The Unintended Consequences of Ending Merit Aid

Council of Independent Colleges

S. Georgia Nugent, president of Kenyon College, has become the public face of a campaign to focus aid on financially needy students.
March 25, 2013

This winter, when a group of private-college presidents decried the escalating use of merit aid and pledged to focus their support on needy students, their message was welcomed by many. Merit aid is wasteful, some educators and experts say, maybe even immoral when most colleges can't meet students' financial need.

In the past couple of decades, merit aid has become an increasingly popular enrollment tactic. For many colleges, offering recognition and a discount brings in stronger students than they'd otherwise get. For some, it's the only way to sustain enrollment.

But colleges' reliance on discounts rather than their own distinctive qualities in competing for students devalues higher education, says Tori Haring-Smith, one of the presidents who released the pledge, still in draft form. Merit-aid bidding wars signal to students and parents that college is overpriced, says Ms. Haring-Smith, who leads Washington & Jefferson College.

Yet backing away from merit aid, even if a noble, popular move, would come with unintended consequences. Colleges are not businesses, but they have to cover their costs. And merit aid helps them make ends meet.

That's because it works differently than people might think. In most cases, it's not like an allowance, money a parent could have spent on anything and uses to reward a child's behavior. It's more like a retail store's offer of $25 off a $75 purchase to customers who wouldn't normally shop there. Like that coupon, a scholarship is a pricing strategy meant to increase revenue. Without it, some colleges, both public and private, would struggle to attract students whose families could pay all or most of their price. The institutions would bring in less money. And ultimately, that would reduce what they could provide in need-based aid.

What's more, the line between merit and need-based aid is blurry. For instance, if a student is found to have $10,000 of financial need, and a college gives him a $5,000 merit scholarship, it will help meet his need. And the formula used to determine students' need produces numbers few find realistic. So even a student found to have no financial need may not be able to pay full price.

Everyone can probably agree that Bill Gates's children don't need scholarships, says Jon Boecken­stedt, associate vice president for enrollment at DePaul University. But can a family making $160,000 really come up with the $45,000 a year the formula expects? "It doesn't even pass the laugh test," he says. A merit scholarship can make college much more affordable for such a family.

Still, let's say that the criticism takes hold, and merit aid goes away. Students with financial need would be prioritized—although it's unclear whether colleges would have more money to support them. That's because fewer tuition dollars may be flowing in, as wealthier families, faced with the full price of a private education, would be unwilling or unable to pay. Their children might choose public colleges instead.

Imagine a set of colleges that compete for students only with one another, says Michael McPherson, a higher-education economist and former president of Macalester College. That's not so different from how the Ivy League operates now. But step outside the Ivy League and the picture changes, he says. "The best hope a college outside of the charmed circle has of getting some of those super students is to offer them a deal."

By that logic, the strongest colleges in the hypothetical set would benefit from a moratorium on merit aid, Mr. McPherson says.

They would fall back on their reputations and lose fewer students to their less-prestigious peers. But those colleges, which probably rely the most on merit aid, would struggle to win any students from the better-known colleges.

So if they didn't discount their prices, what would the weaker colleges do?

They'd get a wake-up call, says David Strauss, principal with the Art & Science Group, a higher-education consulting firm. Discounting can trick colleges into considering themselves destinations for smart kids, he says. When really, they're just cheap destinations for smart kids. Eventually, those colleges would have to find a way to attract students without a coupon.

Maybe that would lead institutions to compete on the meaningful characteristics that set them apart. "We might be forced to be more precise about our particular personalities and our particular strengths," says Ms. Haring-Smith, of Washington & Jefferson.

Colleges that didn't or couldn't distinguish themselves would see their enrollments fall and their main source of revenue—tuition—slip away. Some might end up out of business.

Of course, even without merit aid, colleges could still offer enticements based on price, say by slashing tuition. That might sound like good news. Tuition cuts are popular, and at first blush it seems like everyone wins.

But in all likelihood, many students on financial aid would end up paying just as much as they did before. When colleges cut their prices, they usually cut their aid, too. Full-pay students do benefit, since they're paying the new lower price. The big winners, then, are students from higher-income families. That's exactly the problem critics have now with merit aid.

So yes, colleges could stop discounting. But as long as they rely on tuition revenue, they'll do something to attract students who can bring in a lot of it.