Fiscal 2017 was a strong financial year for Harvard Business School. Revenues grew faster than expenses for the third consecutive year, resulting in double-digit growth in cash from operations. This cash flow enabled HBS to continue executing on its strategic priorities and investing in core programs and activities, while ending the year with a stronger-than-expected balance of unrestricted reserves.

One of our financial goals is for HBS to serve as a living example of a well-run organization, embodying the skills, tools, and frameworks taught across the School’s educational programs. Transparency is intrinsic to achieving this goal, and to this end our fiscal 2017 financial results are reported in detail in the Supplemental Financial Information section that begins on page 24.

The balance of this letter discusses the School’s fiscal 2017 financial performance at a strategic level. It concludes with our financial forecast for fiscal 2018 and some thoughts on the longer-term outlook.

Fiscal 2017 in Review

The HBS economic model is unique among the Harvard University schools and in higher education. The model begins with our commitment to internally funded faculty research. Free from the constraints that can come with grants and other outside funding, HBS research budgets allow the School’s faculty to stay close to practice—to travel wherever their work takes them and to interact in the field with leaders and managers who are confronting the most interesting business challenges and opportunities.

HBS disseminates the resulting intellectual capital to educate leaders and influence the practice of management on a global scale, both through its educational programs and through Harvard Business Publishing (HBP).

Completing the self-sustaining cycle, operating surpluses at Executive Education and HBP supplement revenues from MBA tuition and alumni gifts as the primary source of funding for faculty research. In short, the success of the HBS economic model starts with the value of the faculty’s scholarship and the School’s ability to translate this value into income for operations, which is then reinvested in future intellectual capital creation.

When we began implementing a range of strategic initiatives in fiscal 2011, we knew these efforts would put pressure on the School’s economic model for the next several years. New Executive Education buildings would be under construction and HBX would be in launch mode. HBS would also be introducing the FIELD course in the MBA Program, establishing additional global research offices, opening the Harvard i-lab, and laying the groundwork for The Harvard Business School Campaign.

Near term, we expected the School’s operating expenses to increase faster than revenues. We accepted the risk, however, in light of the potential for several of these strategic efforts to generate meaningful top-line growth over the long term. Fiscal 2017 may have been pivotal in this respect—an inflection point in the transition from a period of aggressive investment to a phase focused on leveraging the related benefits, ensuring the sustainability of what the School has recently built.

Fiscal 2017, then, marked a shift in the balance between revenue and expense growth rates at the School. The five-year compound annual rate of revenue growth exceeded the comparable growth in expenses for the first time in the past half-decade. For the period since fiscal 2012, the School’s compound annual growth rates for revenues and expenses were 7.3 and 6.6 percent, respectively.

Total operating revenues for fiscal 2017 increased 5.1 percent year over year, exceeding our forecast by 2.6 percent, largely driven by Executive Education enrollment and alumni giving. The School’s total operating expenses, however, were up just 3.8 percent—coming in below our forecast and rising at about half of last year’s rate.

Driven by these positive revenue and expense dynamics, fiscal 2017 was a strong year for operating margins and internally generated cash at the School. Operating cash flow grew 21 percent, driven mainly by higher Executive Education margin contributions. The School’s total net margin contribution as a percentage of revenue increased 1.1 percent to 8.6 percent from 7.5 percent last year, and 3.3 percent from 5.3 percent in fiscal 2012.

Together with this robust bottom-line performance, the School’s net capital expenses dropped in fiscal 2017. There also was a large, positive balance sheet impact associated with other non-reserve activity during the year. As a result, HBS continued to fund its core programs and activities, drive innovation in teaching and research, and invest in strategic opportunities while still concluding fiscal 2017 with a substantially stronger unrestricted reserves balance.

Unrestricted reserves are crucial in providing HBS with sufficient financial flexibility to execute on its mission and sustain the campus through economic cycles over the long term. The School’s cash flow and balance sheet are detailed beginning on page 22.

Fiscal 2017 was an exceptionally successful year for philanthropic revenue at HBS. The Campaign passed the midway point, spurring continued growth in current use giving and adding important new endowment funds for key priorities.

