 2014, HBX embodies the HBS principle of participant-centered learning reimagined on a digital platform. HBX aspires to create a learning experience both transformational for students and as distinctive and outstanding as any other HBS activity or program. Totaling nearly $12 million, expenses related to this work at HBX were a significant new factor in the School’s overall financial performance for fiscal 2014. Although HBX is in start-up mode at present, over the long term it has the potential to join Executive Education and HBP as a significant contributor of earned revenue and income from operations.

The School’s fiscal 2014 strategic investments also included the new global research center in Istanbul, Turkey, which opened during the year, as well as The Harvard Business School Campaign launch. In addition to staff support and event expenses, the year’s major Campaign investments included development costs for a new I.T. infrastructure to support the goal of increased alumni engagement with the School.

The School’s total operating expenses for fiscal 2014 rose by $55 million, or 10.1 percent, from the prior year, to $597 million. Approximately $35 million of the $55 million stemmed from these and other strategic initiatives, plus underlying inflation. The other $20 million consisted of investments in Executive Education and HBP made to strengthen their capacity for generating revenue and cash flow to support the School’s economic model. Both groups continued to translate this funding into solid revenue growth and increased margin contributions in fiscal 2014.

Fellowship Spending

Investment in Research

HBP operates in the context of a rapidly evolving publishing industry that necessitates ongoing investment in technology and marketing. Nonetheless, the School’s publishing business results exceeded our expectations for the fifth consecutive year, as four of HBP’s five market groups continued to deliver top-line growth. This growth was led by the Corporate Learning group, driven by strong demand for its flagship eLearning product, Harvard ManageMentor.

Higher Education group sales also grew substantially, reflecting increased demand for HBS cases, particularly in international markets. Further, fiscal 2014 was the second consecutive record year for circulation revenue from Harvard Business Review. At the same time, HBP continued to effectively manage its expenses and growth-focused investments, and its fiscal 2014 margin contribution also came in higher than initially planned.

Executive Education also delivered strong financial results in fiscal 2014, while successfully building for the future. Although opening Tata Hall added much-needed living and classroom space during the year, other capacity was lost with the residence building Baker Hall being taken off line for renovations and the closing of Kresge Hall for dining in order to begin construction on the new Ruth Mulan Chu Chao Center, limiting growth in Executive Education enrollments. In addition, fiscal 2014 marked the first year of higher depreciation expense associated with Tata Hall and related Executive Education facilities recently constructed by the School.

Executive Education rose to these challenges, and executive program revenue growth for fiscal 2014 was significantly stronger than we expected. This growth was driven by additional offerings of multiweek comprehensive leadership programs during the year, higher enrollments in custom and other programs across the portfolio, and tuition increases.

Although Executive Education made major investments in sales and marketing systems, staff, and infrastructure to drive future enrollment growth as new capacity comes on line, total operating costs remained well controlled. As a result, the group’s fiscal 2014 margin contribution was up substantially year-over-year, also exceeding the School’s forecast.

In addition to earned income from Executive Education and HBP, the School’s economic model is heavily reliant on two philanthropic revenue streams: distribution from the HBS endowment and unrestricted current use gifts. Fiscal 2014 was a milestone year for giving to the School, in conjunction with The Harvard Business School Campaign launch. By the fiscal year’s end, the Campaign had raised more than $721 million in new gifts and pledges.

The majority of the Campaign giving was intended to sustain the School’s core operations over the long term by creating new endowment or restricted current use accounts, or by adding to existing accounts. Approximately $160 million was earmarked for capital projects. The School’s distribution of income from the endowment in fiscal 2014, as well as the endowment’s investment performance, is discussed in detail beginning on page 23.

Fiscal 2014 was also a strong year for unrestricted current use giving to HBS. Together with endowment gifts and gifts for capital projects, this type of giving is deeply important to the School. The flexible funding provided by unrestricted current use gifts functions as seed money to launch the kinds of visionary efforts—such as FIELD, the Harvard i-lab, and HBX—that have long been a hallmark of teaching and learning at the School.

Reflecting the HBS community’s generous response to the Campaign, as well as reunion and annual giving during the year, revenue from unrestricted current use gifts in fiscal 2014 rose by $6 million, or 27 percent, from the prior year to a record $28 million. Driven in large part by Campaign gifts, total current use giving in fiscal 2014, including restricted and unrestricted gifts, increased 50 percent from the prior year to a record $65 million.

Income from gifts provides crucial support for the School’s capital investments. Encompassing building renewal and maintenance, infrastructure and I.T. upgrades, and construction of new facilities, these investments are based on a comprehensive, long-term campus planning strategy. For the past three years, this strategy has focused on enhancing the Executive Education buildings at the northeast corner of the campus.

The School’s fiscal 2014 capital agenda also included the majority of the construction of the HBX Live studio (an interactive virtual classroom facility for HBX), numerous building upgrades and renewals, and environmental sustainability measures implemented across the campus. In addition, to meet Executive Education food preparation and service needs during construction of the Chao Center, HBS constructed and began operating a temporary dining facility, Crimson Commons, and expanded the Spangler Center kitchen.

Fiscal 2015 Outlook

Over the past five years the School has made good progress on its strategic objectives while continuing to generate a healthy operating surplus. Nonetheless, in this same period revenues have grown at a compound annual rate of 6 percent while expenses have risen 6.5 percent. As a result, the School’s operating margin has declined from 7.2 percent to 5.7 percent.

