By Dr. Michael K. Clifford
What does the Occupy Wall Street movement have to do with structural challenges in higher education? Apparently, a lot.
Since the movement began in September in New York City’s financial district, protests have metastasized throughout the world. Interestingly, protesters have not yet presented a unified list of demands, other than vague commentary regarding the unfairness of income inequality. That said, increasingly we are hearing through traditional media, social networks, tweets, and blogs about protesters’ anger regarding student loan indebtedness and the inability to pay down such debt given a challenged employment situation.
The Obama administration presumably is attentively listening to media accounts of these protesters. In late October, President Obama announced he would use his executive authority powers to expand the income based repayment program. With the upcoming Presidential election, I expect substantial policy discussions regarding mechanisms to help students pay down their debt burden. Following the rash of government bail outs of many sectors in our economy, I’m curious as to the degree that policymakers contemplate rolling out student loan forgiveness programs.
It would be easy to dismiss the protesters as a passable curiosity or alternatively deride them as ill-informed mobs wrecking economic havoc in the locations where they are protesting. Over the years I have learned to listen carefully to angry people to learn.
In October, The Economist suggested that the total amount of student loans (federal and private) could "surpass $1 trillion in the not-so-distant future". U.S. student loan debt surpasses credit card debt. Unlike credit cards, student debt cannot be discharged in bankruptcy. The government can garnish wages for collection purposes. One can argue that the US government is the largest predatory lender in our country, getting a better than average return on investment on student loans.
Historically education has served a public good in changing lives for the better by increasing income levels. Unfortunately, it now appears that the high cost of education and the consequent level of debt needed to pay for school could be destroying rather than enhancing graduate’s lives. Wall Street protesters are correct to point out that while the federal government bailed out the financial services and automotive industries, they opted not to help students who were promised the American dream so long as students opted to pursue a post-secondary degree. This makes me sick.
On the surface, the answer to the problem of ever escalating student debt remains relatively simple — institutions of higher education need to charge less in tuition. And yet, they are not. Economic challenges require governments to continue to reduce funding to state supported institutions, which in turn has resulted in tuition price increases and reduced capacity. Cutting programs and headcount at state institutions seems like a potential solution, but that is not part of the DNA at most institutions.
The shift to online can potentially serve as a tool to lower tuition. But, technology itself is not the answer — a system of self-supporting activities is needed to advance the mission of tuition deflation.
Ten years ago when I started my career in higher education, online was in its infancy. How things have changed in but a decade. According to the recently released (November) Sloan Consortium report "Going the Distance: Online Education in the United States, 2011", nearly one third of all students in higher education are taking at least one online course. I would be shocked if that figure was not two thirds or more in a decade. Why? Well, the report also states that "65% of higher education institutions now say that online learning is a critical part of their long-term strategy". This makes sense — introducing lower cost online programs at traditional schools has the potential to expand capacity and generate revenue.
To be clear though, online in itself is not the great panacea. There is a difference between online courses and full time online programs in terms of the mission and cost structure of the institution. A high priced institution can offer online classes to students and use the increase of revenue to support that institution’s existing infrastructure in the face of a loss of state financial support or a declining endowment. Or alternatively, that institution might be reluctant to charge a lower price point for an online class given the threat of cannibalizing the existing base of students attending the brick-and-mortar class.
Full-time online institutions present an extraordinary opportunity to rethink the operations of a university. It’s not just about infrastructure investments in land and buildings (although clearly one of the ills of higher education is ever expanding campuses to promote brand and prestige). Its about eliminating traditional notions of "semesters" and "seasons" and making higher education accessible year round, with starts dates on a weekly or monthly basis rather than in the fall or spring. Its about offering courses with varying durations that best fit student needs. Its about standardizing courses which can increase efficiency and ensure academic quality. Its about recording the various touch points that at student has with faculty and with other students to ensure student engagement. These and other activities support a lower cost model than traditional higher education.
So, the real question regarding online is whether institutions are willing to rethink everything that they do. This in part explains the rise of the for-profit industry over the past decade in my opinion. Entrepreneurs and investors created institutions willing to innovate and rethink practices. Regarding my own career, I chose the for-profit path because of the inherent flexibility to innovate to meet student demand (I’ll note though that I’ve also donated a lot to non-profit schools, as its about the mission, not the model).
