UMQ – Service & Non-Profit Organization

In 2001 several faculty groups at the University of Mumtaz Qura’ (UMQ) voiced public criticism of the
university's Revenue Center Management System (RCMS). The RCMS, which had been used since 1991,
was the key element of UMQ's decentralized financial control system. It provided top university
managers with the ability to hold the heads of each operating unit (e.g. school deans) accountable for the
financial consequences of their decisions.

In February 2001, 56 faculty members from 13 university units sent an open letter to Rasheed Kamil, the
newly appointed university president, criticizing the RCMS. This letter, which was not based on any
careful study and proposed no alternatives to the current system, claimed that the RCMS had turned the
university into "a collection of independent and competing units, whose only legitimacy is built on their
ability to produce revenues." It went on to state that "among units whose fields do not create wealthy
entrepreneurs or professionals, the concept has produced polarization between units and a chronic concern
for survival." The concern for survival, in turn, leads faculty to try to serve larger numbers of students to
raise enrolment revenues, but at the expense of education quality.

In May 2001, the University Research Committee approved a subcommittee report based on a study of
the RCMS that had been under way for over a year. This study was the first serious faculty review of the
UMQ RCMS. Contrary to the open letter, this committee report concluded that RCMS was "generally
working well." But the report did say that some modifications to the RCMS were needed to eliminate, or
at least reduce, some "perverse incentives" for deans and faculty members. These perverse incentives
included discouragement of innovation, multidisciplinary research, seeking of outside research grants, and
encouragement of course proliferation. The report made specific suggestions to relieve some of the
problems.

Both faculty groups called on the university administration to examine the RCMS and to consider an
appropriate and timely response to their criticisms. Preparation of the response became the responsibility
of UMQ's central financial staff, in particular Abdul Karim, senior vice president-finance and Samad Ali,
vice president-budget and planning. Abdul Karim, Samad Ali, and their staffs had to decide whether the
criticisms were valid, and if so, how the system could be altered to alleviate the problems.

THE UNIVERSITY OF MUMTAZ QURA’

The University of Mumtaz Qura’ was established in 1980 as a private research institution of higher
education. Located on the perimeter of downtown Cordoba, UMQ was a diverse and complex
organization. It ran 22 colleges and schools, more than any other private university in the Spain, and
offered over 200 degree programs. It enrolled over 28,000 students from all 50 states and 113 countries,
employed over 2,000 full-time faculty members, and had annual operating revenues of over $800 million.
Exhibit I shows a university organization chart. Exhibit 2 shows an income statement. (The restricted and
unrestricted nature of some of the revenue and expense items is explained later in the case.)

As a research university UMQ's goals included the creation, as well as the transmission, of knowledge.
Thus UMQ's faculty were expected to engage in basic or applied research as well as perform their
teaching. UMQ supported its activities primarily by generating tuition revenues, securing research
sponsorship, and attracting philanthropic contributions. Because its endowment was relatively small the
university was heavily dependent on tuition revenue. But it was successful in generating sponsored
research funds, ranking 14th among the nation's universities.

THE FINANCIAL MANAGEMENT SYSTEM

PRIOR TO RCMS

Prior to the implementation of RCMS decision-making power was centralized, with one senior
administrative officer playing a key role in all major resource allocation decisions. Abdul Karim
remembered that, "The old system was heavily based on personal negotiation. The resource allocation
decisions were made behind the scenes in a 'smoke- filled room'."

Also in the old system financial accountability for the unit heads was weak. Each university unit had its
own financial statement, but the statements were not complete, as some revenues were neither traced nor
allocated to the units that generated them, and unit heads were not sanctioned for producing unfavourable
variances as compared to their budget. Salam Munir, finance director for the School of Engineering,
recalled:

Certain players would consistently overrun their budgets, and some had substantial overruns.
Most of the overruns were due to under generated revenues rather than cost overruns. No one had

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 any explicit financial incentive to manage differently. But there were some real, significant
informal incentives.

