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Chapter 16 • Management Control in Not-for-profit Organizations

CASE STUDY
University of Southern California: Responsibility Center
Management System

In 1981, a major change was made to decentralize the alumni. USC employed over 3,200 full-time faculty
management of the University of Southern California. members, and had annual operating revenues of
Deans of schools and managers of administrative units $2.5 billion. It was the largest private employer in Los
were given the authority for most of the decisions that Angeles and the third largest in the state of California.
would determine the university’s academic and fiscal Exhibit 1 shows some quantified university highlights.
success. To hold the operating managers accountable The university’s academic and administrative pro-
for the fi nancial consequences of their decisions, the grams were led by president Steven Sample (see
university implemented a financial control system orig- Exhibit 2). All of the school deans and a number of sen-
inally called the Revenue Center Management System. ior academic administrators reported to the provost,
Most people who were familiar with the system cred- Max Nikias, who was USC’s chief academic officer (see
ited it with playing a significant role in USC’s success Exhibit 3).
over the years, particularly because it provided a high As a research university, USC’s goals included both
degree of financial transparency and encouraged aca- creation and transmission of knowledge (see the state-
demic deans to be entrepreneurial, market-savvy, and ment of mission and goals in Exhibit 4). Thus USC’s fac-
fiscally responsible. ulty was expected to engage in basic or applied research
This system, which over time became to be known as well as to perform their teaching. USC supported its
as the Responsibility Center Management System activities primarily by generating tuition revenues,
(RCMS), was still being used in 2008, but critics com- securing research sponsorship, and attracting philan-
plained that the system had a number of serious, unin- thropic contributions. Because its endowment-per-
tended, dysfunctional side effects. USC administrators student was relatively small, the university was heavily
had modified some of the RCMS elements over the dependent on tuition revenues. However, it was suc-
years to try to maintain the advantages of the system cessful in generating research funds. For example, USC
while minimizing these side effects. More changes ranked 17th among the nation’s universities in receipts
were possibly forthcoming. of federal research and development funds.
Overall, USC’s top priority was to enhance its aca-
demic reputation, and there is evidence that it was
The University of Southern California doing so successfully. In recent years, USC had risen
The University of Southern California (USC), estab- sharply in the many university rankings. For example,
lished in 1880, was California’s oldest private, research in 2008, US News & World Report ranked USC 27th in its
university. Located on the perimeter of downtown Los list of “America’s Best Colleges,” up from a ranking of
Angeles, USC was a diverse and complex organization. 41st just 10 years earlier.
It ran 19 colleges and schools, more than any other pri-
vate university in the United States. It enrolled over
33,000 students from all 50 US states and from
Strategies
115 countries. The student body included almost 7,000 On October 6, 2004, USC’s Board of Trustees approved a
international students, more than at any other univer- new strategic plan called the Plan for Increasing Aca-
sity in the United States. Undergraduate students could demic Excellence.1 This plan stated the following
design degrees from 77 majors and 147 minors. Gradu-
1
ate students could earn degrees in 139 areas of study. The full text of the plan can be seen at www.usc.edu/about/core_
documents/2004_strategic_plan.html
The “Trojan Family” included over 194,000 living
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University of Southern California: Responsibility Center Management System

objective: “USC intends to become one of the most influ- compared to their budget. One finance manager
ential and productive research universities in the world.” recalled that:
The strategic plan focused attention and resources
Some units would consistently overrun their budg-
on three areas that had to be addressed for USC to
ets, and some had substantial overruns. Most of
achieve its goal of providing leadership to the academic
the overruns were due to under-generated reve-
world and society as a whole:
nues, rather than cost overruns. No one had any
1. Meeting societal needs, through research and edu- explicit incentives to manage differently.
cation that examines, anticipates, and resolves
Some deans were also seen as spendthrifts, and some
pressing societal urgencies;
in the central administration believed that one of their
2. Expanding USC’s global presence, through collabo- key roles was to protect the university and its units
ration with institutions around the world, especially from financial ruin.3
in the Pacific Rim; and
3. Promoting learner-centered education, through
adaptive and flexible approaches that redefine
RCMS Design Principles
learning, as the context and content of higher educa- Work on the RCMS began in 1981, at the beginning of a
tion change rapidly. period that promised to be difficult because significant
declines in the population of traditional college-aged
The plan also identified four strategic capabilities
persons necessitated budget cuts. The RCMS was
that should be developed to position USC for success.
designed by a Task Force on Budget Incentives appointed
These were (1) span disciplinary and school bound-
by then-university president James Zumberge. The Task
aries to focus on problems of social significance, (2)
Force based much of the RCMS design on the system
link fundamental to applied research, (3) build net-
used at the University of Pennsylvania (Penn) which, in
works and partnerships, and (4) increase responsive-
turn, was adapted from the system in use at the General
ness to learners.
Electric Company. Reginald Jones, GE’s then-chairman,
had been on the board of trustees at Penn, and he
The Management System insisted that this kind of system would provide a better
Prior to RCMS alignment of authority and responsibility and, hence,
better university management.
Prior to implementation of RCMS, decision-making
The objectives of systems like that used at Penn
power at USC was centralized. One senior administra-
included “clarifying roles and responsibilities between
tive officer – the provost – played the key role in all
local and central units, linking cause and effect through
major resource allocation decisions. Dennis Dougherty,
revenue and indirect cost allocations, placing local aca-
USC’s chief financial officer (CFO), remembered that
demic planning decision making in a cost/benefit con-
“The old system relied on personal negotiation. The
text, and unleashing entrepreneurship.”4 Overall, they
resource allocation decisions were made behind the
allow universities to focus on outcome measures rather
scenes in a ‘smoke filled room.’”
than relying on bureaucracies to administer process
Also in the old system, financial accountability for
controls.
the unit heads was weak. Each university unit (schools
USC’s design task force developed the following
and departments) had its own financial statement, but
nine management principles to guide their develop-
the statements were not complete. Some revenues and
ment of the USC RCMS:5
costs were neither traced nor allocated to the units that
generated them. Some deans felt that the more money
their schools generated, the greedier the central 3
Ibid.
administrators became.2 Furthermore, unit heads were 4
J. R. Curry and J. C. Strauss (2002), Responsibility Center Manage-
not sanctioned for producing unfavorable variances as ment: Lessons from 25 Years of Decentralized Management (Annap-
olis Junction, MD: National Association of College and University
Business Officials), p. 3.
5
J. R. Curry (1991), “Afterword: The USC Experience with Revenue
2
A. Rahnamay-Azar, “Revenue Center Management at the Univer- Center Management,” in E. L. Whalen, Responsibility Center Budg-
sity of Southern California: A Case Study,” unpublished doctoral eting: An Approach to Decentralized Management for Institutions of
dissertation, University of Pennsylvania, 2008. Higher Education (Bloomington: Indiana University Press), p. 178.

