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The private schools’ fee enigma

Karachi

May 26, 2019

Schooling is an expensive business worldwide, especially if it is not subsidised by the government. A typical family spends a significant chunk of its income on children’s schooling, especially considering the relatively large family size of 5-6 persons, on average, in Pakistan. There is an impression that private schools are earning excessive profits. And this may be true as well in a few cases. However, the Supreme Court judgement on the private school fees seems to lack basic understanding of the economic, commercial, and business considerations relating to the issue.

Pakistan has about 50 million children of school-going age, of whom about 23 million are not attending school at all, the key reason being that the government has failed to build sufficient schools’ infrastructure to cater to these students, and the poor parents lack the resources to send their children to private schools. About 16 million children are going to government schools, where independent studies have shown that even a fifth-grade student, on average, cannot write a sentence in Urdu. About forty percent of government schools in the country lack electricity, boundary walls, clean drinking water, furniture, and toilets. Pakistan is ranked 167 in the world on school enrollment and on how much the government spends on education. The government has failed to provide education to the nation’s children, which is a key reason why we are falling behind South Asia and even Africa in human and economic development. Only about 11 million out of 50 million children who are studying in private schools are getting a decent level of education. Even poor parents prefer to send their children to low-cost private schools rather than “free” government schools, understanding the quality difference.

Those who are running private schools are clearly in this business to make a decent return. Otherwise, they could have gone into any other line of business or opened a not-for-profit school. In the process, they are making a huge contribution towards providing quality educating to the nation’s children, where the government has failed to fulfil its constitutional obligations. Private schools’ owners are entitled to a reasonable profit for them to not switch to another business, to not lose interest in providing quality education, and also to encourage more entrepreneurs to get in this line of business considering that over two million children become school-going age every year, and about half of children in Pakistan are out of school.

Private schools neither have monopoly or oligopoly characteristic. In a radius of 2-3 kilometres one can find a private school charging a monthly fee of Rs500, another Rs5,000, and a third possibly Rs25,000. Thus, there is sufficient choice and competition, and market forces are playing their role in fee determination. Parents send their children to private schools while keeping both price and quality in mind. If a parent can no longer afford a school fee of say Rs5,000 per month, he or she can move the child to another school charging a fee of Rs4,000 per month, compromising a bit on the quality of education. Under such a scenario, it is not generally advisable that the courts or the government should intervene in the pricing/fee structure of schools. Globally, governments or courts intervene in pricing only in businesses that enjoy a monopoly status (no-competition, such as Karachi Electric).

The one-time reduction in schools’ fee, and a 5 percent per annum or so fee increase cap by the court will certainly impact the quality of education in these schools. Most private schools are on rented property where the rent is increased by a minimum of 10 percent per annum, while electricity and other utilities’ prices are expected to rise by 20 percent this year. Will the teachers be satisfied by a five percent increase in their salaries when inflation is expected to be in double digits? Will good teachers stick with the schools or open their own tuition centres or join another profession? The school fee cap will force schools to cut corners by replacing better teachers on higher salaries with average teachers on lower salaries, cutting on computer labs, electricity and air-conditioner use (for schools that have such facilities), student-teacher ratio, co-curricular and extra-curricular activities, and other value-added services. My prediction is that in the next 2-3 years, parents, alarmed with the substantial drop in the quality of their children’s education, will resort back to the courts, requesting that the cap on fee increase be removed. However, the children would have suffered immensely in the meantime.

If the Supreme Court had consulted some financial experts on this matter, I believe they would have recommended a return on equity cap, rather than a fee cap. Return on equity (ROE) is the profit that an investor earns on his or her equity investment in a business. The prevailing risk-free rate if someone keeps money in a bank or invests in a national savings scheme of 10-year maturity is about 13 percent per year at present. When someone invests in a business, he or she is not only taking the business risk, but also committing his or her time and efforts, and dealing with several government departments, which is a nightmare in Pakistan. Thus, the expectation is to earn a higher return than the risk-free rate.

Certain prestigious private schools are said to be earning a return on equity of about 26 percent, on average, while their profit margin (profit after tax as percentage of revenues) is around 5.5 percent. Let’s compare this with the average return on equity earned by hundreds of business from various sectors listed on the Pakistan Stock Exchange (PSX). The average ROE of businesses listed on the PSX is around 19 percent. However, the best ten companies listed on PSX have an average return on equity of 43 percent. Some of the private schools that are under scrutiny of the courts are very reputable names, with several decades of track records of quality education. Therefore, they deserve a higher ROE than an average business in the country. It is recommended that the Supreme Court should move from the fee cap methodology to a return on equity cap methodology to enable private schools to make a reasonable return, enabling them to continue to grow their branch network to cater to the millions of children who are either becoming school-going age, or are receiving poor quality education. In my view, the maximum return on equity allowed to private schools should be 30 percent (or 20 percent after tax). This will restrict these schools from making abnormal profits, while still encouraging new entrants to enter the industry to build new schools, which is a desperate need of the country. If a school’s audited financial statements show that the ROE is in excess of 30 percent (or 20 percent after-tax), the school should be required to reduce its fee to remain within the cap. Many private schools are using audit firms that are not particularly well-known, while a few employ highly reputable firms. The court or the government may provide a list of reputable audit firms, and the schools should be mandated to use one of these firms to audit their accounts.

As highlighted above another way of analysing the reasonableness of the profitability of a business is to examine its after-tax profit margin. The average after-tax profit margin of the businesses listed on the PSX is 11 percent versus 5.5 percent for private schools under scrutiny. This shows that these schools, on average, are not making abnormal profits, although there may be some exceptions. The former chief justice of Pakistan passed an interim order to reduce school fees by 20 percent, and return 50 percent of the summer fees. The average after-tax profit margin of the schools under scrutiny is 5.5 percent as discussed above.

In this scenario, the management of the schools will have no choice but to cut costs, which will have a direct impact on the standard of education. Whereas, all the major overheads (salaries, rents, repair & maintenance, etc) are the same for 12 months of the year, charging of fee for 11 months does not seem fair.

To summarise, some controls on private schools and hospitals are necessary as they are providing a public service. However, they should not be financially squeezed to a level where they are forced to compromise on quality, and where new entrants are discouraged from entering these businesses. This will be disastrous for the country, keeping in mind the state of government schools and hospitals. Fixing a five percent cap on the fee charged by these schools is unrealistic and does not make financial sense. Following substantial devaluation of the currency, inflation is expected to touch double digits soon. I propose that a maximum cap of 30 percent of return on equity (or 20 percent after taxes), be imposed on private schools, their accounts be audited by reputable audit firms, and a government school regulatory body should ensure that this cap is being complied with.

If the government is serious about reducing the fee charged by low-cost private schools, it should exempt all schools charging a fee of Rs5,000 per month or less from all types of taxes, start charging residential rather than commercial electricity rates on such schools, and then ensure that these savings translate to lower school fee, without any compromise on quality. This will not only reduce the education burden on poor parents substantially, but also encourage more people to open schools to fill the huge education gap at present.

The author, Dr. Amjad Waheed, holds a doctorate in finance, and has no stake in any private school.

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