Duncan Wingham stands in his laboratory contemplating all the costs involved in its running. The professor of climate physics has just acquired a new ?400,000 mass spectrometer paid for out of the Government's research capital fund. Then there is the salary of the technician who operates it, and the ?5,000 a year the university charges Wingham just to occupy the space - a so-called estate cost that covers everything from the electricity to the paintwork. Later, no doubt, one of his researchers will be in the library. "There are costs you see and costs you don't ... but someone has to pay them," reflects Wingham, head of the department of earth sciences at University College London.

His sentiments underline one of the most significant changes to university research financing in years. In 2002, and on the back of a series of previous attempts, the Labour Government carved out a new deal for universities. In return for extra money, institutions would have to manage their budgets in such a way as to put research on a sustainable footing, including making proper investment in research infrastructure.

The move was intended to fix a problem that had been developing throughout the 1980s and 1990s. In beating each other down in price to win research contracts, universities were failing woefully to invest in the long-term infrastructure necessary to sustain their work. From research councils and government departments to businesses and charities, the hidden costs of research were being ignored by funders and universities. The result was leaking roofs, sackings of support staff, underinvestment in equipment - research infrastructure was literally crumbling. This situation was highly unsatisfactory from the point of view of a Government with big plans to make research deliver economic benefit.

"Universities were accepting funding for research that was ludicrously out of kilter with the true costs," recalls Bob Bushaway, a senior research fellow at the Centre for Higher Education Management and Policy at the University of Southampton and a former director of research support services at the University of Birmingham.

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Fast-forward to today, and one can see that the 2002 sea change is reshaping the research environment. Government capital funding streams are helping to fill in the backlog of underinvestment in research infrastructure. Institutions are expected to recover the "full economic costs" (FEC) or true costs of their activities (taking both research and teaching together over time). A methodology to account fully for costs - the transparent approach to costing (Trac) - is in place for research, and an equivalent one for teaching is being fine-tuned.

Institutions are also selling their research for nearer to its true cost. From April 2006, the research councils have been paying 80 per cent of FEC (the Government has given them extra money so that they can). The expectation is that government departments and industry will pay 100 per cent, although it is up to universities to ensure that ends meet. The state partly subsidises the hidden costs that charities do not pay for research they fund (they generally believe that hidden costs are not their responsibility).

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Although the road to sustainability is long and universities are only in transit between the old and new systems, most are upbeat and believe that the overhaul is putting them on a happier and healthier path.

"British universities are in a very different place from where they were a decade ago. I think the science base is much nearer to sustainability," says Steve Smith, vice-chancellor of the University of Exeter.

"It has changed the way that senior members of staff think about the institution," notes Ian Carter, the director of research and business services at the University of Liverpool and chair of the Association of Research Managers and Administrators.

"Increased funding is starting to flow through," says Jon Gorringe, director of finance at the University of Edinburgh and chair of a working group of the British Universities Finance Directors Group, which has overseen the development of Trac.

Yet digging a little deeper reveals a host of worries and problems around all aspects of the FEC agenda. Figures compiled by the national funding councils show that UK universities are still failing to recover the full costs of their research and teaching to the cumulative tune of about ?1.4 billion (see table, page 35); institutions are still developing their research pricing mechanisms; and, despite the Government's intention to fund research councils so that they can pay "close to 100 per cent of the FEC of projects by the beginning of the next decade, taking account of capital funding streams", the promises will fall short by 10 per cent (see box, opposite).

Quarrels between universities, their academics and funders - each with very different agendas - are also threatening to sour the process.

A forthcoming review of the FEC agenda, to be undertaken by Research Councils UK in collaboration with Universities UK and the funding councils, could be a lightning-rod for the simmering tensions. The main aim of the review, which was announced in March and which is due to report next January, is to ensure that the change to FEC has put universities on track to deliver long-term financial sustainability in research.

"The principle of FEC is not in question ... There is an acceptance that FEC is the right way to ensure the sustainability of the research base," says Alan Alexander, a council member of the Economic and Social Research Council, who is chairing the review. "What we need to look at is to what extent sustainability is being achieved by FEC and to see whether there are any tweaks that are necessary to ensure that the desirable end is achieved."

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But even the timing of the review is an issue, with some on the university management side concerned that it is taking place too soon, given that FEC is currently paid on only about half of all research council grants, infrastructure investments are long term and the sector is not expected to be "robust" in respect of FEC until 2009. For their part, the research councils say the review was always scheduled to take place two years in.

Bill Wakeham, the vice-chancellor of the University of Southampton, sits on one of the research council's audit committees. He sums up the conundrum: "The review is probably slightly too soon, but I understand the accountability argument. The Government has provided money to universities to underpin their infrastructure using FEC. They have a responsibility to make sure it is spent on the proper purpose."