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Chapter 16 • Management Control in Not-for-profit Organizations

1. Responsibility should be commensurate with center managers. As noted in USC’s 1985 Financial
authority, and vice versa. Report:
2. Decentralization should be proportional to organi-
At USC, we believe that the primary planning takes
zational size and complexity.
place at the operating unit level: the school or
3. Locally optimal decisions are not always globally auxiliary enterprise, or the administrative unit. We
optimal: central leverage is required to implement believe that people closest to the action know
corporate (global) priorities. their programs, their customers, and their markets
4. Outcome measures are preferable to process con- best; they are best informed and, therefore, the
trols. most capable of strategic thinking. The role of
central planners is primarily one of coordinating
5. Accountability is only as good as the tools which
and monitoring.
measure it.
6. Quantitative measures of performance tend to drive The central administration maintained the power to
out qualitative measures. hold the responsibility center managers accountable
7. Outcomes should matter: plans that work should for attaining their targets. The academic revenue
lead to rewards; plans that fail should lead to sanc- center managers (i.e. school deans) were evaluated in
tions. terms of their units’ academic excellence (research and
teaching), generation of sponsored research grants,
8. Resource-expanding incentives are preferable to
faculty development, fundraising, and bottom line
resource-dividing ones.
financial performance. Their performances were
9. People play better games when they own the rules. reviewed formally every five years.
The new RCMS system had to include three basic
elements that would permit a decentralized manage- Performance Reports
ment system within USC. First, the university had to be
divided into responsibility centers. Second, the perfor- USC produced an elaborate set of reports to facilitate
mance reports, including methods for tracing or allo- control of each responsibility center’s operations. A
cating shared revenues and costs to the primary monthly financial report presented the current month’s
operating units, had to be designed. Third, the extent and year-to-date performance as compared to budget.
of decision authority to be delegated to the operating Other reports provided information on gifts, grants,
units needed to be clarified. enrollments, student numbers, personnel, space usage,
and the detailed items affecting the revenues and
expenses of each responsibility center. The financial
Responsibility Centers reports included four primary categories of accounts:
revenues, direct expenses, indirect expenses, and par-
USC was comprised of two types of responsibility cent-
ticipations/subventions.
ers, revenue centers and administrative centers. Reve-
nue centers were organizational units to which revenues
Revenues
could be uniquely attributed. Some of these, the col-
leges, schools, and research institutes, were called The revenue centers were allowed to keep the reve-
“academic” revenue centers. The other revenue cent- nues they generated. The university generated two
ers, including athletics, residence halls, bookstores, types of revenues: designated and undesignated.
parking operations, and food services, were called More than 25% of the total funds available to support
“auxiliary” revenue centers. Administrative centers operations were designated, meaning that they were
were entities that did not generate revenues directly given to the university for a specific purpose or pro-
but performed activities that supported the revenue ject. These funds came from grants and contracts
centers. Examples included Admissions and Financial from the federal government and other sponsors of
Aid, Business Affairs, Financial Services, Legal specific research projects, from gifts from private
Services, Library, Office of the President, and Registrar. donors and foundations, and from income from
Most of the responsibilities for raising revenues and endowments to support specific individuals and/or
expending resources were delegated to the revenue activities. The designated revenue funds had to be

