Stanford Report, Jan. 14, 2004

The lump of coal that the university's budget gurus were expecting to find in their end-of-the-year financial statements turned out to be something that resembled a diamond ­ albeit a relatively modest one. Instead of another year of deficits, the university found itself with a $46 million operating surplus, leading to a more optimistic financial picture for the current and future fiscal years. Provost John Etchemendy met with Stanford Report writer Ray Delgado to discuss what the surplus means to the university community and answer the question that's on everyone's mind: Will we be getting raises this year?

Q. The operating surplus suggests that the university is on the road to greater financial stability after a couple of tough years. Is that true?

A. I certainly hope so! I think we are all tired of having to cut budgets the last couple of years, so it's nice when the university's income takes an unexpected turn up rather than down for a change.

That said, it's important to recognize a couple of things about the reported surplus. First, about its size. The university's total revenue last year was about $2.3 billion, and so the $46 million surplus means that we spent all but 2 percent of this. That's like a family with a $40,000 income ending the year with $800 that they didn't spend. It is very nice, and certainly better than ending the year with a deficit, but we shouldn't conclude that we can stop being careful with our expenditures.

Second, about its predictability. As late as last June, we were expecting to end the year with a deficit rather than a surplus. That's why at the last minute we asked units to hold back on their general funds expenditures. The surplus resulted from a combination of financial restraint, for which we can thank all employees, plus the unexpected strength of the university's investment returns, for which we can thank the folks who manage the endowment. It was also a surprisingly good year for gifts, for which we can thank the Development Office and our generous donors.

Q. What portion of the surplus is due to increased strength of financial markets and how much is due to belt tightening?

A. Between two-thirds and three-quarters of the surplus resulted from the unexpected turnaround in the financial markets during the last six months of the fiscal year. The rest was due to various other factors, including savings from belt tightening.

Q. What does the surplus mean to various units and how will it be allocated?

A. You have to understand that 80 percent of the surplus sits in funds whose use is restricted in one way or another ­ for example, as unused payout in an endowed professorship fund. To use another example, if your department's gift fund has more money in it this year than at the end of last year, that extra money is counted as part of the university's surplus, even though its use is up to the department. So the vast majority of the surplus has already been allocated, simply because of the restrictions on the funds where the money sits.

The unrestricted, general funds surplus is about $10 million. This will be used for various one-time expenses; for example, fixing some of the software problems that made the Delphi rollout so painful. There is still a long way to go with this transition and the burden unfortunately falls directly on our devoted staff.

Q. When is the last time Stanford had a surplus? How big was it?

A. We had a surplus of $63 million in 2001, followed by a $17 million deficit in 2002.

Q. You wrote to various units in an October memo that the university is still anticipating a $10 million to $15 million shortfall in general funds for FY05. Is that still the case or is the deficit expected to shrink due to a stronger economy and better-than-expected returns from investments?

A. I hope the October projection of a $10 million to $15 million shortfall is overly conservative and that the outlook will improve as the year goes on. If gifts and investment returns continue to be strong, the projected shortfall should shrink somewhat. On the other hand, as the results from 2001 and 2002 show, it is easy to go from an even larger surplus to a significant deficit, depending on the vagaries of the economy. At this point, it's just too early to tell. The budget process goes on through the year and, as the year goes on, we refine the projection as much as possible. We make final decisions about the budget in May and that's the budget we propose to the Board of Trustees.

Q. Are units still preparing for a 3 to 5 percent cut for FY05? How likely is it that the units will have to implement one of those cuts on top of the existing cutbacks for the current fiscal year?

A. Yes, we are still asking units to prepare for cuts of 3 to 5 percent for next year. But we will not impose those cuts unless it's necessary, either because of financial constraints or because the money is needed for other university priorities. For example, the cost of employee benefits, particularly health insurance, has been increasing much faster than inflation. In order to continue offering our generous benefits package, we might have to take cuts elsewhere in the budget.

Q. What kind of feedback are you hearing from deans and other unit leaders who are affected by another proposed round of cuts, especially when they are aware of the operating surplus?

A. The deans and department heads recognize that a one-time surplus last year doesn't necessarily mean we can avoid further cuts. But I'm fully aware that further cuts on top of the existing reductions won't be easy. The deans aren't shy about communicating the difficulty of additional cuts. We all hope that budget reductions can be kept to a minimum.

Q. Many in the university community will hear news of a $46 million operating surplus and assume that budget cuts are behind us. How would you respond to those people?

A. It's a natural assumption, and I hope it's right. But it is really too early to tell what next year will look like. For now, the responsible approach is to assume that we will still have to trim the budget a bit more.

Q. When the salary freeze was announced, the implication was that it was a one-year measure. Many will now assume that they are going to get a raise. Is that true and if so, how will raises be calculated?

A. As I've said before, President Hennessy and I are committed to providing raises this coming September. We would not ask Stanford employees to go for two years without raises, except as an absolute last resort. I'm confident that a continued salary freeze will not be necessary.

As usual, raises will be given in September, and they will be determined in the standard way, by the employee's supervisor or department chair.

Q. Will there be any change in hiring practices for FY05? Do you anticipate lifting the hiring freeze?

A. I think we have to continue to be careful about any new hiring, especially if it creates a new position. The hiring freeze has not stopped all hiring, but it has allowed us to scrutinize and think twice about filling vacant positions or opening new ones. That's a healthy thing to do in financially uncertain times like these. So we have not yet decided to lift the hiring freeze.

Q. How will the operating surplus affect proposed tuition increases, if at all?

A. Any time unrestricted gifts or investment income increase substantially, it slows the rate at which tuition must increase to balance the budget. But keep in mind that full tuition covers less than 60 percent of Stanford's cost of providing a student's education. The rest is covered by gifts, endowment payout and other unrestricted revenue, like rental income from the research park. If these do not increase as fast as our expenses, then tuition has to make up the difference.

Q. Is there any indication right now about investment returns continuing their strong performance during the next year?

A. If you had a crystal ball like that, you'd be very rich. But we have a very diversified investment portfolio and excellent people managing it. So I'm optimistic that the endowment will perform reasonably well in a wide range of circumstances.