Timing aside, one of trickiest issues to be considered (and undoubtedly a spur to the review) is that FEC appears to be costing research councils more than they anticipated - which presents a problem because they do not wish the amount of research conducted to fall and have aimed to ensure that it does not.

The research councils' official position is that the additional money they have been allocated by the Government for so-called FEC uplift (about ?400 million in the past three-year budgetary period and ?748 million in the current period) is enough to "broadly maintain existing volumes of research". However, statements made by some councils after last year's Comprehensive Spending Review show it is difficult.

Both the Science and Technology Facilities Council and the Arts and Humanities Research Council have in recent months blamed cuts in their research volume, among other things, on the commitment to fund FEC. In evidence to the House of Commons Innovation, Universities, Science and Skills Select Committee inquiry into budget allocations this year, both also suggested that universities could use the additional money they are getting through FEC to ameliorate the situation.

"(FEC) gives (universities) a huge extra resource to manage their budget, their research strategy and their research activities. There is at least the option there for universities to handle their research staff in a very responsive and creative way," Keith Mason, the chief executive of the STFC, said in February.

Any suggestion that universities should be using FEC uplift to increase volume of research is deeply resented by university management. "It would be an inappropriate use of funds," says Edinburgh's Gorringe.

The Royal Society, which has also received extra government funding to pay 80 per cent of FEC, has seen a drop in the volume of research it can fund as well. According to spokesman Bill Hartnett, the number of research fellowships the society funds has dropped from 46 in 2005 to 32 in 2008, and it has also had to close a "relocation fellowships" programme recently. "This cannot be attributed solely to the costs of FEC, but it has been a factor in this," Hartnett says.

But if FEC is indeed costing funders more than they anticipated, what is the reason? Did research councils underestimate the costs (and therefore not seek enough money from Government)? Or have universities been overcharging?

According to some, the research councils have their suspicions about charges. "There is considerable variability in the amounts of indirect costs universities are charging. Research councils want to make sure that universities are not inflating costs," says one source close to the councils.

Yet the implication that universities are overcharging is dismissed by some on the management side. They point out that there is a separate process, "Quality Assurance Validation", in place to ensure that the methodology used to determine FEC is applied correctly and that those who fall short of the standard could face tough penalties.

"We are in danger of losing the whole point of what is going on ... which is about universities being able to sustain a genuine price for their research compared with 20 years ago," says Bushaway. "They (the research councils) are looking for a way to say that universities haven't looked at this properly. I think it is significant that just as we are beginning to see progress there is a muddying of the waters."

"Our theory is that they are short of money," says one university finance manager who wishes to remain anonymous. "Somewhere back in the mists of time research councils estimated that the average grant would go up 20-25 per cent and they used that for their figures. But monitoring our situation, we have genuinely found FEC has given us a 31 per cent uplift versus old-style costing."

Gerry Lawson, RCUK's FEC review project manager, says: "Councils did their best to forecast the effect of FEC on programme costs, but we've always recognised that (this) was likely to change, and that this could impact on budgets."

But there is also the view that there are flaws with institutions' methodology. "Publicly, I would say we are not (overestimating the costs of research)," says one senior university source, "but privately I would say that I worry sometimes whether institutions have robust enough methods for assigning costs."

Part of the problem - and one that Lawson says the RCUK project will examine - is that, as academic time is estimated rather than recorded, staff can overextend themselves so it looks like they are performing superhuman tasks. "One issue, which the FEC review is keen to look at, is whether investigators are becoming overcommitted ... We would expect HEIs to have mechanisms in place to control this," he says.

Exeter's Steve Smith, who is chair of a strategy group set up to help institutions manage Trac, wrote to university heads in May to warn them that some institutions were overestimating the time that their academics were spending on research.

At issue is whether more money needs to flow into the system to maintain the volume of research and 80 per cent of FEC and, if so, where it should come from. The obvious place research councils will be looking, according to some, is the other side of the so-called dual-support system - the ?1.4 billion "quality-related research funding" block research grant that is administered by the funding councils.

"My question is, do the research councils, in the light of what FEC has turned out to be, think that the dual-support system needs rebalancing? Because, if so, then politically it is a massive issue," adds the same senior university source.

Yet behind the RCUK review is a second, even more delicate, issue - the extent to which researchers are seeing the benefits of the new FEC funding. The view of many leading lights is that they are not, and their voices are being channelled by the research councils to the top of the review's agenda. The issue to be confronted is the internal distribution of FEC money: whether the money is just disappearing into the university or whether it is going to those areas that are the most research active.

"Quite a lot of the researchers that we support are telling us that they don't see any of the additional money in their departments," says Lawson. "This is obviously for the institution to decide ... but the review may seek evidence on the degree to which FEC money is used to increase sustainability in the research areas that actually won the grants."