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University of Southern California: Responsibility Center Management System

used only for the specific purpose for which they were Dennis Dougherty concurred:
given and were not allowed to be transferred to an
Our allocations of indirect cost are done with
undesignated account without prior permission from
thumbnail methods that are much less precise than
the central administration.
precise. No study was done, but the allocations
The other revenues were undesignated. They came
were somewhat thoughtful. We developed rules of
from tuition and fees, unrestricted gifts, and indirect
thumb and tried to remove blatant inaccuracies.
cost recoveries from government contracts. Tuition
revenue was credited 100% to the revenue center Over time, the number of cost pools grew. By the late
offering the course taken. Undergraduate student aid 1990s, the number of allocation bases in USC’s indirect
was administered centrally and charged to academic cost allocation system grew to more than 150.
centers on a predetermined percent of undergraduate
tuition. For FY08, that rate was set at 28%. The indi- Participations and subventions
rect cost recoveries were determined by formula
University administrators used a system of participa-
negotiated with each funding source. For example,
tions and subventions to maintain a degree of control
USC’s indirect cost recovery rate on US government
over university-wide resource allocation decisions and
projects was 63% of direct costs. That is, for every
to even out the distribution of monies between revenue
dollar reported as the approved direct costs of a
centers. Participations were contributions required
research project, the university received an addi-
from all academic revenue centers, based on an equal
tional 63 cents to help cover indirect costs. But on
proportion of tuition and fees, sales or service income,
other projects, the recovery rate was lower. Those
and indirect cost recoveries, to further the objectives
funded by the Kellogg Foundation, for example, pro-
and well-being of the entire university. In the revenue
vided only an 8% recovery rate, and some grants pro-
center financial reports, participations were shown as
vided for no overhead cost recovery.
negative indirect income.
These contributions, along with revenues from other
Expenses
discretionary funds (investment income and income
Under RCMS, each revenue center was responsible from endowment restricted to the provost), were redis-
for the full costs of its operations. The direct expenses tributed back to revenue centers as block grants histori-
of a revenue center included the costs of the people cally called subventions. Provost Nikias avoided use of
and the equipment directly assigned to that center. the word “subventions” because, he believed, it
Indirect expenses included the costs of shared made the grants sound like entitlements. He preferred
resources, such as buildings, utilities, and various to call them either Academic Initiatives or Provost’s Ini-
kinds of support (e.g. libraries, computing, security, tiatives. Academic Initiative funding was defined in
transportation, student aid) provided by the adminis- USC’s 2007 financial report as for “specific activities for
trative centers. a limited time period.” Provost’s Initiatives funding
Since the inception of RCMS, the university relied on was allocated “to support university priorities.”
a complex set of allocation methods. University admin- When they made their allocations of subventions,
istrators, in collaboration with revenue center manag- the administrators, particularly the provost and presi-
ers, determined what centers shared what cost pools dent, tended to focus on three key factors: (1) differen-
and how the costs would be spread across pool partici- tials in the costs of educating students in different
pants. Some cost allocations were based on actual fields; (2) the revenue centers’ cost/quality ratios; and
usage, but others were based on approximations. (3) university priorities.
John Curry, USC’s then-vice president of budget and The cost of educating students varied widely
planning, acknowledged that the allocations were between schools. Some schools could educate their stu-
based on: dents effectively by teaching them in large sections,
while others had to provide instruction in small classes
[. . .] imperfect rules, some of which were totally
or in expensive laboratories. John Curry explained:
arbitrary. We used Federal government allocation
guidelines as a guide, but we also put together a The cost of educating a music major is large, espe-
group of deans and administrators and hammered cially in a conservatory-like program like ours. The
the rules out. dominant mode of instruction is one-on-one; a

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Chapter 16 • Management Control in Not-for-profit Organizations

master pianist and pupil on the same bench. Busi- Thornton School received much larger subventions,
ness education is much less expensive, as account- both in total and in a relative sense.
ing and finance can be taught well to classes of 25
or 50, or even more. But we as a university have
decided to charge both music and business stu-
Intercenter Bank
dents the same tuition. Common price, but most The RCMS included one other significant element, an
uncommon “unit” costs! Intercenter Bank. This bank provided revenue centers,
but not administrative centers, the opportunity to carry
Part of the subvention allocations was aimed at even-
unrestricted funds across fiscal year boundaries. It thus
ing out this cost disparity.
provided revenue center managers incentives to produce
The subjectively determined ratio of costs to aca-
year-end surpluses rather than just to meet a break-even
demic excellence represented what the university
bottom-line. It also reduced the “use-it-or-lose-it” men-
administrators perceived they were receiving for their
tality, present in some not-for-profit organizations,
investment. This is illustrated in Figure 1. A school
which causes managers to spend all the money that had
located near point 3, such as the Thornton School of
been approved in their budget before the year-end.
Music, with both high cost of instruction and high aca-
The Intercenter Bank was used both by revenue
demic excellence,6 was most likely to get a dispropor-
centers reporting surpluses and by those reporting
tionately high subvention. It offered high-quality
losses. If a revenue center had a surplus, it was given an
programs and research productivity but was unable to
account in the bank and provided interest on the
cover its costs through tuitions. A school located near
account balance at the fiscal treasury-bill rate as of
point 4 was valuable to the university because it offered
July 1 of the year just started. These revenue center
high quality and financial independence. It could prob-
managers were to spend their account balance in future
ably provide funds that can be used in other parts of the
years, but only up to a maximum of 20% of the balance
university, but administrators had to be careful to allow
each year. Conversely, revenue centers with a deficit
it to keep enough funds to maintain its excellence. A
were assigned a loan from the bank that charged inter-
school located near point 2 was in trouble. It was a can-
est at the treasury-bill rate. They had to budget for
didate for new leadership or program discontinuance.
repayment of the loan at a rate of at least 20% of the
To illustrate the wide disparity in subvention
beginning balance each year.
amounts, Table 1 shows the 2007 summary income
statement numbers for the Marshall School of Business
and the Thornton School of Music.7 As can be seen, the Criticisms of the RCMS System
Over the years, various faculty groups and other critics
Figure 1 Cost/academic excellence ratios voiced a number of complaints about the RCMS. These
included criticisms that the system discouraged inno-
vation, multidisciplinary research, and the seeking of
some outside grants and that it encouraged both the
proliferation of redundant and inappropriate courses
and end-of-period financial gameplaying. It also stimu-
lated numerous debates about the fairness of alloca-
tions of indirect costs.