Although our objective is to reverse this trend, the School is likely to continue facing strong pressures on margin over the next two years. In addition to the underlying increase in costs associated with the growing scope of the School’s operations, these pressures stem from several unrelated, temporary circumstances.

In Executive Education, margins will be reduced because of added depreciation for recently built facilities. At the same time, Executive Education will continue to invest in sales and marketing to ensure that new capacity is utilized as it comes on line over the next two years.

In addition, there will be one-time expenses as The Campaign for Harvard Business School engages alumni in regional events around the world, while Campaign pledges will convert into cash over a longer period of years. Moreover, a revenue recognition accounting change at HBP will significantly affect the group’s top-line results. Finally, as a start-up business, HBX will continue to face revenue uncertainties while its costs become increasingly fixed.

Our financial plan for fiscal 2015 balances these challenges against a modestly favorable outlook for the School’s core operations, and top-line performance is closely tied to the health of the global economy. Global economic growth appears to be on a modestly upward path at this writing. Against this backdrop, we are forecasting total year-over-year revenue growth of 5 percent in fiscal 2015.

Revenue from MBA tuition and fees is projected to rise 5 percent, partially offset by an increase in financial aid. The University has advised the School that its fiscal 2015 endowment payout will grow 3 percent from fiscal 2014. Reflecting this anticipated payout, as well as income from new gifts to the endowment, we expect the School’s total endowment distribution revenue for fiscal 2015 to increase 4 percent from fiscal 2014.

Publishing Revenue

Executive Education Revenue

Capital Investment

At HBP, revenue for fiscal 2015 is forecasted to grow 3 percent—significantly slower than growth over the past four years, and reflecting a new approach to revenue recognition for Harvard ManageMentor as it shifts from packaged software to a subscription service model. The impacts of this accounting transition are expected to begin gradually diminishing in fiscal 2016.

Executive Education revenue is forecasted to be approximately flat in fiscal 2015. The opening of Tata Hall has eased some capacity constraints this past year, but operating with Baker Hall off line and Kresge Hall closed will limit revenue growth in the year ahead.

The top-line challenges faced by Executive Education and HBP underscore the strategic importance of the School’s two philanthropic revenue streams: distribution from the HBS endowment and unrestricted current use gifts. The latter will remain crucial to the School’s success in the year ahead—not only in supporting innovation, but also in remaining cash flow positive during this upcoming period of higher pressure on margins. At the same time, the expanding scope of activity at the School is creating new needs for long-term funding as students and faculty engage in endeavors such as FIELD and cross-disciplinary global research. Endowment giving helps fuel these long-term initiatives.

Endowment giving also provides crucial support for MBA financial aid. Fellowships are more essential than ever to attract not only the most talented students, but also students who bring a mix of backgrounds and experiences that enriches the HBS learning experience for all involved. Consequently, revenue from both current use and endowment giving through the Campaign will be crucial in the School’s financial planning for fiscal 2015 and beyond.

Against this backdrop of uncertainty on the revenue front, HBS will be facing challenges from a cost perspective in fiscal 2015. After retirements and departures, the total size of the faculty declined from 234 a year ago to 228 in fiscal 2015.

Consequently, faculty recruiting, development, and retention continue to be high among the School’s priorities for the year ahead, as does the addition of administrative staff. This staff growth partly reflects expansion in the School’s core operations, but the majority of the new positions will be focused on realizing income growth potential in HBP, Executive Education, and HBX, as well as supporting Campaign-driven growth in External Relations.

Reflecting salary increases and upward pressures on benefits costs, the School’s fiscal 2015 financial plan assumes a 9 percent increase year-over-year in total compensation expense. Professional services costs, however, are forecasted to come in 2 percent lower than in the prior year.

The School is planning major strategic investments for fiscal 2015. In addition to scaling HBX, the faculty will be launching elements of the field method in the MBA Elective Curriculum. At the same time, the School’s External Relations group will be managing a growing number of Campaign events. Incremental dollars have been budgeted in each of these areas for technology and staff support.

In light of the School’s commitment to making education at HBS affordable to a broader cross section of applicants, we have planned a 9 percent increase in fellowship spending across the School for fiscal 2015. In addition, the plan includes significant investment in I.T. infrastructure, spread across salaries and benefits; ser­vices purchased; and equipment, among other expenses. Although academic and administrative I.T. plays a critical role in the School’s strategic priorities, we are working to slow the pace of growth in this key area in order for HBS to maintain a sustainable economic model.

HBS is planning to work on several ambitious capital projects in fiscal 2015. Adding Executive Education capacity remains the focus, highlighted by continued construction of the Chao Center and the renovation of Baker Hall. The capital plan also includes further design work this year on Klarman Hall, a convening facility to be located next to Spangler Center.

The School’s capital investment in smaller renewal and upgrade projects across the campus is expected to double in fiscal 2015. In addition to implementing energy efficiency measures to meet the University’s greenhouse gas reduction goals, these projects are designed to prevent deferred maintenance and preserve the value of the campus for future generations. The School’s total capital budget for fiscal 2015 is $107 million—up 9 percent from the $98 million invested in fiscal 2014.

We are carefully watching the economic trends as fiscal 2015 begins, with an eye toward adjusting spending as necessary. Looking ahead longer term, HBS enters the new fiscal year with a reserves balance sufficient to fund its planned investments in innovation and in the campus, without taking on debt leverage that could lead to increased financial risk. We remain committed to thoughtful stewardship of the School’s resources in the year ahead.

Richard Melnick, MBA 1992 Chief Financial Officer 01 OCT 2014