On condition of anonymity, one top researcher explained his recent alarm at seeing ?2 million of a ?3.6 million grant lost to university managers on account of FEC. "There is no transparency in the system. The university creams off vast sums of money and gives us nothing at all in addition. I would just like to know where all the money I bring in has gone. They use it for hiring people in human resources to give meaningless courses - that is what I worry about."

But the position taken by the research councils, driven by the ire of their grant holders - that they want the additional money to stay in those departments that attract it - raises hackles with university administrations. "It is a curious position - 'as long as my research is sustainable, to hell with the rest of it' - and it is a complete misunderstanding (of how FEC is supposed to operate)," says Bushaway.

Carter at Liverpool agrees. "Researchers think that estates and indirect costs represent free income, but they do not. They support actual costs," he says. "The reason we had a multibillion-pound gap was that few - funders or universities - were willing to recognise that those were real costs."

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Gorringe adds: "There is just no evidence that we are not using FEC in a responsible way to sustain research infrastructure."

Some argue that the budgetary model operated by universities to manage their FEC can make a difference to how academics view the system. Some administrators seem to think the most transparent method is to channel all income to departments and then deduct a "tax" to cover hidden costs such as electricity.

To some academics, the issue is a red herring. "We have no idea whether the tax we are billed is at the appropriate level," says one researcher.

The battle being played out in universities between the administration and its research stars is summed up by one vice-chancellor, who says: "There is an interesting theological debate, which is whether (research council) FEC at 80, 90 or 100 per cent is right, with the remainder made up of (funding council) capital funding ... I suspect I would rather keep capital funding. It would make it easier for me to use it where it was needed rather than having to constantly argue with academics about the fact that it is not their money."

The change to FEC has also created tensions in universities' relationships with other funders, including government departments, industry and charities. Looking at the impact of FEC on these will be another key part of the RCUK review. Again, conflicting agendas abound.

The picture, unsurprisingly, is one of an evolving market littered with anecdotal evidence that universities have, at best, encountered reluctance on the part of government departments and industry to pay 100 per cent of FEC. At worst, the funders use the flexibility within universities to negotiate a lower price, fund less research or go elsewhere.

Seen from a funder's point of view, FEC is simply an extra cost to pay (government departments have not been allocated any extra funding for the outlay). Some university administrators worry that the 80 per cent of FEC paid by research councils will become the de facto maximum for other funders.

"The main concern with government departments is that some appear to still want to fund volume above supporting sustainability," says a UUK spokesperson.

Liverpool's Carter says that there has been a move by government departments away from commissioning research from universities (where they are expected to pay 100 per cent of FEC) to competitive tendering, where they have the option of picking the cheapest bid from among university and commercial bidders. The result is that universities are tempted to offer their services at less than cost.

On the industry side, the reluctance to pay 100 per cent of FEC is summed up by UCL's Wingham: "It is the subject of endless negotiation. Larger industries are probably better at handling the issue, but smaller ones face difficulties in spending money on things other than direct outcomes."

David Cairncross, a senior policy adviser at the Confederation of British Industry, says there is reason to believe that research collaboration with universities "may be losing some of its attraction" on the back of the FEC cost model; other countries with high-quality science bases but lower costs look enticing.

"For some firms, FEC may be a tipping point prompting a move," Cairncross says, although he adds that the more general experience is that businesses are just simply not increasing the level of costs they pay.

An internal survey conducted in early 2007 by Universities UK of 42 of its members concluded that both sectors - universities and business - were showing "increasing maturity" in their discussions. Universities were making strategic decisions about price by balancing factors such as the cost of a project; its strategic worth; the need to ensure sustainability across all activities; the nature of the company; its previous relationship with the university; and the university's market position. UUK are intending a follow-up survey to feed into the RCUK review.

The road ahead for universities and charities also looks rocky. While the introduction of the Government's charity support fund has helped to keep a lid on rows, the higher education sector believes the disputes could flare up again as charities look to boost their research volume further.

"If they want to increase volume - and I suspect they do - can they expect the Government to support that? They need to think about their position," says one source close to universities.

Simon Denegri, the chief executive of the Association of Medical Research Charities (AMRC), which represents 114 member charities including the Wellcome Trust, gives the charity perspective. "Charities have always aligned around a position of not paying indirect costs of research, and that remains. It is one of the AMRC's membership requirements when a charity joins that they sign a position statement," he says.

"If you look at public expenditure on medical research, you will see that by most dimensions the charities are the fastest-growing source of that money, providing approximately a third and growing ... and there is not going to be a let-up in terms of charity ambitions in this area. I agree that there has to be a discussion about how the system works in the future, but there is not going to be any change - I think - in the charity view that money, voluntarily given by the public, should not be used to cover university administration costs. It is just the wrong thing to do."