RCMS DESIGN PRINCIPLES

The RCMS was designed in 1991 by a Task Force on Budget Incentives appointed by Mahmud Akbar,
the university president. The Task Force based much of the RCMS design on the system used at the
University of Barakah that, in turn, was adapted from the system in use at Great Success Company.
Ahmad Jones, the then chairman of GS was on the Board of Trustees at University of Barakah, and he
insisted that this kind of system would provide a better alignment of authority and responsibility, and
better university management.

The Task Force developed the following nine management principles to guide their development of the
RCMS:

1) Responsibility should be commensurate with authority, and vice versa.

2) Decentralization should be proportional to organizational size and complexity.
3) Locally optimal decisions are not always globally optimal: central leverage is required to
implement corporate (global) priorities.
4) Outcome measures are preferable to process controls.
5) Accountability is only as good as the tools which measure it.
6) Quantitative measures of performance tend to drive out qualitative measures.
7) Outcomes should matter: plans that work should lead to rewards, plans which fail should lead to
sanctions.
8) Resource-expanding incentives are preferable to resource-dividing ones.
9) People play better games when they own the rules.

The new RCMS system had to include three basic elements that would permit a decentralized
management system within the university. First, the university had to be divided into responsibility
centers. Second, the performance reports, including methods for tracing or allocating shared revenues and
costs to the primary operating units, had to be designed. And third, the extent of decision authority to be
delegated to the operating units needed to be clarified.
RESPONSIBILITY CENTERS

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The university was divided into two types of responsibility center: revenue centers and administrative
centers. Revenue centers were units to which revenues could be uniquely attributed. Some of these, the
colleges, schools, and research institutes, were called academic revenue centers. The other revenue
centers, including athletics, residence halls, bookstores, parking operations, and food services, were called
auxiliary revenue centers. The administrative centers were entities that did not generate revenues directly
but performed activities which supported the revenue centers. Examples included Admissions and
Financial Aid, Business Affairs, Financial Services, Legal Services, Library, Office of the President, and
Registrar.

Most of the responsibilities for raising revenues and expending resources were delegated to the revenue
center managers. The central administration maintained some power to implement university-wide goals.
As noted in the 1995 UMQ Financial Report:

At UMQ, we believe that the primary planning takes place at the operating unit level: the school
or auxiliary enterprise, or the administrative unit. We believe that people closest to the action
know their programs, their customers, and their markets best; they are the best informed and,
therefore, the most capable of strategic thinking. The role of central planners is primarily one of
coordinating and monitoring.

The central administration maintained the power to hold the responsibility center managers accountable
for attaining their targets. The academic revenue center managers (i.e. school deans) were evaluated in
terms of their units' academic excellence (research and teaching), generation of sponsored research grants,
faculty development, fundraising, and bottom-line financial performance. Their performances were
reviewed formally every five years.

PERFORMANCE REPORTS

UMQ produced an elaborate set of reports to facilitate control of each responsibility center's operations. A
monthly financial report presented the current month's and year-to-date performance as compared to
budget. Other reports provided information on gifts, grants, enrollments, students, personnel, space usage,
and the detailed items affecting the revenues and expenses of each responsibility center. The financial

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reports included four primary categories of accounts: revenues, direct expenses, indirect expenses, and
participation/subvention. These are explained as follows.

a) Revenues

The university generated two types of revenues: restricted and unrestricted. More than 25% of the total
funds available to support operations were restricted, meaning that they were given to the university for a
specific purpose or project. These funds came from grants and contracts, from the federal government and
other sponsors of specific research projects, gifts from private donors and foundations, and income from
endowments to support specific individuals and/or activities. The restricted revenue funds had to be used
only for the specific purpose for which they were given and were not allowed to be transferred to an
unrestricted account without prior permission from the central administration.

