Financial Report 2018

From the Chief Financial Officer

Harvard Business School delivered strong financial results in fiscal 2018. Revenues exceeded our forecast, driving double-digit growth in cash from operations for the fourth consecutive year. This cash flow enabled HBS to continue providing robust support for mission-driven innovation and campus investment, while maintaining the healthy balance of unrestricted reserves necessary to sustain the School’s future relevance and leadership.

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 2018 financial results are reported in detail in the Supplemental Financial Information section. The balance of this letter discusses the School’s fiscal 2018 financial performance at a strategic level, as well as our financial forecast for fiscal 2019.

FISCAL 2018 IN REVIEW

The HBS economic model is unique among the Harvard University schools and in higher education, and 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 pursue the questions that interest them most, and to interact in the field with 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. Completing the self-sustaining cycle, operating surpluses at Executive Education and Harvard Business Publishing (HBP) supplement revenues from MBA tuition and alumni gifts as key sources of funding for faculty research.

The model performed well in fiscal 2018, as revenue grew faster than expenses for the fourth straight year. The resulting income from operations enabled the School to continue strengthening core programs and investing in strategic opportunities.

Total operating revenue increased by $56 million, or 7 percent, from fiscal 2017, compared with our forecast of zero growth. HBP and Executive Education delivered a combined $35 million of incremental revenue, year-over-year, primarily driven by gains in Executive Education enrollment and higher sales across HBP’s Harvard Business Review group, corporate learning, and education divisions.

The School’s recent strategic initiatives—including The Harvard Business School Campaign and Harvard Business School Online (HBS Online, formerly HBX)—also generated strong topline results in fiscal 2018. Philanthropic income from alumni giving and the HBS endowment grew by $9 million, or 4 percent. It was a breakthrough year for HBS Online. Revenue increased by $7 million, or 58 percent, driven by growing enrollment in certificate programs, as well as a strong response to course offerings launched during the year. As a result, the HBS Online operating deficit declined to $5 million, compared with $10 million to $12 million in each of the past four years since the group’s inception.

Capital investment for fiscal 2018 increased 18 percent to $92 million, from $78 million a year earlier. This growth largely reflected a step-up in construction activity at Klarman Hall, which was substantially completed during the year. Maintaining its commitment to sustaining the residential campus, the School also increased its investment in facilities renewal and maintenance, highlighted by a major exterior renovation of Aldrich Hall.

Total operating expenses for fiscal 2018 rose 4.8 percent from fiscal 2017, coming in below our forecast of 6.3 percent. Faculty and staff compensation—the School’s largest expense—was up 4 percent, versus the 5 percent we anticipated. Other line item expenses, collectively, grew 5.4 percent, compared with a budgeted 7 percent increase, reflecting a strong and ongoing commitment to cost control discipline on the part of managers across the School.

The School’s bottom-line performance for fiscal 2018 reflected these revenue and expense dynamics. Driven primarily by higher margin contributions from Executive Education and HBP, total net margin contribution as a percentage of revenue grew to 10.5 percent, from 8.6 percent last year and 7.7 percent five years ago. Cash from operations—the School’s operating surplus—increased 30 percent year over year, from $69 million to $90 million—more than double the average of $42 million over the preceding 10 years.

Concluding the fiscal year in a strong cash position enabled the School to invest $65 million in the HBS endowment reserve, following a similar $50 million investment in fiscal 2017. In contrast with alumni gifts to the endowment, which largely support fellowships, professorships, and other key student and faculty activities, the long-term stream of income from internally generated funds invested in this endowment is unrestricted.

Building the endowment reserve is a strategic priority for HBS. The strategic initiatives implemented since fiscal 2011 have substantially increased the School’s fixed operating costs. At the same time, HBS has become increasingly reliant on revenue from economically sensitive sources to cover those higher expenses. Faced with a prolonged recession, the School’s ability to offset revenue shortfalls with unrestricted annuity income from the endowment will be crucial.

The School’s unrestricted reserves held outside of the endowment are important to the model, as well. Thanks to consistent operating surpluses, HBS has long been successful in maintaining such reserves. These funds, which equate to retained earnings, are primarily available for capital activities—investments aimed at sustaining the residential campus for future generations.

