Bought and paid for

The Minnesota Orchestra leadership released a “financial review” yesterday. Most of the coverage, though, focused on remarks made by MO board negotiating chair Richard Davis, who told the Star Tribune editorial board that he was prepared to say bye-bye to music director Osmo Vänskä, the upcoming Carnegie concerts, and the opening of the newly-renovated Orchestra Hall – “all three may have to fall,” in his words.

But the report itself escaped scrutiny, which was unfortunate. The folks writing the web link to the Star Tribune article certainly didn’t look very carefully, missing even the fact that the review was not “independent” – which was a claim that Graydon Royce, who actually wrote the article, was careful never to make. One senses a large thumb on the scale by Star Tribune management.

It’s not often that scrutiny reveals anything about the cover page. This one, however, is dated June 10, 2013 – odd, considering that it was released yesterday. Why the delay? Are the same PR consultants who suggested  in 2011 how big a deficit to report still on the payroll?

Given the fact that management paid for the report, it’s not surprising that the executive summary states that “the overall logic of the [board’s] Strategic Business Plan is sound, as are the underlying financial assumptions in it.” Nor is it surprising that the report so thoroughly buys into management’s ideological assumptions. A good example occurs on  page 4 while still in executive summary mode:

The Orchestra negotiated a new contract with its musicians in FY2007 that significantly increased its fixed operating expenses (“hard costs”) in a budget that was increasingly dependent upon contributed revenue (“soft funding”), making it particularly vulnerable to adverse financial circumstances.

“Hard” costs and “soft” funding? This is the consultant equivalent of phone sex.

No mention is made of the concessions made in 2009 by the musicians, of course, or the damage such concessions do to the idea of “fixed costs.” It’s hardly a “fixed cost” if it can be changed. Nor is there any mention of the discrepancy between “total musicians’ labor expense increas[ing] some $1.5 million between FY2007 and FY2012” and the cuts being demanded by management, which are between double and triple that amount annually. Not surprising, really – pointing that out might call into question management’s past conduct and  public statements.

…Musicians’ expense is the one untouched area of the operating budget.

Not true, of course, as mentioned above. But it’s also a little bit like complaining that having two pilots in the cockpit is “the one untouched area” of an airline’s operating budget. As a frustrated pilot once radioed a controller, “am I up here because you’re down there or are you down there because I’m up here?” Not much question how MO management would answer that question.

There’s lots more ideology in the body of the report, though:

Orchestras overall have limited opportunities to increase productivity (an issue discussed below), a situation that results in ongoing cost pressures and structural budget deficits. That so many of America’s leading symphony orchestras are facing financial stress, including sizable operating deficits and bankruptcy, is not surprising, though alarming and dispiriting.

Baumol’s syndrome does exist (although whether it’s relevant to an organization that can solicit donations is another question.) But it’s existed for a long time, and for all orchestras, which suggests that it’s not at the root of the current problems in Minnesota. So why highlight it?

Attendance at classical music events in the United States has been steadily decreasing over the past decade, resulting in a significant and continuing decline in classical music ticket revenue. …It is likely that interest, support and participation in classical music programming will continue to decline in the coming years.

Talk about a self-fulfilling prophecy. It’s true that attendance has been trending down – although it appears that the report’s authors have never heard of the success the SPCO had with lowering ticket prices, increasing attendance, and actually increasing net earned income. No reason they should have heard about it, I guess – it’s not as if St. Paul is just across the river.

While some orchestras appear to have been more successful in combatting these powerful secular trends – particularly those in very large metropolitan areas – no major American orchestra is immune from these challenges, as evidenced by the number of the country’s largest orchestras negotiating significant contractual changes with their musicians in the past several years.

None, of course, within hailing distance of the “contractual changes” being demanded of the Minnesota Orchestra musicians.

Overall, the operating climate for the Orchestra was generally favorable during the period of FY2002 to FY2007: the national and local economies were robust; the Orchestra enjoyed widespread respect and support; attendance was strong; and the Orchestra’s artistic quality, reputation and status were growing handsomely. With the appointment of a new Music Director on September 1, 2001, the Orchestra expanded its touring nationally and internationally to considerable critical acclaim.