Driven by the extraordinary generosity of the School’s alumni and friends, HBS received $233 million in new gifts and pledges in fiscal 2017—up 45 percent from $161 million a year ago—and cash gifts to the School increased 35 percent to $190 million. Approximately 60 percent of this cash giving was intended by the donors to sustain the School’s core operations over the long term by funding new or existing endowment accounts, and to support the development of the HBS campus.

The balance of fiscal 2017 giving to HBS consisted primarily of restricted and unrestricted current use gifts, which continue to grow in importance to the School’s economic model. Current use giving has more than doubled over the past five years, growing from $35 million, or 6 percent of total revenues, in fiscal 2012, to $74 million, or 9 percent of total revenues, in fiscal 2017. This revenue has a significant impact on the School’s operating cash flow. It has proved vital as a flexible source of seed money to launch visionary initiatives such as FIELD, the Harvard i-lab ecosystem, HBX, and joint educational programs with other Harvard schools.

Having diverse sources of revenue—generous current use giving plus earned income from Executive Education and HBP—makes HBS less reliant on endowment distribution income to support its operations than all but one other Harvard school. Reflecting new gifts and prior years’ investment returns, the School’s endowment distribution revenue for fiscal 2017 increased 5.8 percent, year over year, representing 18 percent of the School’s total revenue. This year’s distribution from the endowment, as well as the endowment’s investment performance, is discussed in detail beginning on page 26.

Approximately $30 million of fiscal 2017 cash giving to the School was earmarked for capital projects. The School’s capital investments for fiscal 2017 totaled $78 million. This compares with $113 million in fiscal 2016, which marked the conclusion of a five-year period in which the School added nearly 200,000 square feet of occupied space to the campus—an increase of more than 12 percent. Capital activity during this period primarily focused on enhancing and expanding Executive Education facilities.

The School’s fiscal 2017 capital activity centered on the construction of Klarman Hall, a new convening space slated to open in fall 2018. Additionally, HBS completed the Pagliuca Harvard Life Lab, designed to provide life scientists with lab space for entrepreneurial ventures. The School also continued to make substantial investments in facilities renewal and maintenance, energy efficiency projects, I.T. infrastructure upgrades, and digital technology across the campus.

Capital Investment

IN MILLIONS
FY 17	FY 16	FY 15	FY 14	FY 13
$ 78	113	81	92	80

Building Debt Outstanding

IN MILLIONS
FY 17	FY 16	FY 15	FY 14	FY 13
$ 64	71	78	85	91

Total operating expenses at HBS came in nearly 4 percent under budget in fiscal 2017. At both the faculty and staff levels, we continued to operate in as lean a manner as possible: making tradeoffs when necessary to leverage maximum impact from the School’s available resources, and instilling greater rigor in our budgeting processes.

Compensation for faculty and administrative staff represents 45 percent of the School’s total expense base, and therefore remains key to our cost-control strategy. We continued to use a disciplined gating process in fiscal 2017 for new full-time equivalent (FTE) requests, focusing staff headcount growth in functions that are strategically important to the School. The increases in total compensation expense and in the number of FTE positions for fiscal 2017 were in line with our plan, rising slightly less than 6 percent and 3 percent, respectively, year over year.

Driven by a group of major platform investments, I.T. has been a major contributor to the higher fixed costs at HBS in recent years. Slowing the rate of growth in I.T. expenses is one of our key financial objectives, and our work in this area was successful in fiscal 2017. Total I.T. spending was flat with fiscal 2016 and 3 percent below budget, which was key to the reduction in the School’s total expense growth for the year. Looking forward, supporting strategic I.T. investment at HBS in a financially sustainable manner will remain high among our financial planning priorities.

Space and occupancy expenses for fiscal 2017 increased nearly 10 percent from the prior year, coming in 4 percent below budget. The Chao Center was occupied for the full year, the Life Lab was opened, and HBP moved into new, larger facilities— together leading to significant upward pressure on operating costs.

As we expected, this pressure was partially mitigated by designed-in building efficiencies at the Chao Center. It was also partially reduced by lower facilities operations, utilities, and energy expenses resulting from the ongoing modernization and upgrading of buildings and infrastructure across the campus. These positive factors, however, were partially offset by larger-than-expected costs for site remediation associated with Klarman Center construction.