HBS concluded fiscal 2018 with an un­restricted reserves balance of $118 million. This balance was down from $145 million a year earlier, but still substantially above the $100 million in unrestricted reserves held outside of the endowment we have established as the School’s current liquidity management target.

The School’s cash flow and balance sheet dynamics are described in detail {here}.

Fiscal 2018 marked the conclusion of The Campaign for Harvard Business School—a successful, seven-year effort that, with 59 percent MBA alumni participation and 26,000+ donors, has made a significant difference in key areas across the School. In addition to surpassing its financial goal, the Campaign achieved milestones in all four of its non-fundraising objectives, including alumni engagement, student and young alumni focus, support for One Harvard, and building the narrative about the role of HBS and business in society.

Of the $1.4 billion in endowment and current use gifts raised through the Campaign, $1.1 billion had been received by the School as cash at year-end fiscal 2018. Outstanding pledges totaled $317 million. Endowment giving to the Campaign strengthened the School’s core programs by creating an impressive number of new associate professorships and fellowship funds.

Fellowship Spending

IN MILLIONS	FY 18	FY 17	FY 16	FY 15	FY 14
MBA	$ 37	36	34	32	31
Total (includes Doctoral Programs & Executive Education)	$ 50	48	47	44	43

Investment in Research

IN MILLIONS
FY 18	FY 17	FY 16	FY 15	FY 14
$ 144	136	131	123	117

Current use giving to the HBS Fund was a key Campaign objective. HBS alumni and friends rose to the challenge with enormous generosity, achieving the School’s $40 million target three years after the Campaign’s public launch in fiscal 2013. HBS Fund gift income has doubled since then, growing from $22 million in fiscal 2013 to $44 million this year. Restricted current use giving has grown nearly 67 percent during the same five-year period, providing seed funding for HBS Online, the Harvard Innovation Labs eco­system, MBA innovation including Field Immersion Experiences for Leadership Development, and other strategic initiatives.

As much as we are grateful to the alumni and friends who supported Harvard Business School through gifts to the Campaign, we also are proud of the contributions made by many to Harvard. HBS donors supported schools, programs, and activities across the University by leading campaign committees, giving generously, and working to realize the promise of One Harvard.

HBS is less reliant on endowment distribution income than all but one other Harvard school, because of its ability to support its operations with revenue from Executive Education and HBP. Each fall, Harvard approves the University-wide endowment distribution percentage rate for the following fiscal year. The Harvard endowment experienced a disappointing 2 percent investment loss in fiscal 2016.

As a result, underlying year-over-year growth in the endowment distribution was limited to essentially zero for fiscal 2018. At HBS, however, the endowment distribution increased 2.7 percent from fiscal 2017 to $150 million, representing 17.5 percent of the School’s total revenue. This increase was driven entirely by growth in the size of the HBS endowment resulting from gifts during the Campaign.

Harvard Management Company (HMC) and the University endowment portfolio are still in the early stages of a multiyear transition. The Harvard endowment delivered 8.1 percent and 10 percent investment returns in fiscal 2017 and 2018, respectively—above the University’s 8 percent long-term target return.

As in recent years, these results are about equal to the average return of larger college and university endowments, but not yet Harvard’s immediate peers. We are encouraged by the steps that HMC has taken to reposition the endowment for long-term success, knowing that the positive impact of these changes will take time to unfold.

This year’s distribution from the endowment, as well as the endowment’s investment performance, are discussed in detail {here}.

FISCAL 2019 OUTLOOK

The next fiscal year at HBS will be the 10th since the Great Recession. The School’s financial health has improved over the past decade, as has the health of the global economy. Each additional year of recovery, however, makes it increasingly important to prepare for a potential reversal of today’s generally favorable economic conditions.

Looking back at the School’s financial performance in fiscal 2009—when the economy last hit bottom—there are ample reasons for caution. The HBS revenue sources that were most directly affected by the Great Recession—HBP, Executive Education, and current use giving—have grown substantially.

Raising the stakes further, fixed costs at HBS today are significantly higher than they were in fiscal 2009. Continued investment in core activities and strategic innovation have expanded the School’s operating footprint. Our IT infrastructure is larger and more complex. New buildings have added more than 300,000 square feet of learning and residence space to the campus, leading to higher maintenance, repair, and depreciation expenses.

