The University issued its annual financial report today, with a letter from Vice President for Finance Dan Shore and Treasurer James Rothenberg highlighting how Harvard’s financial profile “has changed considerably.” Shore and Executive Vice President Katie Lapp spoke with the Gazette about the ramifications of that changing profile.

GAZETTE: What do you think should be the main takeaway from this year’s annual report?

SHORE: We had a slight deficit, about $5 million on a budget of $4 billion. That’s not worrisome in and of itself. It’s the same type of deficit that we had last year. What is a matter of concern and what readers hopefully will take away is the pressure we feel on our main sources of revenue — the endowment payout, sponsored research, particularly funding that we get from the federal government, and tuition in the context of an economy that isn’t coming back as quickly as anyone would like. We feel like the future could hold continuing and long-lasting pressures for Harvard, and we need to continue to think about how to manage our expenses really carefully, and how to think, perhaps, more creatively about new sources of revenue in order to continue to thrive in a very uncertain world.

GAZETTE: One of the letters that introduces the report talks about two eras — a period of great expansion of programming and faculty and facilities, and then the period after the global financial crisis of 2008.

SHORE: Before the financial crisis, there was an unprecedented level of growth in the country, and when you look at our endowment, we enjoyed, more or less, uninterrupted decades of prosperity. The financial crisis changed us significantly. Now, we have to live in a different context. Before, we might have been lulled into a sense that we could live in more of an unconstrained environment.

LAPP: I just want to elaborate on that. One of the things, I think, that has happened here at the University since 2008 is the tremendous amount of work that Dan and his team and others have done introducing strong financial planning processes, strong capital planning processes, processes for managing our debt, assessing our liquidity — things that really have to be done in order to allow us to make strategic choices. The governance reforms that were introduced by President Faust and the Corporation about a year and a half ago have really strengthened oversight, and helped inform some of our recent strategic investments.

GAZETTE: Can Harvard afford to be as ambitious as it once was given the constraints that you’re describing?

SHORE: We have to continue to have ambitions, and we need to be able to invest in things that we think are critical to maintaining and enhancing our distinctiveness within higher education. To do that in the context of pretty serious economic headwinds, we need to be able to make choices. I don’t see a dissonance between making investments and making choices. Maybe there are certain activities we should do less of, or eliminate altogether. Those are the kinds of choices that strong institutions make in order to continue to pursue the things that they think are most important.

GAZETTE: At the same time, Harvard is also pursuing a number of new initiatives — from the development in Allston to edX to House renewal for the undergraduate residences.

LAPP: The Houses are critical assets that the University wants to maintain and enhance. EdX is a tremendous opportunity to be on the forefront of online learning. Those are strategic commitments that the University has decided to invest in for the future. We made those choices consciously, in the context of all of these new processes that we have in place. In Allston, the planning has shifted significantly in the last few years. It’s much more focused on a five- to 10-year time frame; it’s using our assets to generate income that will support other projects. The big project we’re building in Barry’s Corner, the multiunit market-rate rental housing and retail complex, is being done with a developer, and the long-term ground lease will be providing income to the University.

GAZETTE: When most people look at an institution with a $30 billion endowment, they probably assume that it has the resources to do whatever it pleases.

SHORE: The endowment is an invaluable asset to Harvard and certainly suggests, just by the sheer magnitude of the number, that we do have considerable resources that we can tap into. But the reality is that those resources need to be sustained for generations. So, when you see a multibillion dollar endowment, that doesn’t mean you can spend multiple billions of dollars on the things that you think are important today because the endowment needs to last forever. That’s the nature of an endowment.

When you think about what our commitments are, just how the University works, we are a University that is made of people. People make the University successful. But having a lot of people, needing a lot of physical space to house the people and to house the programs that make Harvard distinctive, those are all fixed costs. Higher education tends to look more fixed than most other industries. So, we need reliable funding sources for those fixed costs. The endowment’s one, tuition’s another. Research funding represents the compact that we’ve had with the federal government to cost share for biomedical research and scientific advancements. But, again, you need to invest an awful lot in laboratories, and the people who are going to work in laboratories, in order to really make that work. So while at first blush, you would think that a $30 billion endowment would allow you to do everything, the reality is that you still absolutely need to make choices.

