Financials

Harvard Business School (HBS) remained financially strong in fiscal 2016. Revenue exceeded our forecast, growing faster than expenses for the second consecutive year. The resulting growth in cash from operations enabled HBS to continue to make strategic investments in priority areas while still ending the year with a healthy unrestricted reserves balance.

One of our financial planning goals is for HBS 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. Achieving this goal starts with transparency. To that end, our fiscal 2016 financial results are reported in detail in the Supplemental Financial Information section that begins on page 26.

The balance of this letter recaps the School’s fiscal 2016 financial performance in light of our key strategic challenges. It concludes with our financial forecast for fiscal 2017 and some thoughts on our longer-term outlook and strategy.

Fiscal 2016 in Review

HBS faced continued pressure on operating margins. Recent MBA curriculum innovation and new endeavors such as HBX added to the School’s fixed costs. We remained committed to investing in information technology (I.T.) and campus renewal and maintenance, including new building construction. To ensure that the School continued to live within its means as the scope of activity at HBS expanded, our top financial priority was to ensure that revenue growth—including developing new sources of revenue—continued to exceed the rise in operating expenses.

We successfully executed on this priority in fiscal 2016, driven by notable successes in our revenue-generating units. Harvard Business Publishing (HBP) continued to manage volatility in its markets by enhancing its content offerings and investing in its digital platform. Executive Education leveraged expanded educational, living, and dining capacity to drive strong participant demand. HBX made solid progress in its efforts to strengthen and stabilize its platform and increase its portfolio of offerings.

In parallel with these operating revenue initiatives, The Harvard Business School Campaign produced double-digit growth in current use giving and added substantial new endowment funds for priorities such as associate professorships and student financial aid. With fiscal 2016 marking the Campaign’s midway point, the School received more than $161 million in new gifts and pledges during the year.

The School’s total operating revenues for fiscal 2016 rose 7.6 percent, year over year, exceeding our forecast by 360 basis points. Revenues at HBP were up nearly 7 percent from fiscal 2015, coming in higher than planned for the seventh consecutive year. Executive Education once again delivered upside, with revenues up nearly 5 percent against our forecast of 1 percent growth. At HBX, revenue doubled from last year to $10 million, resulting in a planned operating deficit of $12 million.

The HBS economic model relies on multiple revenue streams, including MBA tuition, distribution from the endowment and current use gifts, and income earned by HBP and Executive Education. This mix of revenue sources makes HBS less reliant on fluctuations in the endowment (and endowment distribution income) than all but one other Harvard school. The School’s endowment distribution and current use gifts represented 18 percent and 9 percent, respectively, of total revenue in fiscal 2016. This year’s distribution of income from the endowment, as well as the endowment’s investment performance, is discussed in detail beginning on page 27.

Fellowship Spending

IN MILLIONS	FY 16	FY 15	FY 14	FY 13	FY 12
MBA	$ 34	32	31	29	27
Total (includes Doctoral Programs & Executive Education)	$ 47	44	43	40	37

Investment in Research

IN MILLIONS
FY 16	FY 15	FY 14	FY 13	FY 12
$ 131	123	117	110	109

Current use giving—unrestricted and restricted gifts intended to support near-term priorities—has grown in importance to the School in recent years. Together with endowment gifts and gifts for capital projects, current use giving has proved vital as a flexible source of seed money to launch visionary initiatives, such as FIELD, the Harvard i-lab, and HBX.

The HBS community has responded with impressive generosity. On a combined basis, restricted and unrestricted current use giving to HBS has grown from a total of $26 million in fiscal 2010 to $72 million—or 51 percent of total giving—this past year. Unrestricted giving was especially strong in fiscal 2016. Including Campaign, reunion, and annual giving, revenue from unrestricted current use gifts grew by $4 million, or 11 percent, from the prior year to a record $40 million.

The balance of this year’s giving was intended to sustain the School’s core operations over the long term by funding new or existing endowment accounts, and to support development of the HBS campus. Approximately $16 million of fiscal 2016 giving to the School was earmarked for capital projects.

Based on a comprehensive master plan for enhancing and expanding the campus to meet programmatic needs, capital activity at HBS has increased substantially in recent years. The School’s plan focused on expanding Executive Education academic and residence space in the northeast section of the campus, culminating in the opening of the Chao Center in June 2016.