Discouragement of innovation
The discouragement-of-innovation criticism stemmed
from the belief that the RCMS forced deans to think of
their mission more in financial terms than in terms of

7
The entire USC 2007 financial report can be seen at www.usc.edu/
private/factbook/USC.FR.2007.pdf. On pages 20–23, this report
6
Rolling Stone magazine ranked the USC Thornton School of Music shows revenue center summaries for all of USC’s colleges, schools,
as one of the top five music schools in the United States. centers, institutes, healthcare services, auxiliaries, and athletics.

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University of Southern California: Responsibility Center Management System

Table 1 Individual revenue center summary (2007–2008 budget) ($000)

Marshall School of Business Thornton School of Music

Undesignated Designated Undesignated Designated

Revenues:

Direct: $126,866 $12,928 $22,044 $2,404

Center 156,799 12,928 28,862 2,404

UG Student Aid Fund (25,434) (6,012)

Facilities Improvement Fund (4,499) (806)

Indirect: (8,485) 2,951

Participation (10,078) (1,911)

Academic Initiatives 4,500

Provost’s Initiatives 35 97

Graduate Programs 1,558 265

Total Revenues $118,381 $12,928 $24,995 $2,404

Expenses:

Direct $85,846 $12,928 $17,106 $2,404

Indirect 32,535 7,889

Allocated Central Costs 30,292 6,944

Facilities Based 2,243 945

Total Expenses $118,381 $12,928 $24,995 $2,404

their academic mission. An open letter sent by some financial performance would lead university administra-
faculty to President Sample stated: tors to hire deans with, perhaps, more financial manage-
ment abilities than leadership vision for their schools.8
The system in place makes few allowances for the Another group of critics believed that innovation
various missions and contributions of the academic and initiative were stifled because RCMS institutional-
units of the university. Those units unable to show a ized decentralization only to the level of the deans and,
“profit” under current budgetary formulas are con- thus, did not go far enough. Deans were unlikely to
demned to live in a deficit situation, to depend carry the delegation any further and, as a consequence,
upon subventions given after demeaning negotia- the university was stripped of the entrepreneurial ener-
tions, and to face inferior status among other units gies of many faculty leaders.
in the university. Still another group of critics lamented that much of
the power and discretionary funds had been taken
Some believed that the financial pressure discouraged
from the USC’s top-level managers, and their roles
innovation and even teaching quality. One committee
essentially became those of administrators, not leaders.
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 dis- 8
Indeed several of the new deans recently hired at USC (e.g., Medi-
couraged from innovating.” Another added that, “Fac- cine, Libraries) had MBA degrees in addition to the terminal degree
for their field. But Provost Nikias argued that to be successful in
ulty under pressure to produce income are not focused the twenty-first century, deans needed both leadership vision and
on students.” Some even believed that the emphasis on financial management skills, in that order.

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Chapter 16 • Management Control in Not-for-profit Organizations