Denegri says charities see many thorny issues around FEC. First, they say, the Government has not put enough money into the charity research support fund to enable charities to compete with research councils and industry to fund projects. "As a consequence, there is some anecdotal evidence that researchers are being told that charity money is not the first port of call for them," he says. Secondly, he is worried that some charities are being "quite pressured" by universities to cover costs of research that they would never have paid previously. There is also lack of awareness on behalf of some senior researchers who steer away from charity funding because they do not realise that the charity support fund is in place, he explains.

The AMRC also plans to survey member charities on how FEC is affecting their relationships with universities and feed the results into the RCUK review.

Another old issue that some on the university side are angling to revisit is whether the research councils and others should be paying for the postgraduate students they fund. At the moment, councils pay full stipends and fees, but students are placed completely outside FEC mechanisms.

Yet, says Carter, if institutions cost postgraduate students on an FEC basis, they find that a certain amount of deficit is associated with taking them on. "If we want to encourage academic staff to have postgraduate research students, we have to look at this again," he says.

Just quite how far the RCUK review will examine these pressing issues remains to be seen. Certainly for David Wingham in his laboratory and others, it is follow-through on implementing the FEC vision on the part of both funders and universities that will make their research truly sustainable. And that is needed now more than ever.

What are the full economic costs? A guide to research funding and costing

The full economic costs (FEC) model of university management is based on the premise that it is possible to calculate the true costs of all activities. The FEC of research is its true cost when visible and hidden costs are accounted for. It replaces traditional definitions of direct and indirect or overhead costs.

Under the FEC model, costs are classified according to three categories:

• Directly incurred costs: these are specific to a project. They include research assistants and dedicated support staff, consumables, travel and equipment;
• Directly allocated costs: this is expenditure that a project shares with other activities. These costs are divided into investigator time, laboratory technician time, contributions to major research facilities and estates costs (which vary depending on whether the space is a lab or an office). Universities have their own standard rates for each and calculate costs based on estimated use;
• Indirect costs: these are not related directly to a project but are essential for the research environment, such as the costs of human resource and finance services, running a library or having a research support office. Each institution has a standard indirect cost rate (calculated as pounds per full-time employee) that is accepted by research councils but kept confidential for commercial reasons (although a benchmarking process between institutions allows rough comparisons). Under the FEC model, a methodology known as the transparent approach to costing (Trac) is used to calculate the costs.

From April 2006, the research councils and the national academies such as the Royal Society have been required to pay 80 per cent of FEC on the grants and fellowships that they fund (postgraduate students are excluded), replacing the previous payment of a direct cost and a contribution to overheads.

To fund the additional costs of FEC, the so-called FEC uplift, the Government has provided the research councils and academies with extra money. This will rise to ?500 million a year by 2010-11. Of the ?1 billion increase seen in the science budget in the 2007 Comprehensive Spending Review, about 75 per cent has gone to fund FEC uplift.

The Government has also provided capital funding to maintain research infrastructure and to fill in the hole caused by years of underinvestment. Previously known as the science research investment fund programme (SRIF), it is being phased out and replaced by a permanent capital investment fund, worth about ?180 million a year.

Taking the research council and learned society uplift with the capital funding, the FEC contribution from "the science budget" is about 90 per cent.

The Treasury's basic principle is that government departments should expect to pay 100 per cent of the FEC (although there can be exceptions such as the National Health Service). Universities are also expected to recover 100 per cent of FEC on industry research.

Charities generally pay only directly incurred costs on their research, with separate government funding through the charity support fund providing a top-up. Universities are developing a separate methodology to allow them to recover most of the FEC for research funded by the European Union's Seventh Framework Programme.

The cost and the price of a research project are different. Universities must calculate cost on an FEC basis, but they can then set their own price, bearing in mind the market and the need to balance their books overall. The exception is work funded by research councils, in which case 80 per cent of FEC is paid.

How FEC is dispensed to researchers can be controversial. Universities generally use one of two budgetary models. Under the "devolved model", research income flows directly into departments, which are then charged a "fee" or a "tax" by their central administration to cover hidden costs. In the "top-slicing" model, research income is amassed centrally and a cut is returned to the department for the project.

There are various schemes in place to monitor the effects of FEC. Universities are required to report an annual "Trac return" to funding councils. Viewed collectively, these data show the extent to which the sector is recovering its costs on an FEC basis (see table attached).

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Research funders have also developed a method to monitor financial sustainability based on comparing institutions' plans for achieving long-term sustainability with "trigger metrics" on income, staff, equipment and buildings to see if they are going in the right direction. The first set of data, produced in April 2006, showed that long-term sustainability was of some concern in 13 institutions, none of which was highly research intensive. The data are being updated and will feed into the research councils' FEC review.