Minnesota Orchestra Releases AKA Strategy Financial Review

The Minnesota Orchestra has released an independent financial review conducted by the New York firm AKA Strategy, which finds that the Orchestra's independently audited financial statements for the past half decade are sound and that "the underlying financial assumptions in the Strategic Business Plan for the next several fiscal years . . . appear to be reasonable, appropriate and prudent."

Conducted by AKA Strategy's Managing Director Anthony Knerr, the independent financial review was launched at musicians' request in order to provide an additional objective, third-party view of the Orchestra's financials in the midst of a long labor dispute. (Two previous reviews have been conducted over the past year with clear results as well, one by independent audit firm CliftonLarsenAllen and the other by the Minnesota State Legislative Auditor.)

Mr. Knerr's report focuses on assessing the scope of the Orchestra's financial challenges and testing the reasonableness and cogency of the financial assumptions upon which its Strategic Plan is based.

The Musicians' Union had approved Mr. Knerr's qualifications and agreed to his participation in a financial review to be commissioned jointly by the Board and Union. Those discussions broke down last spring when the parties could not agree on terms of the review: the Board sought a financial review that examined the accuracy of the Orchestra's financial position and its business plan for future years, and musicians wished to expand the scope to examine artistic decision-making and the quality/effectiveness of the Board. Mr. Knerr has no prior association with the Minnesota Orchestra or any of its leaders.

The review was finalized in June and intended to be shared with the Musicians' Union within the parameters of mediation. "Since we haven't found a workable avenue into mediation over the summer, we gave the report to the Union last week and feel it is important to share with the wider community today," said Orchestra President and CEO Michael Henson.

Summary of Key Findings:

Mr. Knerr's report finds:

• "The orchestra has prepared a thoughtful and analytically reasonable Strategic Business Plan that seeks to promptly balance its operating budget and achieve financial equilibrium and thus reverse a recent pattern of growing and unsustainable annual operating deficits."

• "If not corrected, its growing operating budget deficits could ultimately result in the Orchestra completely spending down its endowment."

• "The one expense area not substantially touched over the last several years has been total musicians' expense.... While [the proposed decrease] may appear to be draconian in size and timing, the Orchestra has no other recourse but to bring that cost element in line and construct a smaller operating budget that can be supported by a realistic view of fundraising and earned revenue."

• "The Orchestra will continue to be confronted with serious and persistent budget pressures going forward."

Scope of Financial Challenges
Following an analysis of the Orchestra's audited financials, print and electronic financial materials and further queries in a series of interviews, Mr. Knerr concludes that the scope of the Orchestra's financial challenges includes structural "budget deficits of more than $22 million in the three-year period of FY2010 through FY2012, an amount equal to two thirds of the Orchestra's FY2012 operating budget of $31.5 million."

He notes also that "The Orchestra's independently audited financial statements for the past half decade are unqualified." An unqualified audit is the term used to define a complete audit that has analyzed internal systems of control as well as details of an organization's financial records.

Factors Producing Financial Challenges
Mr. Knerr points to a confluence of two kinds of forces, "secular" trends and issues "specific" to the Minnesota Orchestra as the reason for a growing imbalance between the Orchestra's revenues and expenses over the last five years. "Secular" trends, those faced by orchestras nationwide, includes a steady decrease in classical music attendance over the last decade and the fact that "orchestras overall have limited opportunities to increase productivity, a situation that results in ongoing cost pressures and structural budget deficits."

Issues "specific" to the Minnesota Orchestra stemmed from the Great Recession, Mr. Knerr reports. Describing the operating climate for the Orchestra as "generally favorable" from FY2002 to FY2007, Mr. Knerr notes "the Orchestra negotiated a new five-year contract with its musicians in FY2007 that increased their salaries by 26 percent." [The report notes that mid-term contract modifications later decreased that raise to 19.2 percent.] Soon after the initial settlement, the Great Recession "had a dual negative impact on the Orchestra," leading to a decline in market value of the Orchestra's endowment by 30 percent and contributed revenue decreases of 17 percent, the report states.