One critic noted, “Neither [the president or provost at Encouragement of

that time] has become identified with any public posi- “inappropriate” courses
tion. All the leadership that is being exerted is coming
Some courses tended to proliferate across campus
from the [good] deans.”
because tuition revenues were captured by the school
Discouragement of who offered the course. Thus many schools offered sim-
multidisciplinary research ilar or even identical courses (e.g. statistics, communi-
cations) in order to retain all of the tuition dollars at
Some faculty believed that the best research, particu- their school. Many schools created general education
larly that of an applied nature, was multidisciplinary, courses intended to have market appeal to large num-
involving researchers with different skills and perspec- bers of undergraduate students. Some schools were
tives. But since RCMS emphasized financial priorities, also accused of offering courses that were popular for
most deans could not see the financial benefits of multi- the wrong reasons. Among the examples cited were
disciplinary research. “gut” (excessively easy) courses that fell below tradi-
In fact, it could be a burden trying to figure out how tional university standards and the toleration of profes-
to share project revenues. If, for example, faculty from sors who graded “liberally” to keep their courses
three schools were involved in a multidisciplinary popular. Although proposals for new courses were sub-
research project, should the revenues be shared ject to review and approval by the university’s curricu-
equally? If not, how much should be allocated to the lum committee, this control was deemed by many not
school whose personnel conceived of the research idea? to have been effective.
How much to the school whose personnel prepared the
proposal? How much to the school that provided the Encouragement of end-of-period
facilities where the project was completed? What if financial gameplaying
facilities from two schools were used but the costs of
Many examples were cited of revenue center managers
these facilities were quite different? The effort required
moving revenues and expenses between fiscal years
to answer all these questions could be sizable. And
depending on whether they were in a budget surplus or
depending on how the revenues and costs of the cross-
deficit position. For example, they could ask donors to
revenue center work were shared, the outcome could
accelerate or delay contributions, or they could deposit
be a financial drain on a revenue center, not a benefit.
June donations immediately or wait until after July 1,
Critics noted that little multidisciplinary work was
the start of the new fiscal year. They could move
being done at USC. They blamed the RCMS, at least in
expenses between years by, for example, accelerating
part, and cited examples in which deans had repri-
or delaying discretionary expenditures or by asking
manded faculty members for getting involved in research
faculty and staff members to submit requests for reim-
with someone from outside their revenue center.
bursement of expenditures already made in the current
or following fiscal year.
Discouragement of the seeking
The deans and many others within the university
of outside grants
did not consider such manipulations unethical
Some faculty were discouraged from seeking some out- because they had observed top-level university
side funding grants because those grants appeared to administrators taking the same types of actions. In its
be “unprofitable” to the revenue center. This is because entire 126-year history, USC had never posted a fiscal
those grants provided indirect cost recoveries at rates year deficit. That record was seen as important
lower than the departments’ actual spending rates. For because it provided evidence that the university was
example, even the US government’s recovery rate of well-run, and it contributed to the high quality (Aa1)
63%, which was higher than the recovery rates allowed bond rating that USC was given by Moody’s and
by many foundations, did not cover the overall USC Standard and Poor’s. Both of these indicators facili-
average overhead rate, which was approximately 68% tated the raising of capital and donations from
of direct costs. Furthermore, the indirect cost rates in alumni, foundations, and the investment community.
some departments, such as those with expensive labo- As Dennis Dougherty noted, “Big donors will not give
ratories, were several times higher than the overall to a school running a deficit. They assume the people
university average. there can’t handle the money.”

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University of Southern California: Responsibility Center Management System

Debates about the fairness were non-majors who might develop an interest in the
of cost allocations School’s offerings. But while most of the GE courses
offered in various Schools were well designed and
Under RCMS, each revenue center was responsible for
effectively delivered, these courses seemed to provide
the full costs of its operations, including its share of indi-
some of the greatest opportunities for offering courses
rect costs, the allocated costs of centralized support ser-
seemingly only for revenue reasons. The decision to
vices. Since the inception of RCMS, the university relied
centralize the offering of GE courses was made to
on a complex set of allocation methods. University
ensure academic quality.
administrators, in collaboration with revenue center
This change created a large revenue boost for the
managers, determined which centers shared which cost
College and significant revenue challenges for some
pools and how the costs would be spread across pool
other schools. To allow schools that were adversely
participants. Some cost allocations were based on actual
impacted by this change to adjust their operations and
usage, but others were based on one or more approxima-
priorities, the provost instituted a two-year phase-in
tions. Eventually, the number of allocation bases in
period. Most schools quickly adapted and stabilized
USC’s indirect cost allocation system grew to nearly 150.
themselves financially, but a couple continued to strug-
Doing all the calculations required a major effort.
gle with largely fixed costs (e.g. tenured faculty) and
Not surprisingly, the system caused much tension
sharply reduced revenues. The survival of one school
and many debates about the fairness of the allocations
was seriously threatened.
of indirect costs. Deans would closely examine their
indirect costs and compare them with their perceived
usage of central services. Then they would argue as to Centralization of doctoral
why they should not be charged with costs from a given program finances
pool, or charged only at a reduced rate perhaps because In FY03, the finances related to doctoral education
the central services duplicated services provided were centralized. This was done to encourage cross-
locally by the school or because they simply did not school cooperation, to make sure that the best teaching
value the centralized services. Indeed, the students and research assistants were employed. Formerly doc-
from some schools made little use of such services as toral programs were treated like all other graduate pro-
the central library, computer labs, career services, and/ grams. The schools were credited with the revenues
or transportation services. These discussions con- generated from the courses they offered and were
sumed considerable time and effort, and the outcomes charged with the costs of teaching those courses.
of the discussions often led to an even greater prolifera- But this policy created some revenue/expense mis-
tion of cost pools and more complex calculations. matches. For example, many students from the Engi-
Deans worried about their ability to predict what the neering School can serve quite effectively as teaching
allocation parameters and, hence, their indirect costs, assistants in math or physics courses, which are offered
would be in the forthcoming year. by the College. Math has a large undergraduate popula-
tion but few graduate students. Formerly, if engineer-
Refinements Over the Years ing students worked as teaching assistants in math
classes, engineering would get the revenue because the
Over the years, USC administrators made a number of engineering students would probably take most, if not
changes to the RCMS to try to address some of the criti- all, of their courses in engineering, but math would
cisms of it. These changes included the following: have to pay the teaching assistant cost. This type of
mismatch discouraged schools from using PhD stu-
Centralization of General
dents from outside their school.
Education courses
After the change, starting in FY03, all of the PhD
In fiscal year 1998 (FY98), the offering of all General revenue was captured centrally and used to cover all
Education (GE) courses for undergraduate students the costs of PhD student fellowships, teaching
was centralized in the College of Letters, Arts and Sci- assistantships, and research assistantships. This
ences (“the College”). The various schools loved the change allowed schools to hire the best PhD student
opportunity to offer GE courses because they provided help for their courses and research projects without
access to large numbers of students, many of whom concern for possibly adverse financial consequences.