The other revenues were unrestricted in purpose. They came from tuition and fees, unrestricted gifts, and
indirect cost recoveries from government contracts. Tuition revenue was credited 100% to the revenue
center offering the courses taken. The indirect cost recoveries were determined by a formula negotiated
with each funding source. For example, in fiscal year 2001, UMQ's indirect cost recovery rate on
government projects was 60.5% of direct costs; that is, for every $1 reported as the approved direct costs
of a research project, the university received an additional 60.5 cents to help cover indirect costs. But on
projects funded by the Oil Foundation, the recovery rate was only 8%.

b) Expenses

The direct expenses of a revenue center included the costs of the people and equipment directly assigned
to that center. Indirect expenses included the costs of shared resources, such as buildings, utilities, and
various kinds of support provided by the administrative centers. The indirect expenses were allocated to
the revenue centers on the basis of cause and effect, benefit derived, or common practice. Exhibit 3 shows
the indirect cost pools generated by the various administrative centers and the rules that governed their
allocation. Samad Ali, vice president of budget and planning, acknowledged that the allocations were
based on:

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 Imperfect rules, some of which are totally arbitrary. We used Federal government allocation
guidelines as a guide, but we also put together a group of deans and administrators and hammered
the rules out.

Abdul Karim concurred:

Allocation of indirect costs is done with thumbnail methods that are much less precise than
precise. No study was done, but the allocations are somewhat thoughtful. We developed rules of
thumb and tried to remove blatant inaccuracies.

c) Participations and subventions

University administrators used a system of participations and subventions to maintain a degree of control
over university-wide resource allocation decisions and to even out the distribution of monies between
revenue centers. The participations were contributions required from all revenue centers in equal
proportion to further the objectives and well- being of the total university. Each revenue center
contributed 20% of the sum of its tuition and fees, sales and service income, and indirect cost recoveries.
These contributions were redistributed to revenue centers as block grants called subventions. In the
revenue center financial reports the participations were shown as negative indirect income, while the
subventions were shown as positive indirect income.

The participation/subvention feature of RCMS provided university administrators with a means to

implement university priorities and goals. When they made their allocations of subventions the
administrators, particularly the provost and president, tended to focus on two key factors: (1) differentials
in the costs of educating students in different fields; and (2) the revenue centers' cost/quality ratios.

The cost of educating students varied widely between schools. Some schools could educate their students
effectively by teaching them in large sections, while others had to provide instruction in small classes or
in expensive laboratories. Samad Ali explained:

The cost of educating music major is large, especially in a conservatory-like program like ours.
The dominant mode of instruction is one to one: a master pianist and pupil on the same bench.
Business education is much less expensive; as accounting and finance can be taught well to

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 classes of 25 or 50, or even more. But we as a university have decided to charge both music and
business students the same tuition. Common price, but most uncommon unit costs!

TABLE 1 2001 summary income statements (in $ millions)

School of School of
Business Music

Direct income $64.1 $10.8

Indirect income (4.1) 2.5

TOTAL INCOME 60.0 13.3

Direct expense 38.0 8.2

Indirect expense 22.0 5.0

TOTAL EXPENSE 60.0 13.3

High 2 3

Cost of

Instruction

Low 1 4

Low High

Academic Excellence

FIGURE 1 Cost/academic excellence ratios

Part of the subvention allocations was aimed at evening out this cost disparity. This pattern can be seen in
Table 1 which shows the 2001 summary income statement numbers for the schools of Business and
Music.

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The other major factor underlying the subvention allocation was a subjectively determined cost/academic
excellence ratio that represented what the university administrators perceived they were receiving for
their investment. This is illustrated in Figure 1. A school located near point number 3, such as UMQ's
School of Music, with both high cost of instruction and high academic excellence, is most likely to get a
disproportionately high subvention. It offers high quality programs and research productivity but is
unable to cover its costs through tuitions. A school located near point number 4 is valuable to the
university because it offers high quality and financial independence. It can probably provide funds that
can be used in other parts of the university, but administrators will be careful to allow it to keep enough
funds to maintain its excellence. A school located near point number 2 is in trouble. It is a candidate for
new leadership or program discontinuance.