The for-profit model has been successful in increasing access…
Over the past 35 years over 1,000 private sector institutions have opened compared to 350 public and private institutions. The for-profits led the way for adoption of online technologies throughout the 2000s. Unlike brick-and-mortar institutions, the cost structure of online enabled a high margin (in some cases 50%) on an incremental dollar of revenue (for reasons still not entirely clear to me state institutions incur a loss per incremental student). As well, my thought was that in theory, operating as a for-profit school would create value to students, shareholders, and society. To attract and retain students, the school in this model would provide greater support services than a typical institution. The school would also provide a career oriented education that ensures gainful employment upon graduation, which would build the brand of the institution and creates a sustainable and steady pipeline of future students. To generate a profit, schools would operate efficiently, extricating extraneous activities like faculty research or extracurriculurs (e.g., athletics) that take away from the mission of serving students, and tenure.
In many respects, the for-profits succeeded over the past decade, particularly on the access side. From 2000 to 2009, enrollments grew at a 13% CAGR, from 673K to 2.2M (Source: BMO). The
market share of proprietary institutions as a % of total post-secondary enrollments increased from 4% in 2000 to close to 10% today.
… but with the good comes the bad, as questionable business practices by for-profit operators have tarnished the reputation of the model.
Unfortunately, the growth of enrollments in the 2000s corresponded with business practices at some institutions that besmirched the reputation of the entire industry and in turn brought the attention of regulators to propose change (some good and some not). Such questionable business practices include aggressive marketing tactics, misrepresentation during the enrollment process, and fraud relating to placement rate reporting. As well, institutions sought to enroll students regardless of whether the student would succeed or not. I would never invest in a school that promises a person to be the next Vidal Sassoon or Wolfgang Puck, then laden them with $60,000 in debt. The pervasiveness of questionable business practices is outside the scope of this piece. The point though is that activities happened, the government got involved, and businesses are in the process of cleaning up their practices (with some having seen new start declines of up to 50%).
My vision of the future of for-profit education — primarily online, relationship marketing as a driver for lower tuition, higher graduation rates, greater student satisfaction, ethical behavior, and regulatory compliance.
The notion of profit generation and education in my opinion isn’t antithetical. The challenges that the industry has seen over the past several years is a function of unsustainable business models that produced bad behavior. People forget that while proprietary institutions have operated in earnest the United States since the late 19th century, the industry as we know it today remains relatively nascent given the emergence of online education. For better or worse, Version 1.0 of online operators relied upon lead aggregation vendors to provide the lion share of leads. Such leads were then sent to call centers, where enrollment counselors sought to convert leads into enrolled students. In this model, operators acted as marketing companies. It was in the operator’s best interest to enroll a student so long as the stream of cash flow from an enrolled student exceeded the cost to acquire a customer. Typically an operator achieved break-even on a contribution profit basis after an enrolled student attended two to three classes. Institutions did focus on compliance with regulatory metrics including cohort default rates and placement rates (depending on accreditation standards), but such metrics did not necessarily ensure that students were receiving value relative to the amount of capital invested for the education. Finally, these operators increased tuition at a similar rate to that of state and private schools, a rate which exceeded CPI.
My firm SignificantFederation help to create Version 2.0 online providers back in the early and mid- 2000s through the successful launch of Grand Canyon University and Ashford University (owned by Bridgepoint Education). The only real innovation between 1.0 and 2.0 was the conversion from non-profit to for-profit – Grand Canyon being the first in American history to do so. From an operational perspective, these institutions were indistinguishable from Version 1.0 institutions. However, we sought to improve the value proposition to the student by reducing the net debt that a student would take on by: 1) offering a lower tuition price relative to competitors; and 2) increasing the transferability of credits. As well, we thought that institutions with a traditional ground campus that targeted a niche (e.g., Christian heritage) would increase the brand of the institution and thereby lower the need for marketing spend, which would in turn support the reduced the tuition cost and provide a return to investors who risked their capital for the creation of the schools. Fortunately for all stakeholders, the model worked. In 2000 the predecessors to today’s Grand Canyon and Ashford enrolled less than two thousand students combined. In 2010 they enrolled close to 120,000 students. Meanwhile, as Version 1.0 operators like University of Phoenix, Kaplan University, American Intercontinental University and others saw new starts decline by up to 40+% YoY in 2011, Version 2.0 operators saw starts remain flat YoY. We believe that the enhanced value proposition sustained those institutions’ enrollment levels. More importantly, we believe that these institutions are well positioned to take market share in the years ahead as they create value to students and alumni (disclosure: I remain a shareholder of both LOPE and BPI).
