The popular method of measuring the average salary against the fees to calculate the Return on Investment of an MBA program has no fundamental basis by any concept of Finance, says IMI Delhi’s Admission Chairperson Prof Himadri Das. He suggests a more sound method to calculate the RoI and demonstrates how it is linked to the quality of the b-school’s professors.

Students today have a very wide choice of Business Schools and MBA programs to choose from. This means they need to have an appropriate evaluation mechanism to compare MBA programs. This becomes an even more important issue because most MBA programs are quite expensive in terms of tuition fees and other related expenses. A large number of students take huge bank loans to finance their expensive MBA education. Being able to comfortably repay the loan over its life becomes an important consideration. This has led students to employ financial evaluation methods to compare MBA programs.

Possibly the most common one used today is what the students call ‘RoI’ or ‘Return on Investment’. They typically calculate this as the average salary on graduation divided by the two years tuition fees (or one year’s fees for one-year programs). The higher this ratio the more attractive is the MBA program. While this seems to make sense at first glance, it is, however, fundamentally flawed as it defies all basic concepts of Finance that these same students will study in their first year of any MBA program. What these students are computing using their so called RoI metric is what is the payback period of their investment based on starting salary levels. In other words, they are computing how soon they will recoup their MBA expenses assuming their salaries stay put at the level of their starting salary in their first post-MBA job. This is fundamentally flawed as it does not at all considering future salaries over the entire career of the student. The appropriate financial metric for evaluation of the return on the investment would be the ‘NPV’ or ‘Net Present Value’. This is something these students will learn in their first Finance course in the MBA program. This computes the present value of all future salaries they earn over their career and subtracts from that the initial investment they make in the MBA program. This is essentially a measure of the amount of wealth creation the MBA enables net of the MBA expenses. In other words the NPV measures the life time value of the MBA whereas the flawed RoI metric commonly employed today only measures the short term value of the MBA.

So how does a student then take a stab at calculating NPV to evaluate MBA programs on financial metrics? They should still look at average salaries on graduation but this is only a very small piece of the financial evaluation as it gives only one future salary value. In addition they should find out about alumni of different vintage for the different MBA programs they are evaluating. For example, they should find out what kind of job and salary is representative of a 5 year alumnus, a 10 year alumnus, a 15 year alumnus, etc for different MBA programs. This information is of course more difficult to get than the most recent years average salary but should nevertheless be sought if a meaningful financial evaluation is to be performed.

The next question that needs to be answered is whether this distinction between NPV and the current RoI calculation employed is really an important distinction or merely an academic distinction. If MBA programs that have a higher average salary on graduation also have a higher salary than others 5 years later, 10 years later, and 15 years later, then the average salary on graduation becomes a good surrogate measure of the lifetime value. The interesting thing to note is that this is often not the case. Some MBA programs with an impressive average salary on graduation may fizzle out in salary growth for their alumni down the road and not deliver on their initial promise. On the other hand, some MBA programs that do not have a very impressive average salary on graduation can really have an explosive salary growth for their alumni going forward. To illustrate this consider two Business Schools, A and B, that both have total fees of Rs 10 lacs for their MBA programs. Let us say Business School A has an average salary of Rs 10 lacs on graduation and a 15% annual increase thereafter for its alumni. Business School B has an average salary of Rs 8 lacs on graduation and a 20% annual increase thereafter for its alumni. Based on the current RoI calculation employed, Business School A has an RoI of 1 and Business School B has an RoI of 0.8, making Business School A appear significantly superior. An NPV calculation employed over a 15 year horizon based on a 10% discount rate gives an NPV of Rs 180 lacs for Business School A and an NPV of Rs 205 lacs for Business School B, clearly showing that Business School B is actually far superior in terms of future earnings. The fact that a Business School with a lower starting salary can have a higher salary growth rate and a higher NPV is not a matter of chance or luck but is tightly coupled to the education philosophy of the Business School.

Many Business Schools focus on imparting to their students narrow based employable skills. This is a wonderful strategy in the short term as these skills make the graduates of these programs in high demand for entry level positions where these students have to start performing quickly and do routine structured jobs that do not require much need to think. Alumni of such MBA programs are, however, at a disadvantage further down the road as they are not equipped with broad based competencies and the ability to think. This significantly affects their performance in more senior roles that require frequent decision making and out of the box thinking.

A few Business Schools, on the other hand, focus on imparting to their students broad based competencies instead of narrow based employable skills, and most importantly make them think. These students may not be that sought after during entry level employment but later on in their career they greatly outperform their peers from other MBA programs that have a skill focus. The broad based competencies allow them to adapt quickly to a business environment that makes the old skills obsolete. They are better at decision making roles and since they have been made to think they can be more creative and are better at out of the box thinking. The better future performance leads to better career growth and better future salaries.

The difference between these two categories of Business Schools having these two fundamentally different education philosophies is akin to the proverbial difference between giving someone a fish and teaching someone to fish. Imparting narrow based skills is akin to giving someone a fish, whereas imparting broad based competencies and making them think is akin to teaching someone to fish. Being given a fish may seem more attractive in the short term but being taught to fish is definitely much more attractive in the long term.

Can a Business School decide on their education philosophy independent of their faculty quality? The answer is a definite no. Average quality faculty can teach students only narrow based employable skills. It requires extremely high quality faculty to teach students broad based competencies and make them think. What defines extremely high quality faculty? These are people who typically have PhDs and preceding degrees from top class academic institutions that in turn teach their students broad based competencies and make them think. This is true only for a handful of the most reputed academic institutions in the country and universities in the US and Western Europe where the tradition is more on broad based competencies and making students think, rather than narrow based skills.

So then how does one evaluate the real RoI of an MBA program? The answer is by looking at the faculty quality as that gives an indication of the education philosophy, which is possibly the best leading indicator of the lifetime value of an MBA program rather than what is measured by the average salary on graduation.

The author Dr Himadri Das has been a Professor at IMI Delhi for the last 9 years and is currently the Admissions Chairperson prior to which he was the Dean (Academics). He has been educated at IIT Delhi and the University of Virginia and has 13 years of industry experience prior to joining IMI Delhi.