How Athletic Departments (And The Media) Fudge The Cost Of Scholarships

Paula Lavigne has an insightful piece on about how college sports thrived even as the rest of America suffered through a terrible economic downturn starting in late 2008. Paula is one of the best people writing in the mainstream sports press on money issues, and this piece is no exception. She presents a high-level economic view of how scholarships costs aren't accurately measured and cites two of the best sources on the topic, Profs. Brian Goff of Western Kentucky and Chad McEvoy of Syracuse.

But then she quotes University of Iowa associate athletics director Rick Klatt:

"The AD is writing a check for every scholarship athlete that we extend a scholarship to," he said, adding that the athletic department also pays the university for utilities and the university hospital for medical care. Athletics do not receive any direct financial support from the university's general fund, either.

This is why you should not let your kid learn economics from an associate athletic director. To understand why Iowa's logic is wrong, and to understand what the consequences are to this particular misperception, it helps to look at college-athletics accounting practices through the lens of oil-pipeline pricing, of all things.


It's All About The Spread

When an oil-extracting company pays an oil-pipeline company to move oil to a refinery through a pipeline, the law requires the pipeline firm to take legal title of the oil. My guess is that it's a matter of legal liability: If the pipeline leaks, the people affected by the oil spill will have a specific person to sue.

But the pipeline company doesn't really want to bear the risk of the fluctuating price of oil. It might take a few days for the oil to be moved—and note, too, that the molecules of oil that enter on one end aren't literally the same ones extracted on the other—and if the price is volatile, the pipeline firm could end up losing money. How does the industry solve this problem? The two firms, the extractor that gets the oil out of the ground and the pipeline firm that moves and temporarily "owns" the oil, use a kind of contract called a buy/sell.

A buy/sell is a contract wherein the pipeline company agrees to buy the oil for one price at one end of the pipeline and then to sell it back to the company that actually owns the oil at another, higher price at the other end. Both prices are specified at the same time, before the oil is actually put into the pipeline. It might say: I buy from you at the source at $50 per barrel; you buy from me at the refinery for $60 per barrel.

When you price things like this, the actual prices are almost meaningless. All that matters is the spread. The pipeline company is getting $10 per barrel to transport the oil. They would also get $10 per barrel to transport the oil if the contract had said: I buy from you at the source at $150 per barrel; you buy from me at the refinery for $160 per barrel. And also the same if it had said: I buy from you at the source at $5 per barrel; you buy from me at the refinery for $15 per barrel. In each case, the extractor pays the pipeline $10 per barrel. The rest is just fancy self-canceling accounting.

Scholarship "Costs" Aren't Real Numbers

So now look at a school that claims to provide its athletic department with $10 million in "Direct Institutional Support" and that also claims that the athletic departments pays for its athletic scholarships (GIAs in the jargon of college sports) by sending money to the university.

Schools typically claim that a GIA cost is equal to the full, zero-financial-aid price of attending the school, getting room and board, and getting all required books. That probably has very little to do with (a) what providing the scholarship costs, in terms of the schools' expense (what we can think of as the "expenditure" associated with the scholarship) or (b) what revenue is lost by providing the scholarship to the athlete (this is classic economic "opportunity cost"). Instead, it represents a list price that almost no one pays, because most people who attend a college receive institutional financial aid of one kind or another. The list price is the starting point and almost everyone gets a discount off of the list. (This isn't the place to rehash all of that, but suffice it to say that the economic literature ballparks the true cost of an academic scholarship in the range between 20 and 40 percent of the list price.)

OK, so if the school decides to put it on paper that $50,000 per year is the cost of a GIA and also determines that it provides $30,000 per athlete in "direct institutional support," then it looks as if the school has been super generous, to the point of providing money to the athletic department to cover more than half the scholarship amount. But if that $50,000 is just a made-up number, unrelated to the actual cost of the scholarship, then this is really just a buy/sell transaction with a spread of $20,000 (which is the net payment by the athletic department to the university). In other words, the athletic department (figuratively) put the athlete into a pipeline and paid the university $50,000; when the athlete (figuratively) came out the other side of the pipeline, the school sent back $30,000.