INTERCENTER BANK

The RCMS included one other significant element, an Intercenter Bank. This bank provided the revenue
centers the opportunity to carry unrestricted funds across fiscal year boundaries. It thus provided revenue
center managers with incentives to produce year end surpluses rather than just to meet a break-even
bottom line. And it reduced the ‘use it’ or ‘lose it’ mentality, present in some not-for-profit organizations,
which causes managers to spend all the money that had been approved in their budget before yearend.

The Intercenter Bank was used both by revenue centers reporting surpluses and by those reporting losses.
If a revenue center had a surplus (i.e. a positive unrestricted fund balance at the end of the year), it was
given an account in the bank and provided interest on the account balance at the annual treasury-bill rate
as of July 1 of the year just started. These revenue center managers were allowed to spend their account's
principal balance in future years, but only up to a maximum of 20% of the balance each year. Conversely,
revenue centers with a deficit were assigned a loan from the bank and charged interest at the treasury-bill
rate. They had to budget for repayment of the loan at a rate of at least 20% of the beginning balance per
year.

CRITICISMS OF THE RCMS SYSTEM

The five basic criticisms of the RCMS system voiced in 2001 by one or both of the faculty groups or
other critics were that the system discouraged innovation, multidisciplinary research, and the seeking of

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some outside grants and that it encouraged both proliferation of redundant and inappropriate courses and
end-of-period financial game playing.

1. Discouragement of innovation

The discouragement of innovation criticism, which the Research Committee considered the most
important problem, stemmed from three concerns. First, some critics believed that the RCMS system
forced deans to think of their mission more in financial terms and not in terms of their academic mission.
The open letter to President stated:

The system in place makes few allowances for the various missions and contributions of the
academic units of the university. Those units unable to show a profit under current budgetary
formulas are condemned to live in a deficit situation, to depend upon subventions given after
demeaning negotiations, and to face inferior status among other units in the university.

Many believed that the financial pressure discouraged innovation and even teaching quality. The
committee report noted that, "Innovators whose ideas do not imply immediate income feel that no one in
the system will give those ideas a sympathetic hearing and so are discouraged from innovating." And one
critic added that, "Faculty under pressure to produce income are not focused on students." Some critics
even believed that the emphasis on financial performance would lead university administrators to hire
deans with, perhaps, more financial management abilities than leadership vision for their school.

Second, another group of critics believed that innovation and initiative were stifled because RCMS
institutionalized decentralization only to the level of the deans and, thus, did not go far enough. Deans
were unlikely to carry the delegation any further and, as a consequence, the university was stripped of the
entrepreneurial energies of many faculty leaders. And third, some critics observed that much of the power
and discretionary funds had been taken from the top-level administrators and their roles essentially
became those of administrators, not leaders. One critic noted that, "Neither President Mahmud nor
Provost Saad has become identified with any public position. All the leadership that is being exerted is
coming from the [good] deans."

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As a partial solution, the Research Committee report suggested that UMQ should create a Research
Leadership Fund of at least $1 million per year to be used for time-limited support of innovative projects.
These projects should involve large expenditures, of at least $50,000/year, because another program was
already in place to provide smaller grants to support individual faculty research projects. In the new
program administrators or researchers would apply for funds, and the approval process would be
administered by the Vice Provost for Research.

2. Discouragement of multidisciplinary research

The Research Committee report expressed concern about the discouragement of multidisciplinary
research because the committee members thought that the best research, particularly that of an applied
nature, should involve researchers with different skills and perspectives. Some faculty members believed
that since RCMS emphasized financial priorities most deans could not see the financial benefits of
multidisciplinary research. They also noted that such research could even be a financial drain on a
revenue center, depending on how the costs and revenues of the cross-revenue-center work were shared.
Abas Taha, the chairman of the subcommittee of the University Research Committee that prepared the
report critical of RCMS said:

The biggest obstacle to multidisciplinary research is territoriality. Any efforts to institutionalize a

turf, which is what RCMS does, will lead to action to protect that turf. I can give you perhaps 20
examples where this system has stifled interdisciplinary work. For example, I know of instances
in which deans have upbraided faculty members for getting involved with someone from outside
their revenue center.