So much for Baumol.

Even though the Orchestra reported deficits it was able to balance its budget during these years through a combination of recurring special fundraising efforts to underwrite operating expenses; significant, though not unreasonable, exceptional draws from its endowment; and assumption of $11 million of debt in 2005.

In this context of generally favorable financial and environmental circumstances, the Orchestra negotiated a new five-year contract with its musicians in FY2007 that increased their salaries by 26%. This increase added approximately $2.3 million to the annual expense base of its operating budget.

Which, of course, was substantially reduced by the concessions the musicians made in 2009 – but we’re not going to talk about those, are we? (In fairness, they do get around to it on page 7 – perhaps they hoped that folks would have stopped reading by then.)

Shortly thereafter the Great Recession had a dual negative impact on the Orchestra: the market value of its endowment declined by some 30%, from $106.3 million to $74.0 million in FY2009, and contributed revenue decreased by 17% from the pre-recession annual average of $8.0 million in FY2006-FY2008 to an annual average of about $6.8 million in FY2009-2010. Complicating the situation was continuing flat ticket revenue in part because of reduced interest in and attendance at classical music concerts, a problem endemic to virtually all major symphony orchestras.

It certainly complicates the analysis that ticket revenue refused to take the same plunge that asset values, expenditure on travel, and lots of other things did. One would think the report’s authors might view flat ticket revenue as an achievement during the Great Recession.

The key components of the Strategic Business Plan designed to achieve financial equilibrium are as follows:

• A variety of initiatives projected to3generate about $2.1 million of annual incremental net revenue going forward;
• Staff and overhead expense reductions to produce approximately $1.5 million of savings annually;4 and
• Projected reduction in total musicians’ expense – the largest component of the Orchestra’s operating expenses, comprising some 49% of the FY2012 operating budget – of $4.6 million. This reduction, amounting to a 30% decrease in musicians’ expense, would be achieved through an unspecified combination of changes in the number of musicians, the number of concerts and the length of the concert season as well as changes to base salary and add-on compensation arrangements and benefits.

Not surprisingly (again), the report neglects the necessary context, which in this case is the fact that the musicians are being asked to absorb most of the expense reductions, apparently on the Willie Sutton theory of institutional ethics (“because that’s where the money is”).

In seeking to balance the budget and achieve financial equilibrium, it is surely appropriate for the Orchestra to also seek to reduce the single largest operating expense in its budget.

The “surely” adds a nice pleading touch. See “Willie Sutton” and a list of successful airlines with one pilot in the cockpit for whether it’s appropriate.

Total revenues and operating expenses are projected to grow in FY2014 through FY2016 by 2% for inflation, a rate that seems reasonable in view of current general rates of inflation in the United States. (Cost increases in any expense category or decreases in any revenue category would thus have to be realized elsewhere in order for the budget to remain balanced.)… Total musicians’ expense is projected to grow annually by 1% in FY2014 through FY2016 from the lower base assumed in the Strategic Business Plan.

“Lower base” sounds so innocuous, doesn’t it? And 1% sounds pretty reasonable, except of course that increases in health insurance premiums will require musician salaries to continue to decrease for that 1% to hold. And, as the report generously neglects to point out, 1% is below the likely rate of inflation. Even Willie Hutton didn’t rob the same bank over and over again.

The Orchestra participates in an American Federation of Musicians multi-employer musician defined benefit plan that is severely underfunded. The pension plan and the amount of the Orchestra’s contributions are contractual matters that must be negotiated with the union. The Orchestra presently estimates that the current withdrawal liability to exit from the plan would be approximately $25 million. The Orchestra is monitoring the status of the plan and the options available for dealing with the liability.

This is profoundly, and deliberately, misleading. Yes, the plan is underfunded. But no mention is made of the rehabilitation plan put into effect by the Fund’s trustees a few years ago, which required only a very modest increase in the orchestra’s contribution. The withdrawal liability is only relevant if the “Orchestra” wants to withdraw. But why would it? There’s no advantage to management to leaving the plan unless they simply want to stop providing pension to musicians altogether. Otherwise, dropping the $25 million figure into the report is about as intellectually honest as warning funders of the boogyman.

