How much will fees rise?
VAT will be applied at the standard rate (20%) on all parts of school fees, including the boarding element. There will only be a few exemptions made to fees for nursery-aged children and those with an education, health and care plan (EHCP), which cannot be catered for in the maintained sector.
Since Labour first floated the idea of VAT on school fees several years ago, independent schools have been planning how they will respond, and many had put up fees over the previous year (AY23/24) and for the coming year (AY24/25) at above-inflationary rates to soften the increase they would need to ask parents for once VAT was introduced. With the government’s announcement coming after the end of the academic year, a majority are yet to commit to a decision about their response to an earlier introduction of VAT than expected. Schools will likely need to call extraordinary meetings during the summer holidays to prepare for the impact of VAT introduction midway through an academic year and communicate to parents how this will impact the fees that they pay.
Schools can mitigate some of the impact of this fee rise on parents by reducing their list price fees and therefore “absorbing” some of the costs. The amount that they will be able to absorb will depend on the school’s reputation, financial position, how much they had already increased prices above inflation in anticipation, and their amount of recoverable VAT (dependent on current operating expenditure and historic capital expenditure recovery).
We estimate that on average around 15% of VAT will be passed across to parents nationally, but this will include some schools passing on the full amount of 20%.
How are parents reacting and what is our outlook for the market?
The biggest concern in all of this is how parents are likely to react to the introduction of VAT. The latest DfE figures on school enrolment were released in early June and show that Labour’s VAT policy, despite not yet being implemented, may already be having an impact on enrolment. New entrants are where the declines are most pronounced, with Reception enrolment declining 4.2% year-on-year and Year 7 enrolment dropping 1.2% (AY23/24 vs. AY22/23), representing a share decline of 0.1p.p from the independent sector in both cases. This is indicative of the way that the enrolment impact of the introduction of VAT will be felt, with a decline in new entrants that will then feed through the cohorts of a school which will compound with some existing pupils leaving the sector.
Looking forward to AY24/25, we are seeing many schools reporting lower than expected enrolment forecasts for September 2024. With the announcement that VAT will be payable midway through this coming academic year, there could be a higher level of last-minute withdrawals from parents, depending on the response taken by schools over the next few weeks in their decisions on fees for this year.
We estimate that total enrolment due to VAT will decline between 5 and 11%, with the biggest portion of this decline coming in academic year AY25/26 when VAT will be fully applicable for the whole school year. This will compound with a total demographic decline of 2%, resulting in a overall decline of between 7% and 13% between AY23/24 and AY29/30.
How will this impact different types of schools?
The impact on the independent school sector will vary by type of school and also be very localised, depending on the particular affluence of an area, competitive landscape and whether there are any closures.
Larger, prestigious schools with endowments might choose to absorb large portions of this cost, and at the same time, their popularity and long waiting lists could help them to retain high levels of enrolment.
On the other hand, smaller schools run on lower margins and with slimmer balance sheets, so they might need to pass more of the cost onto parents; these higher fee increases could in turn result in a higher reduction in enrolment and financial stress given the high impact that small changes in enrolment would have on the viability of these schools. This will disproportionately impact prep schools, as these tend to be smaller than their senior or all-through counterparts.
Less prestigious schools will likely also struggle, with the decline in market demand freeing up spaces in more prestigious schools and meaning that parents may opt to trade up in a flight to perceived quality. Often these lower “tier” schools are also the smaller ones with already precarious financial positions.
Some schools will benefit from closures in their area, and the best performing schools could be well placed to take on these pupils and grow their pupil roll. These schools could look to increase their capacity, which will have an impact on other schools within their local market.
What can schools do?
There are several strategic levers that schools and groups must consider in the current environment to both survive and thrive: (1) optimising based on current configuration; (2) reconfiguration and diversification; and (3) merging or divesting.
There are many factors to consider here, and we do not propose to cover all of these here. However, we make a few observations below:
- Optimising based on current configuration: This could include refining the core value proposition, doubling down on domestic and international sales and marketing, and rationalising overheads.
- Reconfiguration and diversification: Reconfiguration would include focus on expanding the types of pupils the school is able to attract e.g. by becoming co-educational, expanding the age offering, adding day/boarding pupils, offering weekly/flexi boarding. Diversification strategies include creation or expansion of a UK school group, as well as building revenue streams beyond traditional tuition fee revenue. The latter might include nurseries, summer schools, online learning or consultancy services, as well as international expansion – these could also benefit from VAT exemption.
- Merging or divestment: Schools that are unable to adequately optimise, reconfigure or diversify should be realistic about their ability to survive or be effective on a standalone basis and will need to evaluate all options including closure, sales and mergers.
For a sector that has undeniable headwinds, there appears to be quite a lot of appetite for investment, from for-profit groups, charitable trusts and other investors. Mergers and acquisitions have various rationales, including shoring up local market share (e.g., retreat to one site if two schools merge), creating all-through provision, benefiting from a combined balance sheet to weather the storm, and having scale benefits in the back office. There are clearly differences if not-for-profits combine (no money changes hands) versus when a for-profit is involved, either as buyer or seller (because there is a likely to be a cash consideration).
The sector has survived many changes over the years and this latest change could end up forging a more commercial, efficient and forward-looking sector, even if a little smaller. VAT is just one of many future factors facing the sector and it will always need to adapt for future changes, with the impact of AI on teaching and learning another near-term example.
Authors: Arun Kanwar, Partner I Alison Hinds, Manager I Amy Cooper, Senior Consultant
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