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Chapter 16 • Management Control in Not-for-profit Organizations

Removal of constraints on 6.4% in both FY07 and FY08. When the participation
capital investments rate was 5% or lower, most of the schools could balance
their budgets even without receiving a subvention.
In FY02, a major change was made to USC’s capital-
In FY08, the subvention pool was approximately
planning processes. In earlier years, a school had to
$100 million. About $60 million of this amount was
raise nearly all of the money needed to build a new
spent to balance the budget of some schools that could
facility, plus funds to endow most of the costs of main-
not do so on their own. The other $40 million was to be
tenance, before construction could start. This conserv-
used to further the provost’s strategic objectives.
ative requirement caused significant delays in building
and often caused completed buildings to be smaller Modifications of assignments
than the actual needs of the school. of indirect costs
In FY02, USC’s trustees adopted a centralized capi-
tal program that enabled the university to use debt As mentioned earlier, the methods used to allocate
capital, as well as other resources, to build capital pro- indirect costs to revenue centers were complex and
jects more quickly. Academic deans would still be controversial. University officials sought to simplify the
responsible for fundraising, but gifts intended to fund situation. In FY00, it was decided that the 157 cost
an academic building would be heavily levered. The pools would be collapsed into one. The allocations of
gift monies would actually be invested in USC’s endow- indirect costs in FY99 would become the new baseline
ment pool to support the academic programs to be going forward. Future years’ allocations were deter-
housed in the new facility. The facility would be built mined simply by applying the average rate increase in
with funds from USC’s new Capital Plan, with debt pay- all the administrative cost pools, regardless of how
ments made from a number of sources, including sub- much of the central services they and their students
ventions, indirect cost recoveries, and investment consumed. In recent years, growth in the overall pool
income. Although the Capital Plan originally sought to of administrative center expenses was capped at 5%.
expand the university’s research infrastructure, the Margo Steurbaut, Associate Senior Vice President
Plan has since been used also to fund some seismic and University Budget Director, explained:
upgrades and renovations. Non-academic (i.e. auxil- The allocation of central costs is one of the most
iary) units still had to pay for the entire costs of their widely debated and most reviewed aspects of
capital projects through their fundraising efforts and RCMS. Any allocation system needs to allocate
operating budgets. costs in an efficient manner, yet the allocated costs
Early evidence suggested that many deans were should bear some resemblance to actual usage.
reenergized in their efforts to seek new monies for con- Most of the allocations are based on averages.
struction of new facilities. Many new facilities were Since the averages do not represent actual for any
being built and planned. individual unit, the methodologies can become
dysfunctional over time.
Changing of the participation “tax” While there will always be a spirited discussion
When the RCMS was first implemented, the schools’ over allocation methodologies, most of the focus
participation rate was lowered. It started at 20% of tui- should be on managing the central costs – not allo-
tion and fees, sales or service income, and indirect cost cating them. Once the costs are established, the
recoveries. At that participation rate, all schools were allocations of those costs then create a zero sum
put in a deficit unless they could negotiate with the game on a consolidated level.
provost for some subvention relief. Thus, the focus of Over the years, the number of allocation pools
every dean during the bonus meetings was on how to used at USC was reduced from 157, to 5, to 1. Hav-
increase their subvention. ing fewer pools allowed revenue centers to predict
Then-provost Lloyd Armstrong decided that he future costs more accurately and allowed central
wanted to change the tenor of the budget meetings and administration to focus on controlling costs rather
to increase the decentralization level. Thus, at his direc- than trying to determine how to allocate those
tion, the participation rate was lowered in FY95 to 10%. costs. We sacrificed a degree of accuracy for pre-
It was lowered again in FY00 to 3.4%. Since then the dictability, and this trade-off was well received by
participation rate had been increasing gradually. It was both revenue centers and central administration.