Construction also began on the 1,000-seat Klarman Hall, a new convening space slated to open in fall 2018, and the Pagliuca Harvard Life Lab, designed to provide life scientists with lab space as they pursue entrepreneurial ventures. Additionally, HBS made substantial investments in facilities renewal and maintenance, energy efficiency projects, I.T. infrastructure upgrades, and digital technology for newly built classroom space.

In fiscal 2016, HBS invested $113 million in capital activity, up from $81 million in the prior year and $19 million seven years earlier. The increase was primarily driven by construction activity at the Chao Center, Klarman Hall, and the Life Lab, plus the renovation of HBP’s new headquarters adjacent to the campus in Allston.

Against this revenue and capital investment backdrop, we continued to tighten the reins on expenses in fiscal 2016. Careful budget discipline is part of our culture at HBS as we work to generate the greatest possible impact with the resources available. Our efforts are bearing fruit. Reflecting new strategic initiatives and revenue-focused investments in HBP and Executive Education, our fiscal 2016 financial plan assumed a 9 percent increase in total operating expenses, year over year. Actual operating expense growth, however, came in at 6.7 percent. Fiscal 2016 capped a three-year period during which the School’s total revenues grew at a compound annual rate of 7.5 percent, while total expenses increased 7.2 percent.

Our expense control performance in fiscal 2016 was mainly attributable to lower-than-forecast spending at HBP and Executive Education. Driven by the resulting sales growth leverage, their combined operating margin contribution increased substantially, and the School’s total operating margin grew to 7.5 percent, from 6.6 percent in fiscal 2015.

Information technology is vital to teaching, learning, and research at HBS, and I.T. spending fueled a large part of the School’s expense growth in fiscal 2016, as it has for the past decade. HBP and HBX continued to make growth-focused investments in their digital platform offerings during the year.

Publishing Revenue

IN MILLIONS
FY 16	FY 15	FY 14	FY 13	FY 12
$ 217	203	194	180	165

Executive Education Tuition

IN MILLIONS
FY 16	FY 15	FY 14	FY 13	FY 12
$ 176	168	163	146	142

I.T. Investment

IN MILLIONS; excludes capital expenses
FY 16	FY 15	FY 14	FY 13	FY 12
$ 85	72	66	57	48

These investments were accompanied by several large mission-driven I.T. projects, including a new Executive Education ecosystem, a major student information system upgrade, a new learning management system in the MBA Program, and enhanced wireless and digital video capabilities across the campus.

The School’s I.T. spending has increased at a compound annual rate of 13 percent over the past decade, from $25 million in fiscal 2006 to $85 million this past year. I.T. expenses represented 12 percent of the School’s total operating expenses in fiscal 2016, compared with 11 percent last year, and 7 percent on a significantly smaller expense base 10 years earlier. Careful management of I.T. spending therefore is essential to controlling future expense growth.

Faculty and administrative staff compensation represents 44 percent of the School’s total expense base. Using a gating process for new full-time equivalent (FTE) requests, we have focused staff headcount growth in key areas, including those that are mission-critical and generate additional revenue.

As a result, the School’s fiscal 2016 revenue growth rate exceeded both the increase in compensation expense and the growth in the number of FTE positions. Although our fiscal 2016 financial plan assumed a 7 percent year-over-year increase in total compensation expense, the actual increase was 5 percent.

Driven by the healthy contribution margins from HBP and Executive Education, as well as increased alumni current use giving to HBS, the School’s cash flow from operations was stronger than we expected in fiscal 2016. This internally generated cash enabled HBS to continue to fund its core educational programs, drive innovation in teaching and research, and invest in strategic opportunities, while still concluding the year with a stronger-than-expected balance of unrestricted reserves. These reserves are crucial in providing the School with sufficient liquidity to execute on its mission and to sustain the campus through economic cycles over the long term. Further, the HBS surplus contributes to the overall financial health of Harvard University.

Fiscal 2017 Outlook

Looking ahead to fiscal 2017, our financial plan is focused, as always, on continuing to generate a healthy operating surplus as we work to fulfill the School’s mission. HBS is making progress, but we need to remain diligent in monitoring the relative rates of expense and revenue growth, as there may be softness in the School’s revenue streams at a time of continued strategic innovation and campus growth.

Our fiscal 2017 plan includes a commitment to further strengthening educational programs across the School and providing the faculty with generous research support. At the same time, we will continue to work toward the goal of evolving HBX into a self-sustaining and surplus-generating activity. Fiscal 2017 will be an active year for capital investment in the campus, primarily focused on ongoing projects, including Klarman Hall, the Life Lab, facilities renewal, and I.T. infrastructure upgrades. We will strive as always to maintain a balance of unrestricted reserves for initiatives and investments such as these, while maintaining the School’s long-term financial security and flexibility.

