March 17, 2007

I got ROI'd! All that talk on return on investment.

"Return on Investment (ROI)" - that's the first buzzword MBA applicants learn even before the school starts. It's the first among the many to follow (like PE, Hedge Funds, IB and what not - terms wannabe's like me use without a clue of what they really are..sounds good anyway!). But ROI is discussed a lot - it's sometimes the topic of heated discussions on whether school 'A' is worth it, or whether it makes more sense to let go of an elite school and go to a lesser known school just because 'ROI' makes more 'sense'. Let me present my take on ROI. Especially considering top institutions.

ROI in the traditional sense is calculating, say, what you have earned in about 5 years on the investment on your education and figuring out if you will recover that cost and make more, or will you break even, or will you be 'broke.'

The most straight forward calculation takes into consideration the following variables on investment

  1. The Tuition

  2. Difference between living expenses during study and otherwise

  3. Lost wages (including average pay increase)

And then post study earnings by taking a 5 year view of earning using past reported numbers as a benchmark. When you compare this with what you would make without the disruption, you can see if, overall, you made more or less.

Many discussions are centered around this mathematical calculation to the extent that some rely solely on this factor by ignoring everything else (I read of a discussion where an applicant chose a lesser known school compared to Columbia because he felt 50K difference could not be justified based on ROI). We will come to that 'else' very soon. The mathematical calculations are tangible, and they can be made to look reasonable based on linear progression, a relatively stable economy and job outlook, a good understanding of the target sector for which the calculations are made, and comparison and adjustments based on past reported numbers.

In reality ROI can vary wildly based on pre-MBA earnings (if you are from a lower wage country), lifestyle changes, economy, job growth, surprise investments, emergencies - a lot of which do happen over a course of 5-10 years. ROI calculations also often omit stock grants, perks, bonuses (which, at higher positions, all happen at larger scales as a percentage of annual salary and this gap can be significant) so ultimately, when taken over a decade of career growth post MBA, the calculations done now cannot be 'deal breakers' on choosing schools. Of course, calculations must be made keeping a certain positive outlook - otherwise it doesn't make sense anyway.

What ROI calculations omit completely are the intangibles of education. Those that cannot be measured monetarily but have a real effect on career and business progress. The top ones are

  • Brand of the school helping to open doors to interesting, and otherwise unavailable positions. International mobility - in an increasingly flat world, this is a big plus.
  • Strength of the alumni network that could assist in job searches, business deals, entrepreneurship ideas, venture capital and so on.
  • The experience of attending classes with a whole bunch of smart, driven people (discounting some who you might hate) and learning from the interaction, if not from the books.
  • The fact that your career is not over in 5 years after MBA and that it will possibly be for another 30 years - and in majority of cases, post MBA you will probably be working for a longer time than you have been alive so far!

Studying in top class institutions, whether it is Harvard, Wharton, Columbia, INSEAD or MIT etc., gives a certain leverage that you cannot measure (not everything is material) and average reported numbers do not give that picture. If you class mate starts a venture and you can be part of it, and you make a million dollars 5 years down the lane, then all your ROI calculations go bust. A single big bonus or a stock grant can render your old ROI calculations useless. (As a kicker - Last year the top London Goldman trader made 50 million dollars in bonus and he's an INSEAD alumnus)

By sticking to straight metric driven ROI, you are discounting all the other benefits of going to top institutes, even if they cost more. Now before you spew fire on me, I'm not saying you can't do that from other ranked schools - it's just that with established large brands it's more likely and the probability of such chances is higher. Taking advantage of that is up to you.

To me, current considerations are more pressing than what I perceive 10 years later. In my own case, I simply could not afford 2 years off the market given my condition (personal, financial, visa) and that is why it made more sense to apply to INSEAD than, say, Chicago GSB. But it had nothing to do with ROI between the two schools. My own take is, don't go overboard with ROI calculation. Focus more on your fit and whether you can afford it now without major issues. If you are not positive that your degree will do you good, why do it anyway?

1 comment:

Anonymous said...

Congrats on INSEAD admission!!! Great job! And thanks for insightful discussion on ROI.

As to opportunity costs, I guess we should look only at lost savings plus pv of pensions (as you are saying). I.e. if you earned say 50k and your savings/investments were nil, the opportunity costs won't be so huge - before reflecting deteriorated lifestyle quality of course ;)

On the revenue side, there surely will be explicit gains like salary/bonus differential times incremental probability of gaining the job (hard to estimate) and they will be amortized over several years after graduation.

But on top of that we will have implicit gains like options coming from alumni network in long-term. How do we price them? Theoretically, it is a portfolio of rainbow options with potentially huge value.

I personally think that for many admits IRR (before option value) of the top 1-year program is slightly negative/breakeven and for a 2-year top program it is just negative.

I think, when buying MBA, most people pay for flexibility and for future options (across industries/functions/geographies).