The risk for problems with the Fund lies almost entirely on the beneficiaries’ shoulders. Fortunately, those beneficiaries currently in the Minnesota Orchestra have a benevolent employer who is determined to do the right thing by them … oh wait.

There is no reason to believe that additional marketing efforts will reverse secular downward trends in ticket sales and earned income over the next several years.

I guess the authors really haven’t heard about the SPCO experience.

The Orchestra faces a number of challenges with respect to increasing contributed revenue over the course of the next several years and beyond:

• There may well be limitations to the Orchestra’s current donor and prospective donor pool. A younger generation of philanthropically inclined individuals is less likely to support the Orchestra than the current generation because their interests lie elsewhere. Current corporate and foundation support may also be less interested or inclined to support the Orchestra, for a variety of reasons.

I suggest the authors of the report haven’t read this 2008 publication from an outfit by the name of AKA Strategy, which states that:

Although charitable giving may fall off by five to ten percent during the coming recession, the news is not all bad. The wealthiest donors are still well-positioned to make principal gifts. Thinking strategically and having a strong strategic plan is likely to help keep them attracted and will increase the likelihood of their continued support.

The wealthiest one percent of families in the nation are, for the most part, unaffected by a three-to five-year downturn in the economy. Those families have been, and are, the inheritors of the largest transfer of wealth in the nation’s history, even when diminished by market values in the short run. Their capacity to give remains virtually untouched in the longer run, though their portfolios may have taken a beating in the short run.

The active philanthropists among this wealthy cohort are unlikely to decrease their support of the causes, new and old, that they cherish most. Recent data indicates that as the U.S. economy slows, these individuals and families are likely to give even more generously than they have in the past.

It’s so hard to remember which versions of reality to tell which clients.

In the final part of the report, the authors jump into full doom-and-gloom mode:

Like other nonprofit organizations, orchestras have only limited opportunities to realize steady increases in productivity. Labor required to perform the standard orchestra repertoire is essentially frozen, while the compensation of musicians typically increases at least at the rate of inflation and more or less in step with that of other highly trained professionals…

The terrible problem facing all orchestras (and most non-profit arts and cultural organizations for that matter) is that even though their operating budgets may be balanced in any one year or period of years, their inability to increase productivity over time means only a temporary respite: their personnel costs will inevitably rise faster than their operating revenue, all things being equal. Thus while the Orchestra has projected balanced operating budgets for the next several years, this state is only temporary. The Orchestra will continue to be confronted with serious and persistent budget pressures going forward.

The Curse of the Baumol! We’re all going to die!

Waving Baumol’s curse at the problems of orchestras is almost invariably a sign of lazy thinking. For those who don’t know of this hoary old chestnut in the consultant’s bag of tricks, Baumol’s Curse suggests that, in an environment where secular productivity is generally rising, enterprises that can’t increase productivity will eventually price themselves out of business because of the need to match salary increases with enterprises that are becoming more productive.

This might matter if the only source of revenue was ticket sales. But, for orchestras and most other non-profits, it’s not. What matters is if the institution can raise enough money to cover the gap, assuming that other methods, such as the SPCO approach of lowering ticket prices and marginal expenses associated with ticket sales, don’t work. And that is far more a function of overall societal wealth and what consumers want to buy than it is an artifact of differences in productivity. (A very good take on this is contained in this article.)

This is just a first pass at some of the intellectual weaknesses in the report. An even bigger problem for readers who might want to think for themselves is the complete absence of any financial data, or even much context. Instead, the authors rely on things that “everyone knows” – attendance is declining (except where it isn’t), most orchestras are facing financial stress and bankruptcy (without mentioning the small matter of the Great Recession), most of the “country’s largest orchestras” have negotiated concessions (without mentioning that no other management of a Big 10 orchestra has asked for anything like the cuts demanded in Minnesota). When that doesn’t suffice, they throw in a few figures – but no context.

And, true to their remit, at no point are they critical of their paymasters at the  leadership of the orchestra for anything other than their failure to be even harder on the musicians, both now and in the past.

Bought and paid for.