In addition to sustained financial vigilance and discipline, this will require continued strength in unrestricted current use giving in fiscal 2017. It also will require continued endowment giving for activities such as associate professorships, fellowships, MBA Program enrichment, and cross-disciplinary global research. Giving for these purposes will remain a priority as the Campaign progresses.

We will carefully monitor the School’s financial performance as fiscal 2017 unfolds, with contingency plans and processes in place to adjust spending if warranted by changing economic conditions. Given the increasing potential for an economic slowdown as the recovery approaches a decade in length, we are being cautious in planning for fiscal 2017 growth at HBP and Executive Execution. HBX is expecting to report growth in expenses as well as revenue, precluding a positive operating margin in the near term.

In addition, we are cognizant of the challenges associated with today’s low-return investment environment, which directly affects income distributed from the University endowment to HBS and the other Harvard schools. The 2 percent annual investment loss experienced by the Harvard endowment in fiscal 2016 will limit growth in the endowment distribution across the University in fiscal 2018. As a result, the various parts of the University face a diverse set of challenges as they plan for fiscal 2018 and future years. Since HBS is a part of the University family, future pressures on endowment income are likely to have implications for the School.

Capital Investment

IN MILLIONS
FY 16	FY 15	FY 14	FY 13	FY 12
$ 113	81	92	80	51

Building Debt Outstanding

IN MILLIONS
FY 16	FY 15	FY 14	FY 13	FY 12
$ 71	78	85	91	99

With this as background, let me provide a brief look at our fiscal 2017 financial expectations. Starting at the top line, we expect the School’s total revenues to increase in a range of 2 to 3 percent from fiscal 2016. Revenue from MBA tuition and fees is projected to increase 4 percent. This will be partially offset by a 4 percent increase in financial aid, primarily earmarked for MBA fellowships.

Revenue for fiscal 2017 at both HBP and Executive Education is forecasted to grow in the range of 2 to 3 percent. HBP faces ongoing revenue recognition impacts from an earlier shift by Harvard ManageMentor® from packaged software to a subscription service model. The upcoming year’s revenue growth at Executive Education will compare with the strong results in fiscal 2016.

Philanthropic revenues will remain vital to the School’s economic model in fiscal 2017. The University has advised HBS that its endowment payout will grow 4 percent from fiscal 2016. With this anticipated payout, as well as potential income from new gifts to the endowment, we expect the School’s total endowment distribution revenue for fiscal 2017 to increase 4 percent, year over year. Although the School will be starting the second half of a stronger-than-anticipated Campaign, we are confident that fiscal 2017 will be another successful year for total current use giving.

Moving down the Income Statement to operating expenses, we will be closely monitoring our budget performance, quarterly forecasts, and monthly dashboards in HBP, in Executive Education, and across the School as fiscal 2017 progresses. Reflecting anticipated salary increases and benefits costs, our financial plan assumes 6 percent growth in total compensation expense. The School’s other line item expenses, collectively, are expected to climb 9 percent from fiscal 2016.

This anticipated increase reflects higher mission-driven spending on core I.T. projects. Fiscal 2017 operating costs also reflect the opening of the Chao Center and new research initiatives, as well as growth-focused I.T. and business capacity investments in Executive Education, HBP, and HBX.

The School’s total capital budget for fiscal 2017 is $71 million. This is 37 percent below the $113 million invested in fiscal 2016, primarily because the Chao Center has been completed, and Klarman Hall construction activity is not scheduled to peak until fiscal 2018.

In addition to building Klarman Hall and the Life Lab, the fiscal 2017 capital plan includes continued investment in facilities maintenance, renewal, and upgrades. These smaller projects are designed to prevent deferred maintenance, improve energy efficiency, enhance sustainability, and preserve the value of the campus for future generations.

In summary, HBS begins fiscal 2017 with a healthy economic model and a strong reserves balance. Our financial plan provides flexibility for adjusting to changes in the economy, while continuing to invest in mission-driven innovation, faculty recruiting and retention, teaching and research, and campus development.

We remain committed to thoughtful stewardship of the School’s resources in the year ahead.

Richard Melnick, MBA 1992 Chief Financial Officer 01 OCT 2016