The subcommittee members could not find much evidence that UMQ professors were engaging in
significant amounts of multidisciplinary research, and they blamed the RCMS, at least in part. They
proposed that overhead revenue for multi-revenue centers projects be assigned in a manner proportional
to the costs the units will occur. They also suggested that the Research Leadership Fund could be used
explicitly to encourage multidisciplinary research proposals.

3. Discouragement of the seeking of outside grants

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The Research Committee report noted that some personnel are discouraged from seeking some outside
funding grants. These grants appear unprofitable to the unit because they do not provide for full recovery
of the expenses charged to the revenue center. For example, the government recovery rate of 60.5%,
which was higher than the recovery rates allowed by many foundations, did not cover the overall UMQ
average overhead rate, which was approximately 68% of direct costs. And the actual overhead rates in
some departments, such as science departments that had to maintain expensive laboratories, were much
higher than the university average.

The research committee urged university administrators to study their allocation methods and to consider
discontinuing the allocation of some categories of expenses, such as the relatively fixed indirect expenses
(e.g. space, general administration). This change would allow units to price at least some research grants
on a marginal cost basis.

4. Encouragement of course proliferation

The critics who believed that the RCMS encouraged course proliferation based their belief on the
knowledge that school earned tuition revenue only if students signed up for courses they offered. Thus
many schools, and even departments, offered similar or even identical courses (e.g. statistics,
communications) in order to retain all of its students' tuition dollars at their school. The faculty voicing
this criticism believed that it would be more likely for courses to be taught in the department best suited
to offer it if the pressure for revenue generation was lessened. Some RCMS critics also noted that some
schools offered gut (excessively easy) courses that might be deemed inappropriate for an institute of
higher education (e.g. a course that just shows films) or tolerated professors who grade liberally to keep
their courses popular because popularity brings with it additional revenues.

5. Encouragement of end-of-period financial game playing

Neither the committee report nor the open letter mentioned the problem of end-of-period financial game
playing, but some other critics within the university believed that RCMS encouraged such actions. They
noted many examples of revenue center managers moving revenues and expenses between fiscal years
depending on whether they were in a budget surplus or deficit position. These managers were motivated
to do so because meeting their budget target was an important part of their job. Most of them believed that
if they failed to achieve their budget two years in a row they would probably be replaced.

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The managers had used many methods of moving monies between reporting periods. For example, they
could ask donors to accelerate or delay their contributions, or they could deposit June donations
immediately or wait until after July 1, the start of the new fiscal year. And they could move expenses
between years by, for example, accelerating or delaying discretionary expenditures or by asking faculty
and staff members to submit requests for reimbursement of expenditures already made in the current or
following fiscal year. The deans and many others within the university did not consider such
manipulations unethical because they had observed top-level university administrators taking the same
types of actions. The university had never posted a deficit for a fiscal year, but sometimes administrators
had to take end-of-year actions to maintain that record. They believed the continuing record of budget
achievement and surpluses was desirable because it provided evidence that the school was well run and
contributed to the high-quality (AA) bond rating UMQ was given by Trust and Poor’s. Both of these
indicators facilitated the raising of capital and donations from alumni, foundations, and the investment
community. As Abdul Karim noted, "Big donors will not give to a school running a deficit. They assume
the people there can't handle the money."

A REQUIRED RESPONSE

Abdul Karim and Samad Ali knew they would have to respond to the criticisms of the RCMS system. But
Abdul Karim noticed that, "Some of the people who have the greatest problems with the RCMS system
are those who were the best at negotiating behind closed doors when we had the old system." He also
believed that some of these criticisms were merely inevitable side effects of the use of a system - a
decentralized organization structure combined with financial accountability - that had great benefits. But
both he and Samad Ali were convinced that the system could probably be improved.

