Colleges Offer Early Decision Admission to Maximize Tuition Revenues, Not to Benefit Students

Colleges price discriminate just like other businesses

The New York Times published an article today, Meet the Millionaire Masters of Early Decision at Colleges, suggesting that early decision admissions policies must be a big business for colleges, given that the directors of admissions that design and administer these early admission programs can be paid a million dollars per year. But the article didn’t really challenge a spokesman for one of the colleges who it quoted as saying that early decision is not about revenues, but instead “…builds true school spirit around a cohort of like-minded students.”

But of course, early decision programs are designed to maximize tuition revenues. Universities, like other businesses, engage in price discrimination, charging different prices for the same good or service. Businesses price discriminate whenever they can because it increases their profits. An airline, for example, knows that a business passenger will pay more for a ticket than a vacationer. The airline distinguishes the types of passengers by observing their behavior. A ticket bought a few days before to leave on Sunday and return later in the week is probably a business ticket and will be priced higher. A ticket purchased months in advance that includes a weekend stay is probably a vacation ticket and will be cheaper. Movie theaters and retail stores often have senior citizen discounts. Senior citizens are more likely retired and thus have lower incomes. They also have more time to shop around, so it makes sense for a business to offer senior citizens lower prices. Universities also price discriminate, charging different rates of tuition for the same education based on ability and willingness to pay.

Universities, however, are in the enviable position of being able to price discriminate far more effectively than other businesses. To understand the universities’ advantage and contrast it with traditional businesses that price discriminate, such as auto dealers, let’s imagine that auto dealers are able to price cars like universities price tuition.

Suppose there are five cars on the market: a Toyota Camry, a Honda Accord, a Nissan Altima, a Hyundai Sonata, and a Kia K5. Each car has an outrageous MSRP of about $100,000. To buy the car, you must go into the dealership to apply to purchase the car. They might not agree to sell it to you, even if you have the money to buy it, so you’ll need to apply to purchase a car from the other dealerships too. A lot of drivers can’t afford $100,000. Fortunately, you can speak with the dealership’s finance manager who will discuss the “financial aid” options they have available: scholarships, work-drive programs in which you can clean up around the dealership in exchange for a lower car price, and loans that you can never discharge, even if you declare bankruptcy. To qualify for this financial aid, you’ll have to undergo a financial proctology exam in which the financial aid department will probe every crevice of your financial innards—how much you earn, how much savings you have, what your house is worth, whether you own any additional properties or investments, and what your expenses are.

Normally the dealership would have to waterboard you to get these financial secrets. But you’ll answer all their intrusive questions willingly. You’ll do it because if you don’t drive up to a job interview in one of their shiny new cars, your chances of getting one the best jobs plummets. You also won’t have the best friends or the most respect. The dealership marketing department has done such a good job convincing the public that you must have one of their cars if you want to succeed in life that everyone believes it; it has become a self-fulling marketing prophecy.

The dealership’s sales department’s job is to figure out who to sell to and how to extract the highest sales price from each customer. Some customers will have to pay the full $100,000 MSRP. Others might get a $20,000 discount and those with a lower income receive an even greater discount.

The dealership faces three challenges in getting the highest price from each customer. The first is competition from the other dealers. A competitive market is the enemy of price discrimination. Although each dealership can adjust its “financial aid” package to maximize the price it charges for each car, its ability to tailor price reductions in the guise of financial aid is limited because each dealership is competing with the other dealerships. If Toyota offers a stingy financial aid package, Honda can undercut Toyota by offering a package that’s a bit better.

The second challenge is how to get the most buyers who are willing to pay full price for the car. The dealership also wants to figure out who will stretch the most on financial aid. In both cases, the dealership needs to know if the customer strongly prefers their car to the other four.

The third challenge is revenue uncertainty. The dealership can approve the applications of buyers, but it doesn’t know whether they will buy their car or a competitor’s. They’d like to lock in the best buyers if they can. If the dealership offers to sell the car at a high cost, they want the buyer to pre-agree to the purchase, even if a competitor dealership offers its car at a lower price.

How would a dealership overcome these challenges? To eliminate competition, the best strategy is for the dealership to agree on a common financial aid calculation method they will all adhere to. If they have a common methodology that can be set parsimoniously, they can effectively fix the price of any discounts to the MSRP, eliminating competition.

The second and third challenge can be handled by instituting an early buyer program. If the customer puts in an application to buy a car early, then he agrees to buy if his application is accepted. Early buyers self-select into those customers who really prefer the dealer’s car and are willing to pay full price or accept a lower financial aid discount to buy it. In that way, the dealership increases the collective revenue from the cars it sells and reduces revenue uncertainty to boot.

If we substitute “university” for “car dealership,” we’ll see the behavior we’ve predicted. The Department of Justice in 1989 filed a civil antitrust case against the “Ivy Overlap Group,” a collection of prestigious universities that collaborated to set a common standard to decide financial aid packages. Although they sold the common financial aid methodology as a means of eliminating college cost uncertainty, it had the effect of fixing the price of financial aid, eliminating competition. The universities entered into a 10-year consent decree in which they pledged not to develop a common method of deciding financial aid.

Under pressure from the universities, in 1992 Congress passed the 568 Exemption, allowing colleges to collaborate on a more general financial aid framework as long as admissions are need blind. Universities often claim to be benevolent non-profit institutions, bragging that their admissions are need blind and that they also have financial aid calculators to aid students to understand costs. In reality, need blind admissions and financial aid calculators are the direct legal result of their long standing desire to collude to price fix financial aid packages.

In fact, in 2022 a class action lawsuit was filed against seventeen elite colleges alleging that their financial aid calculation methodologies were too similar and their admission practices insufficiently need blind. The lawsuit asked for $685 million in damages produced by an illegal price fixing financial aid cartel that overcharged over 200,000 students. Ten universities settled with total damage payments in the range of several hundred million dollars; the lawsuit continues for the other seven. The 568 exemption expired in 2024, making it harder for universities to price fix financial aid packages.

Since universities have lost the 568 exemption and have already been sued on the price reduction side of the tuition equation, early admissions programs will likely become even more important to keep tuition high. Universities will have to compete more on tuition price reductions in the form of financial aid packages. But through early admissions they can lock in the students who are willing to pay the most. In the future, admissions experts that can design good early admissions programs will command multimillion dollar salaries. If you are a university administrator who wants to get paid like an investment banker, early admissions is the high growth area to get into.