If instead, the GIA were listed at $60,000 per year, the school would have to cover $40,000 through "direct institutional support." If the GIA were listed at $120,000, the school would have to cover $100,000. Either way, the actual economic transaction is that, on net, the athletic department is sending the school $20,000. The school is giving the athletic department NO MONEY in this example, regardless of the prices we pick for both transactions (just like the oil extractor isn't really selling the oil to the pipeline company). Instead, the school provides a service (educating one athlete) just like the pipeline company provides a service (moving oil long distances to a refinery), and the net difference in the two prices represent the actual PRICE the school charges the athletic department. It says almost nothing about the cost of providing that service.

So when schools with zero "direct institutional support" give out a GIA, they are simply transferring money from athletics to the university as a whole. Remember: This is the price, not the cost, of that service. To learn about cost we have to look elsewhere.

The Real Cost Depends On Many Other Things

Go back to the oil example again. What does it cost the pipeline company to actually move the oil from point A to point B? $10 per barrel? Maybe. Maybe not. That $10 per barrel spread is just the price they charge. It could cost ANYTHING to provide the service, and we know almost nothing about the true cost from the difference in prices.

The same is true for the scholarships. We cannot learn much about the cost of providing a college education to an athlete from the listed price of a GIA or from the net spread between "direct institutional support" and that listed price. The difference tells us how much money the athletic department is paying the school for the scholarships, but not what the scholarships cost the school to provide.

What they cost depends a lot on the school. At schools with capped enrollment—where the dorm rooms are full, where profit margins on food and books are low, where little or no institutional financial aid is given to non-athletes—the list cost might well be close to correct. At schools with a desire to grow enrollment—where there's still dorm space and where profit margins on food and books are healthy—the actual cost might be pennies (or at least dimes) on the dollar of listed cost.

It turns out the federal government has rules about using buy/sell prices to actually figure out the value of oil. That's because of all the federal land where oil extractors pay for their leases as a percentage of the value of the oil they extract. And those rules pretty much say to use ANY other method to estimate price before you rely on a buy/sell price. (I last worked on an oil case around 2001, so please forgive me for not having citations on this at my fingertips.)

The same should be true for any analysis of the "cost" of providing a scholarship. The numbers reported are the gross price the university charges the athletic department, not the cost. When you net out "direct institutional support" those numbers become the net price the university charges (and if that "support" is high enough, the net price might be negative).

It Comes Down To Iffy Accounting

To be fair to poor Rick Klatt, from his perspective as a guy running a department and trying to manage a budget, the price the University of Iowa charges his department looks like a cost to him. As he says, he write a check for that amount (though I doubt there is literally a paper check) and his ability to spend that money elsewhere is curtailed as that check gets bigger. And he emphasizes that because there is no "direct institutional support" the gross price and the net price are the same. But in no sense is either of those numbers a good estimate of the "cost," accounting or economic, of providing the goods and services underlying an academic scholarship.

This matters a lot. As Brian Goff and Dennis Wilson very perceptively have written, athletic departments are trying to walk a rhetorical tightrope. They want to hide their profits to make it easier to keep them away from other would-be claimants. They also want to avoid looking so poor that other stakeholders within academia use sports' apparent poverty to strip them of power. Rhetoric that turns a price into a cost, and a transfer of profit into a loss of money, helps play a role in confusing things enough that the moment in the magic trick where the profit is moved from one pocket to the other gets obscured.

This sleight of hand confuses the media, who then (unknowingly) magnify and perpetuate the deception. Articles that use the label "scholarship cost" for what the schools call "athletic student aid" on their financial reporting documents are confusing price and cost, and those that don't net out direct institutional expense are reporting a fake price at that. Schools and athletic departments have no real incentive to correct the record, and so the public is left with the perception that somehow these wildly profitable enterprises are just scraping by—all the easier to claim poverty when the workforce comes around looking for a more competitive cut.

Andy Schwarz is an antitrust economist and partner at OSKR, an economic consulting firm specializing in expert witness testimony. Follow him on Twitter, @andyhre.