Fiscal 2018 Outlook

Thanks to top-line growth and fiscal discipline, for the past five years we have been able to execute on the School’s mission, consistently generate operating surpluses, and conclude each year with a healthy reserves balance. Our goal is to continue delivering sound and consistent financial results going forward.

Innovation will remain important to the continued vitality of the School, but the pace of investment is likely to slow as our focus shifts toward sustaining recently launched activities over the long term. Consequently, we anticipate a period of greater stability in both revenues and expenses at HBS compared with the past half-decade.

Looking at fiscal 2018 specifically, we expect to be operating in an environment of uncertainty about the health of the global economy and how long the currently favorable conditions can extend their run. Our top-line growth expectations for fiscal 2018 are conservative, as a result.

We developed our fiscal 2018 financial plan with this backdrop in mind, and will continue to closely monitor the School’s actual financial performance versus budget as fiscal 2018 progresses. Contingency plans are in place should revenues fall short and, as in recent years, the School’s top-line performance may turn out better than we had anticipated.

Working our way down the income statement, we expect the School’s total revenues for fiscal 2018 to be essentially level with the $800 million reported for fiscal 2017. Revenue from MBA tuition and fees is projected to rise 4 percent. At the same time, financial aid spending, representing MBA, Doctoral, and Executive Education student fellowships, is expected to increase 6 percent.

At HBP and Executive Education, revenue for fiscal 2018 is forecasted to be essentially flat with fiscal 2017 on a combined basis. Both groups continue to battle competitive headwinds. Additionally, Executive Education may see declines in enrollment should travel to the U.S. be curtailed for international participants. HBX plans to introduce several new courses, and the group’s revenue is expected to grow 50 percent from fiscal 2017, but it will take several more years for HBX to become a surplus-generating activity.

Sustaining the School’s multi-year record of strength in current use giving as the Campaign winds down will be another key challenge in fiscal 2018. HBS will continue to rely on the generosity of alumni and friends for the financial flexibility and security that current use gifts provide.

The 2 percent investment loss experienced by the Harvard endowment in fiscal 2016 also presents a challenge for HBS and other Harvard schools. Endowment investment returns drive the payout rate set by the University for a given year. This payout rate, plus any increase in the size of the endowment resulting from endowment gifts received during the prior year, determines the amount of income distributed from the endowment.

The Harvard endowment’s negative performance in fiscal 2016 will limit growth in the endowment distribution across the University to essentially zero in fiscal 2018. The endowment posted a return of 8.1 percent for fiscal 2017, which will support modest growth in the endowment distribution across the University in fiscal 2019.

Moving down the income statement to operating expenses, our fiscal 2018 financial plan assumes a larger increase in spending compared to the prior year. Driven by anticipated increases in salaries and benefits, we are forecasting 5 percent growth in total compensation cost. The School’s other line item expenses, collectively, are expected to rise 7 percent from fiscal 2017. As a result, total operating expenses are expected to increase 6 percent.

This planned expense growth reflects our commitment to further strengthen core teaching and research programs across the School in fiscal 2018. As an example, eight Short Immersive Programs will be offered to MBA students in January 2018, an increase from three in 2017. Additionally, we plan to continue selectively expanding the range of programs offered jointly by HBS and other Harvard schools.

Fiscal 2018 will also be a year of robust faculty research investment. Our financial plan includes increased support for the School’s Behavioral Research Services and lab for experimental research. Observing human behavior in a controlled setting has developed into one of the faculty’s mainstream research methodologies. We expect our investments in this area to continue to grow.

Driven by the planned increase in Klarman Hall construction activity, the School’s total capital budget for fiscal 2018 is $92 million, up $14 million year over year. Our fiscal 2018 capital plan also 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 HBS campus for future generations.

In summary, our financial outlook for fiscal 2018 is positive. The School’s economic model and reserves balance are strong, positioning HBS to continue providing robust support for mission-driven innovation in teaching, research, and enhancing our residential campus as the year unfolds. We remain committed to extending the School’s record of prudent resource stewardship, and look forward to rising to the challenges ahead.

Richard Melnick, MBA 1992
Chief Financial Officer
01 OCT 2017