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University of Southern California: Responsibility Center Management System

A major problem with the original allocation sys- an incentive for deans to turn in their surplus. Thus the
tem with 157 pools was that it penalized any reve- withdrawal amount was raised in a later year to 33% to
nue center that was growing faster than the allow the deans quicker access to their monies.
university. That revenue center would experience The vision of Max Nikias, who assumed the provost
allocated indirect cost increases at a rate larger role in 2005, was that all of the surplus funds would be
than the growth in overall costs. The pie wasn’t placed in a provost reserve account. Deans would have
becoming more caloric, but they had to take a to submit a proposal to justify the withdrawal and
larger slice of the pie. The move to a simplified spending of monies from that account. Details of this
methodology was driven by central administra- procedure were still being worked out. It was expected
tion’s desire to encourage growth. that before approving any withdrawal, Provost Nikias
would examine the reasons why the surplus was gener-
After the FY00 cost allocation method change, the
ated. Was it for good reasons, such as an increase in the
revenue centers that were growing their operations
student retention rate? Or was it for bad reasons, such
faster than the growth in the indirect costs benefited
as the creation of a questionable new course that “stole”
from this change because the indirect costs would
students from another school? He would also be look-
become a smaller proportion of their overall budgets.
ing for a good academic justification for spending these
Those that were growing more slowly faced an increas-
monies. In addition, he might require the schools to
ingly large indirect cost burden.
maintain a minimum balance of, perhaps, 8–10% of the
In 2002, an attempt was made to devise a new indi-
school’s operating budget as an emergency reserve.
rect cost allocation system based on only five or six
allocation bases. A number of analyses were completed
that showed a different set of revenue center “winners” Some Senior Management Opinions
and “losers.” In particular, schools with new buildings about RCMS
would have received significantly higher indirect costs.
Then-provost Lloyd Armstrong decided at that time to Here are some opinions about RCMS from USC’s CFO,
stick with the one-pool system. an experienced dean, and a recently appointed dean:
In 2007, updated numbers were input into the allo-
Dennis Dougherty
cation model developed in 2002. This analysis showed
quite a number of surprising differences in “winners” Dennis Dougherty had been USC’s CFO for the entire
and “losers.” But Provost Nikias decided not to imple- period that USC had used the RCMS. He was closely
ment an allocation change. He concluded that the one- involved in the original RCMS implementation, and he
pool system was achieving the desired goals: it enabled thought the system had served its purposes well over
schools to be able to predict future costs easily, and it the years.
rewarded growth. Further, there was concern about
One of the advantages of the system is that it’s very
the relatively large number of new deans – eight – who
transparent. You can see everybody’s financial
had been hired recently. Some senior managers did not
statements. But to make it work you need good
think it was fair to confront these new deans with, pos-
information systems, which not all universities have.
sibly, a dramatically different financial picture than the
one they were shown during the interviewing process. Dennis also noted that the current provost, Max
Nikias, was making some subtle shifts in the applica-
More flexibility in the use of Intercenter tion of RCMS:
Bank funds
We will be shrinking our undergraduate student
The Intercenter Bank was originally intended to allow population. Max is encouraging the deans to gen-
some cross-year flexibility in the use of funds. Academic erate new money, such as from graduate educa-
units generating surpluses could put those surplus tion, sponsored research, intellectual property, and
funds into the Intercenter Bank and withdraw a portion continuing professional education. The deans are
of the balance in a subsequent year to use for any pur- not going to get subvention monies based on size.
pose. In the original RCMS design, the dean had to He will base them on the quality of the schools’
withdraw 20% of the balance in the subsequent year. academic plans and the degree to which they are in
But the 20% withdrawal rate was not seen as enough of sync with the university’s academic plan.

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Chapter 16 • Management Control in Not-for-profit Organizations

Elizabeth Daley revenue center but are necessary for the good of the
whole university. They also need central funding and
Elizabeth Daley had served as the dean of USC’s School
no doubt some of that funding has to come from the
of Cinematic Arts (until 2006 named the School of Cin-
revenue centers. RCMS has to be balanced between
ema-Television) since 1991.
self-sufficiency/independence and the good of the
RCMS enables USC to attract people who like to whole. It’s a philosophy that I think is healthy as long
build something. The key message in RCMS is very as it is applied with some flexibility.
clear: you bring in the revenue, and you manage it,
as long as what you do is academically sound. It Jim Ellis
allows a school to establish itself, grow itself, and
Jim Ellis, one of the eight USC deans appointed in 2007,
manage itself. In industry, I had to make payments
was dean of the Marshall School of Business:
on time and balance a budget. Here too I am
responsible for the bottom-line. I prefer it that way. It’s a good system for a school like this one with
[. . .] With a top-down management system, critical mass. It carries with it an “eat-what-you-kill”
deans might have little control over their own des- philosophy. We know how much we need to raise to
tiny. For example, they might be forced to ask cover our expenses and to hire new faculty. It’s
their provost questions like, “When can we get tougher for some small schools. Those deans have
another faculty line assigned?” With [RCMS] we to go hat in hand to the provost because they don’t
don’t ask that question because we know generate as much income, and their alumni are not
the answer. If the faculty hire is appropriate for as wealthy or as generous as some of ours are.
the academic program, then we can make the hire [. . .] I don’t worry about the arbitrary cost alloca-
when we have raised the money to sustain that tion bases as long as they are maintained on a con-
position! So, for example, if we want an animation sistent basis year to year. This is not like a business.
program, we know that if we raise the money, pre- We know our revenue stream. But the indirect costs
pare a solid curriculum, and show that there is are very significant for us. If the indirect costs
demand for the program, then we can do it. This change, our whole income statement can get
is important because I can go to potential donors screwed up. If I feel some uncertainty about the
knowing that we have the freedom to propose size of indirect cost allocations that we will have to
that they fund such a program. We can assure cover, I will be very conservative in what I do. If I
them that the funds they give us will indeed be know the parameters, I will deal with them.
used for that program. [. . .] Some of the other deans yell at us for steal-
[. . .] Without a system like RCMS, I might not ing their revenue. That is because the undergradu-
have been as interested in staying here because ate business minor has become huge. But we
the cinema school needed a great deal of outside require our students to take two courses in math
support that it did not have at the time I came. and two in economics, and those are taught by pro-
RCMS enabled us to take the entrepreneurial fessors in the college. So we give back. We under-
approach that was required to build the resources stand that we are not just here for ourselves; we are
we needed. part of the larger university community.
[. . .] Sure, there are things I don’t like with any
budget system. I don’t like surprises. I don’t like
Looking to the Future
unfunded mandates, as not every proposal from a
central administration office fits every school RCMS was more than an accounting system; it defined a
equally well. And I don’t like what I sometimes con- complete style of decentralized management in a large,
sider as “excessive” taxation. But the negatives are complex academic setting. Almost no one connected
very minor compared with how much I like RCMS. with USC wanted to abandon that style of management.
[. . .] I do want to note that I have always believed Some of USC’s successes were attributed to the use of
that there are some programs, important programs RCMS. The system tended to encourage deans to be
for the university’s academic mission, that probably entrepreneurial, yet fiscally prudent. Clearly further
can’t be self-supporting. They need central funding refinements were necessary, but USC administrators
help. There are other programs that don’t fit in any were loathe to make changes too quickly.
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University of Southern California: Responsibility Center Management System