In summary: "The Orchestra negotiated a new contract with the musicians [in 2007] 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. Contributions were already being used to fund the Orchestra's total operating costs but were not sufficient to close a growing gap between operating revenue and expenses. These growing deficits were increasingly funded through larger annual exceptional draws from the endowment. These exceptional draws, in turn, reduced the market value of the endowment, already battered by the recession, which resulted in lower endowment draws over time and placed growing pressure on the operating budget."

Assessing the Strategic Plan
In order to address the organization's growing financial challenges, the Orchestra's Board approved a Strategic Business Plan in November 2011 for FY2014 through FY2016 that sought to bring the Orchestra to financial sustainability.

Upon analyzing the assumptions in the plan, Mr. Knerr finds that "the overall logic of the Strategic Business Plan is sound; its independently audited financial statements for the past half decade are unqualified. The Orchestra has had a history of overestimating its ability to generate revenue, particularly contributed revenue, hoping that it would be able to close the ever-growing gap in the operating budget through fundraising. But the combination of adverse economic circumstances and limits on donor capacity and interest have hindered the orchestra's efforts to reliably bridge the gap in recent years."

Mr. Knerr notes that the organization has undertaken significant cost reductions in administrative employee costs while at the same time musician salaries increased by 19.2 percent over the life of the most recent contract. He notes, "Since the modest concessions reached with the union in FY2010, total musicians' expense has not only been untouched, but has grown both nominally and as a percent of total expenses . . . 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."

With regard to specific revenue and investment assumptions in the plan, Mr. Knerr found them to be "reasonable, appropriate and prudent."

Caveats With Regard to the Strategic Plan
Mr. Knerr identifies several caveats that may impact the organization's ability to reach the goals in its strategic plan. These include:

• The unknown implications of the long labor impasse on future ticket sales and contributions;
• A "severely underfunded" multi-employer American Federation of Musicians defined benefit pension plan that the Orchestra participates in and for which "the amount of the Orchestra's contributions are contractual matters that must be negotiated";
• A lack of "cushion" to protect against unforeseen problems. "To the degree that such outcomes arise, the Orchestra may need to borrow against its endowment and reserve funds, thereby hindering its effort to achieve financial sustainability."
• The "thorny" problem of productivity. Mr. Knerr notes that a challenge facing all orchestras is that "even though their operating budgets may be balanced in any one year . . . their inability to increase productivity over time means only a temporary respite: their personnel costs will inevitably rise faster than their operating revenue. . . . The Orchestra will continue to be confronted with serious and persistent budget pressures going forward."

About AKA Strategy
Anthony Knerr, the managing director of AKA Strategy, is known for his work with numerous institutions of higher learning, serving as Vice President of Finance for Columbia University and Vice Chancellor for Budget and Planning at the City University of New York. In his work with Yale University, he prepared the University's first long-range financial plan, which set the course for the University achieving (and maintaining) financial equilibrium. Today, his firm specializes in assisting nonprofits and has worked for arts clients from Carnegie Hall and the Kennedy Center to the Budapest Festival Orchestra and Salzburg Festival.

Background
Contract talks between the Minnesota Orchestral Association and its musicians, who are members of the Twin Cities Musicians' Union (Local 30-73), began on April 12, 2012. The Orchestral Association's latest proposal offers a total compensation package averaging $135,000 per musician, including an average salary of $102,200 and benefits valued at more than $33,000. The package also includes 10 weeks of paid vacation and up to 26 weeks of paid sick leave. Musicians have not yet put forward a contract counterproposal. In December, the Orchestral Association made public its annual independent audit, conducted by CliftonLarsonAllen, which revealed an operating deficit of $6 million for Fiscal 2012. CliftonLarsonAllen has audited the Orchestra's accounts since 2007. In June, a special review by the State's Legislative Auditor confirmed that the Orchestra has appropriately used all state funding.

The complete Financial Review is available at minnesotaorchestra.org/review.

To post a comment, you must register and login.