Wednesday, February 8, 2012

Financial Leadership Required to Fight Symphony Orchestra ‘Cost Disease’

In a new book, economics Professor Robert Flanagan explains why symphony orchestras need multiple strategies to keep their finances from ballooning out of control. 

What if you sat down in the concert hall one evening to hear Haydn’s Symphony No. 44 in E Minor and found 5 robots scattered among the human musicians? To get multiple audiences in and out of the concert hall faster, the human musicians and robots are playing the composition in double time.

Today’s orchestras have yet to go down this road. However, their traditional ways of doing business, as economist Robert J. Flanagan explains in his new book on symphony orchestra finances, locks them into limited opportunities for productivity growth and ensures that costs keep rising.

 The symphonies’ financial problems are rooted in what has come to be known as the “cost disease,” a term coined in 1966 by two then-Princeton economics professors, William Baumol and William Bowen, in a study of the economics of the performing arts. “The labor requirements for the music are set by the composer. For the most part, you don’t toy around with that,” Flanagan says. Furthermore, it takes 25 minutes to perform a Haydn symphony. Speeding up the playing or substituting a robot or digital device for one of the players doesn’t appear on any music director’s solution list, at least not yet.

U.S. manufacturing companies offset higher labor and materials costs through gains in productivity. They work to ensure that output rises for each person employed. Automakers, for example, have added hundreds of robots to their assembly lines. Productivity gains based on computer technology have also occurred in many white- collar fields, but performing arts groups haven’t found a way to do the same.

Flanagan, the Konosuke Matsushita Professor of International Labor Economics and Policy Analysis, Emeritus, at the Graduate School of Business, has firsthand experience with the economics of playing music. He has played a clarinet and saxophone weekly for years in a 17-piece amateur jazz orchestra. He began investigating the finances of American symphony orchestras in 2006 and published a paper in 2008 that irritated more than a few symphony board members, managers, and musicians’ union officials, because it illuminated the fragile finances of orchestras, and questioned some management practices. In the last 20 years more than a dozen U.S. symphony orchestras declared bankruptcy.

With assistance from data collected by others, Flanagan has analyzed the finances of orchestras in the United States, continental Europe, and Australia, and reported his findings in his book, The Perilous Life of Symphony Orchestras: Artistic Triumphs and Economic Challenges, published by Yale University Press in January 2012.

The financial health of symphony orchestras in the United States continues down a perilous path of an ever-widening gap between operating revenues and expenses, he says, after studying the financial experience of the 63 largest domestic symphony orchestras between the 1987 and 2005 concert seasons. “Even the most artistically accomplished orchestras in the United States relentlessly have trouble balancing their books,” he says.

Flanagan explores changes in operating revenues and expenses, searching for ways to narrow operating deficits. The book covers ticket pricing strategies, marketing activities, the rapid growth of artistic pay, and competition with other performing arts organizations for the time of potential patrons. He examines how tax policies, the economic capacity of a community, and orchestra policies influence the trends and determinants of nonperformance income, such as grants and donations from private and public sources. Because there is no guarantee that nonperformance income will exactly match operating deficits, the result is an uncertain financial future.

Orchestras outside the United States face similar economic challenges even though they benefit from millions of dollars in direct government subsidies. “Every symphony in the world incurs an operating deficit,” Flanagan says, and, if the cost disease cannot be offset, “symphony orchestras will face increasing overall deficits.” For example, performance revenues of U.S. orchestras have declined from 60% of budgets in 1940 to 41% in the 2005-06 season.

Classical music lovers in the United States often complain that U.S. governments should treat symphony orchestras as cultural necessities and support them with larger grants. In other countries grants often cover 50% and more of operating budgets. While direct federal government grants in the U.S. have fallen to what he describes as “a negligible level,” the value of federal government tax expenditures has soared. Those tax expenditures, defined as foregone government tax revenues, because individuals and corporations can deduct their donations from taxable income, now account for 96% of all federal government support to U.S. orchestras. Such tax expenditures are much less common abroad.

Though direct government grants provide more certainty to orchestras when planning their budgets, Flanagan sees much to like about the tax expenditure approach. “It produces a highly decentralized system of government support for orchestras and the arts,” he says, and puts the power in the hands of classical music patrons to decide which organizations to support. “The system resists capture by arts elites.” The drawback is that tax policy could change in ways that discourage support. For example, reduced tax rates at the federal level would weaken the incentive to donate by lowering the after-tax benefit to the taxpayer.

Flanagan would like board members to shift their emphasis from “involvement as a social networking activity to an opportunity to apply their business skills to improve the organizational and financial performance of orchestras.” He feels that some board members see strikes, for example, as an embarrassment — a mindset that can produce quickly settled rather than sound long-term collective agreements.

His analysis of endowment returns, using data from the American League of Orchestras, suggests some experienced business leaders on boards “leave their business skills at home.” “Some orchestras earned returns on investment as much as 10 percentage points lower than the returns earned by other orchestras incurring the same level of risk,” he says. For orchestras increasingly dependent on non-performance income, such as donations and the monies earned on their endowments, the inefficiency of their investments represents a considerable lost opportunity.

In the long-term Flanagan reiterates that orchestras must change their habits in multiple ways. The book documents the futility of single solutions. Just adding more performances or selling out the concert halls won’t fix the problem, for example.  The mix of solutions includes a refined approach to pricing. The Chicago Symphony, for example, more finely determined the patron-preferred seats and priced them commensurately higher. Other strategies include reining in the growth of artists’ costs and management salaries, assessing the value of incremental marketing and development expenditures, better management of endowments, and perhaps cooperating with other performing arts organizations to increase attendance and contributions to the entire performing arts sector. “Neither managers, musicians, nor trustees get a free pass,” Flanagan says. None of these groups can restore an orchestra’s economic balance by itself, but each group must take actions to increase the economic security of orchestras.