Exhibit 1 Highlights of the University

June 30 2007 June 30 2006

Financial (in thousands)

Total revenues $2,523,525 $2,257,234

Total cash gifts and equipment gifts $350,725 $379,471

Capital expenditures $240,851 $283,869

Total assets at year end $6,342,621 $5,533,079

Total debt at year end $505,897 $406,771

Increase in net assets $674,181 $461,496

Market value of endowment $3,715,272 $3,065,935

Executed contracts, grants, subcontracts and $726,485 $794,363

cooperative agreements

Property, plant and equipment, net $1,444,566 $1,293,549

Net Asset Balances:

Unrestricted $3,731,115 $3,147,924

Temporarily restricted $209,520 $208,009

Permanently restricted $1,266,961 $1,177,482

Students

Enrollment (head count, autumn):

Undergraduate students 16,729 16,897

Graduate and professional students 16,660 15,939

Degrees conferred:

Bachelor degrees 4,676 4,269

Advanced 5,380 5,274

Certificates 209 188

Annual tuition rate $33,314 $31,458

Faculty and Staff

Faculty 4,596 4,510

Staff 7,992 7,855

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Exhibit 2 USC Organization Chart

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Exhibit 3 USC Provost Organization

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Chapter 16 • Management Control in Not-for-profit Organizations

Exhibit 4 Role and Mission of USC

The central mission of the University of Southern California is the development of human beings and society as a whole
through the cultivation and enrichment of the human mind and spirit. The principal means by which our mission is
accomplished are teaching, research, artistic creation, professional practice and selected forms of public service.
Our first priority as faculty and staff is the education of our students, from freshmen to postdoctorals, through a broad
array of academic, professional, extracurricular and athletic programs of the first rank. The integration of liberal and pro-
fessional learning is one of USC’s special strengths. We strive constantly for excellence in teaching knowledge and skills
to our students, while at the same time helping them to acquire wisdom and insight, love of truth and beauty, moral
discernment, understanding of self, and respect and appreciation for others.
Research of the highest quality by our faculty and students is fundamental to our mission. USC is one of a very small
number of premier academic institutions in which research and teaching are inextricably intertwined, and on which the
nation depends for a steady stream of new knowledge, art, and technology. Our faculty are not simply teachers of the
works of others, but active contributors to what is taught, thought and practiced throughout the world.
USC is pluralistic, welcoming outstanding men and women of every race, creed and background. We are a global institu-
tion in a global center, attracting more international students over the years than any other American university. And we
are private, unfettered by political control, strongly committed to academic freedom, and proud of our entrepreneurial
heritage.
An extraordinary closeness and willingness to help one another are evident among USC students, alumni, faculty, and
staff; indeed, for those within its compass the Trojan Family is a genuinely supportive community. Alumni, trustees, vol-
unteers and friends of USC are essential to this family tradition, providing generous financial support, participating in
university governance, and assisting students at every turn.
In our surrounding neighborhoods and around the globe, USC provides public leadership and public service in such
diverse fields as health care, economic development, social welfare, scientific research, public policy and the arts. We
also serve the public interest by being the largest private employer in the city of Los Angeles, as well as the city’s largest
export industry in the private sector.
USC has played a major role in the development of Southern California for more than a century, and plays an increas-
ingly important role in the development of the nation and the world. We expect to continue to play these roles for many
centuries to come. Thus our planning, commitments and fiscal policies are directed toward building quality and excel-
lence in the long term.
Adopted by the USC Board of Trustees, February, 1993.

This case was prepared by Professor Kenneth A. Merchant with the assistance of Sahil Parmar.
Copyright © by Kenneth A. Merchant.

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