With these realities in mind, we developed our fiscal 2019 financial plan with the goal of strengthening the School’s resilience in the event an economic downturn materializes. We will continue to closely monitor the School’s actual financial performance versus budget as the year unfolds. Contingency plans for spending are in place should revenues fall short, and, as in recent years, the year’s top-line performance may turn out better than we had anticipated.

Starting at the top of the Statement of Activity and Cash Flows, we expect the School’s total revenues for fiscal 2019 to be essentially level with the $856 million reported for fiscal 2018.

Revenue from HBP and Executive Education is forecasted to be essentially flat with fiscal 2018 on a combined basis. Both groups face strong competitive challenges in an increasingly risky global economic environment. Additionally, Executive Education faces uncertainties about international travel to the United States. HBS Online remains in startup mode. Although we expect its revenue to grow nearly 50 percent, the group is not likely to become a surplus- generating activity in the year ahead.

Publishing Revenue

IN MILLIONS
FY 18	FY 17	FY 16	FY 15	FY 14
$ 240	221	217	203	194

Executive Education Tuition

IN MILLIONS
FY 18	FY 17	FY 16	FY 15	FY 14
$ 207	191	176	168	163

I.T. Investment

IN MILLIONS; excludes capital expenses
FY 18	FY 17	FY 16	FY 15	FY 14
$ 82	85	85	72	66

MBA tuition is budgeted to increase a modest 2 percent in fiscal 2019—the smallest amount in many decades—reflecting the School’s focus on slowing the pace of growth in the cost of MBA education. Revenue from MBA tuition and fees is projected to rise 1 percent, year over year, reflecting normal fluctuations in actual class size. Financial aid spending—MBA, Doctoral, and Executive Education student fellowships—is expected to increase 6 percent.

Philanthropy will remain essential to the School’s financial health in fiscal 2019. Now that early Campaign donors have largely fulfilled their pledges, sustaining the $40 million given yearly to the HBS Fund since fiscal 2016 is one of our most pressing financial challenges. The School’s ability to continue investing in innovation while offering generous financial aid depends on the HBS community’s success in building on the achievements of the Campaign and sustaining the School’s momentum in current use giving.

We expect HBS to benefit from mid single-digit growth in the endowment distribution for fiscal 2019. A portion of this growth relates to the increase in the University’s distribution rate. The balance reflects growth in the size of the endowment as a result of endowment gifts and the School’s fiscal 2018 investment in its endowment reserve.

Moving down the income statement to operating expenses, our fiscal 2019 financial plan targets a 9 percent year-over-year increase in the School’s total spending. This forecast includes approximately 5 percent growth in total compensation cost, reflecting growth in the size of the School’s faculty and staff, in addition to higher salaries and benefits expenses.

The balance of the increase in fiscal 2019 budgeted expenses primarily reflects higher costs of goods sold in HBP as that group continues to grow, Klarman Hall space and occupancy expenses, and growth in spending for fellowships. In addition, the School’s fiscal 2019 plan includes a larger expense contingency to offset possible margin contribution shortfalls in the event of a revenue slowdown.

Capital Investment

IN MILLIONS
FY 18	FY 17	FY 16	FY 15	FY 14
$ 92	78	113	81	92

Building Debt Outstanding

IN MILLIONS
FY 18	FY 17	FY 16	FY 15	FY 14
$ 55	64	71	78	85

With construction of Klarman Hall winding down, the School’s total capital budget for fiscal 2019 is $37 million, a decrease of $55 million from fiscal 2018. Completing the Klarman Hall video center, landscaping, and reconfiguration of the parking lot in time for the facility’s opening in October 2018 will be the School’s largest capital project. Our plan also includes increased investment in security enhancements for buildings across the campus.

In summary, thanks to top-line growth and fiscal discipline, for the past five years we have been able to execute on the School’s mission and consistently generate substantial operating surpluses. These surpluses have enabled HBS to strengthen core programs and drive innovation, while strongly positioning the School to sustain its excellence over the long term. We remain committed to delivering sound and consistent financial results in fiscal 2019 and future years.

Richard Melnick, MBA 1992
Chief Financial Officer
01 OCT 2018