GAZETTE: And the endowment is still about 20 percent off its peak in 2008, correct?

SHORE: Right. We try to make sure that we’re spending about 5 percent of the endowment every year for our operations. When you lose 20 percent, you’re essentially losing 20 percent of the revenue that you would get from that funding source. And again, with a lot of fixed costs at Harvard, it becomes a management challenge to think about how you do business differently in order to accommodate lower revenue.

LAPP: It’s also worth remembering that we have a huge commitment to financial aid, and much of our tuition goes to support that very important initiative. And nobody wants to be increasing tuition to a point where people just can’t afford a college education. That’s something we always have to take into account, and so tuition is not the place where revenue is going to be generated in any significant way. And then, as Dan mentioned, there is the pressure that we know is happening in Washington with regard to the federal budget, and what that may hold for the research funding universities across the nation rely on.

GAZETTE: Harvard invests nearly $2 billion annually in compensation for its employees. What has been done to mitigate the pressures on the workforce as Harvard tries to operate within the financial constraints you have described? And moving forward, what may be changing in terms of compensation and benefits and the way people work at Harvard?

LAPP: We really value our workforce, and we want to pay competitive wages. We are proud of the fact that we pay very competitive wages and benchmark in the top 25 percent when we look at the Boston market. Having said that, we also have the pressures on our costs, and, as you just alluded to, half of our budget goes to wages and benefits. We take all of that into account when we try to figure out wage increases and changes in benefits. Our benefits cost has doubled in the last 10 years. That is a trajectory that we cannot sustain. So, we made some changes in our benefits programs last year, and we are making some more during this year’s annual open enrollment process. We have to do this in order to be able to provide a financially sustainable program for our employees, and for our retirees.

GAZETTE: Right now, the University is engaged in negotiations that have gone on longer than many expected with the HUCTW. Are these current constraints a factor in these negotiations?

LAPP: Absolutely. We’ve been at the negotiating table for months. We have negotiated in good faith, and we continue to do that. We have put what we believe to be a competitive wage package on the table. We have to take into account all of the financial constraints that are facing this University when we put together a compensation program for our employees, whether they be union employees, non-union administrators, or faculty. The offer we have made to the HUCTW is consistent with the contracts that we’ve reached with seven other unions in the past year, ranging between 2 and 3 percent increases in wages.

GAZETTE: Do you think a new mindset needs to take hold at Harvard when it comes to budgeting and priorities?

SHORE: Anyone who thought that the financial crisis came and went and that it’s business as usual at Harvard again is just as mistaken as someone who thinks that the U.S. economy is completely back on its feet. I think that everybody at Harvard, recognizing that we need to make choices, should look at their day-to-day work and think about whether they are doing it in the most efficient way. Are there smarter ways to do our jobs? Are there more creative approaches to doing our jobs? Have an open mind about the ways in which we can adapt to the current circumstances. Nobody can live in an unconstrained environment anymore, and we need to make choices about where and how we invest. It’s difficult to change your mindset that dramatically, but that’s the world that we find ourselves in, so the more quickly and successfully we can adapt to that, the better off we’re going to be.

LAPP: I would urge everyone in the University to read Dan and Jim Rothenberg’s letter, which really encapsulates the challenges that this University is facing. I think it’s an important touchstone that can help people to appreciate the challenges. Change is difficult in any environment, and we’ve made a lot of changes since 2008. We will continue to have to make changes over the next several years, whether it be ways in which we can be more efficient, as Dan indicated, or ways in which we can generate additional revenue. What we hope that people understand is that as we go through this change, we need a team effort, and the reason why we’re doing these things is to deal with the real constraints that confront the University.

Woodworkers