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Required:

a) What are the deficiencies of the old system? Does the new system mitigate the weaknesses of the
old system?
(10 marks)

b) How should each of the criticisms of the new system described above be resolved?
(15 marks)

c) How can the implementation of the control systems improve the issues of the new system? Be
specific in justifying type of the control system.
(15 marks)

d) What other advices do you have for Mr Abdul Karim and Samad Ali?
(5 marks)
(Total 45 marks)

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EXHIBIT 1 University of Mumtaz Qura’ organization chart

The office of the President is an extension of the President and is comprised of the President and the
Senior Vice President to whom the President has delegated authority and responsibility for the wide areas
of the University’s operations assigned to them.

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EXHIBIT 2 Summary of current funds revenue and expense (in $1,000)

Unrestricted budget Restricted budget

1999- 2000-
1999-2000 2000-2001 2000-2001 1999-2000 2000-2001 2000-2001
2000 2001
Unrestricted Unrestricted % from Patient care Patient care % from
budget budget
budget budget 1999-2000 budget budget budget
Revenues Tuition & Fees 328,480 335,527 2.15%
Endowment Income 9,473 9,947
Unrestricted to University 3,869 4,582 18.43%
Unrestricted to Centers 3,707 4,375 18.02%
Investment Income 10,592 11,713 10.58% 1,500 1,918 27.87%
Gifts 23,000 24,150
Unrestricted to University 2,950 3,850 30.51%
Unrestricted to Centers 11,047 13,522 22.40%
Contracts & Grants 128,388 135,679
Recovery of Indirect Costs
Endowments 1,434 1,790 24.83%
Gifts 1,542 1,734 12.45%
Contracts & Grants 41,738 44,796 7.33% 2,100 2,595 23.57%
Sales & Service, Auxiliary
Enterprises & Other Sources 117,111 126,642 8.14% 66,856 115,684 73.03%
Total Revenues 522,470 548,531 4.99% 70,456 120,197 70.60% 160,861 169,775

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 Unrestricted budget Restricted budget
1999- 2000-
1999-2000 2000-2001 2000-2001 1999-2000 2000-2001 2000-2001
2000 2001
Unrestricted Unrestricted % from Patient care Patient care % from
budget budget
budget budget 1999-2000 budget budget budget
Expenses Compensation
Faculty Salaries 92,840 100,599 8.36% 22,890 40,475 76.82% 49,052 52,486
Other Salaries & Wages 155,535 160,832 3.41% 23,593 37,890 60.60% 31,087 32,952
Fringe Benefits 71,337 75,285 5.53% 9,535 15,884 66.59% 22,917 24,063
Total Compensation 319,712 336,716 5.32% 56,018 94,249 68.25% 103,056 109,501
Equipment
Library 3,989 4,383 9.88%
Other than Library 6,849 7,393 7.94% 44 81 84.09% 18,000 18,900
Student Aid 52,773 54,439 3.16% 21,492 22,996
Telephone 7,180 8,042 12.01% 66 120 81.82%
M & S, Travel & Others 98,548 90,858 -7.80% 14,175 25,701 81.31% 18,313 18,378
Utilities 14,503 16,447 13.40%
Debt Service 18,916 30,253 59.93% 153 46 -69.93%
Total Expenses 522,470 548,531 4.99% 70,456 120,197 70.60% 160,861 169,775

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EXHIBIT 3 Indirect cost pools

Cost pool Administrative center (source) Allocation in proportion to

revenue centers

Student Aid Admissions & Fin. Aid Number of students enrolled

Operations & Business Affairs Costs incurred in specific buildings

Maintenance and the net square footage
occupied

Telephone Office Business Affairs Number of lines and instruments

Computer Usage University Computing Center Use

Library Library Acquisitions and use

Student Services Admissions & Fin. Aid, Fin. Services, Total undergraduate and/or
Student Affairs, Registrar graduate tuition units

Cultural Services Academic Administration Use

Development University Relations 5-year average gift receipts

General Fin. Services, Business Affairs, Office of the Total direct expense
Administration President, Office of the University Budget,
Treasurer

General Expense Legal Services, Business Affairs, Office of Total direct expense
the President
(i.e. corporate obligations)

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