I expect over the coming years for Version 3.0 post-secondary operators to emerge, shaped by the 1) intense media and government scrutiny on the post-secondary sector; 2) increased competition from traditional state institutions online; and 3) changed consumer behavior regarding taking on excessive student debt. Unlike Version 2.0 institutions, Version 3.0 is operationally distinct from Version 1.0 companies. The key difference? Relationship based marketing – especially social networking in very specific niches. Version 3.0 operators work closely with partners, whether they are traditional non-profits universities, corporations, industry associations, or other membership organizations in these like-minded niches. Version 3.0 operators do not buy Internet banner ads, nor have commissioned enrollment counselors at boiler room call centers that are required to “convert leads”. Rather, the Version 3.0 enrollment counselors work together in a consultative role with partners to serve the best needs of students, with much more control in who gets enrolled by faculty.
Relationship marketing enables a lower spend to acquire customers, which in turn allow institutions to charge a lower price point than with online competitors. Leads will cost anywhere between $0-1,000, depending on the type of partnership. In comparison, publicly traded online institutions are spending $3-4,000 for acquiring new starts, with such costs having increased by 50-100% YoY at some institutions in 2011. Version 1.0 and 2.0 companies are likely to see a continued rise in customer acquisition costs given the limited supply of high quality students that institutions seek to improve their regulatory standing. Such operators have started to alter their mix away from the Internet lead aggregator channel to other media. However, investments in brand could prove costly, and make it challenging for the institution to support a lower tuition price point.
American Public Education stands as the only publicly traded postsecondary institution to use the relationship marketing at the core of its strategy. Despite investor concerns regarding a reduction in military funding (which represents 40% of that company’s revenue), the stock trades at 7x EBITDA vs. 4x for the rest of the publicly traded post-secondary companies. We think that investors are beginning to understand that Version 3.0 companies warrant much higher valuations than Version 1.0 and 2.0 companies given 1) lower tuition price points, which are compelling to students in an environment of increased price sensitivity for higher education; and 2) better regulatory profile given the lack of call centers.
The solution — invest in Version 3.0 operators with dual social and financial interests, those being to lower tuition and generate a profit.
Institutions should lower their tuition. If only life were simple. The problem is that institutions have a cost structure predicated on current tuition levels. Lowering tuition threatens to destroy an institution’s mission.
In my opinion, the only way to catalyze meaningful price reductions in higher education is to encourage and fund new market entrants with business models set to reinforce tuition deflation. The commitment to continued tuition decreases (rather than increases) necessitates a different operational and marketing approach from incumbents. We need more Version 3.0 institutions. For better or worse, government cannot do this alone. Given budgetary constraints, government cannot by itself fund the next generation of low cost institutions. However, government, investors, and entrepreneurs can partner together to create Version 3.0 institutions.
At SignificantFederation, we are currently invested in two emerging institutions named Victory University and United States University whose strategy centers on employing social networking centric relationship based marketing providing an education with a purpose via niches to drive lower tuition prices. Our academic’s work closely with community colleges in educating those students committed to completing their degree in a timely manner.
We only want to enroll students who have the commitment and demonstrated capability to graduate. We want students, faculty, and staff that are passionate about how they fit into the fabric of society to help people live better lives with their degrees. Top line growth is not as important to us as higher graduation metrics, lowering tuition, all while increasing margins via technology. These two institutions will be exporting American education via online at price points that will allow millions of global students to improve their lives. Our students will be connected globally in an education social network online.
Playfully, I have referred to this vision as: “We are the Wal-Mart of education, delivered at the speed of FedEx, in the Spirit of Mother Teresa…”
As well, we are committed to partnering with existing state and private institutions in helping schools develop online capabilities to launch their own Version 3.0s. As part of our mission, we want to facilitate the broad adoption of online education, which we believe over the long haul will act to reduce tuition prices. We welcome any institution that would like us to help provide funding, technology, and management between accredited institutions in good standing to help provide better access, lower tuition, and help provide financial stability.
I’ve never seen a better time to invest in education today given the level of regulatory scrutiny that the sector has faced over the past two years.
Its unfortunate but not surprising that many of the investors that I speak with have little desire to invest in higher education given the regulatory challenges that the sector has faced over the past two years. A year ago investors were shell-shocked. Today, many seem burned out. As a compassionate capitalist, I am generally opposed to regulations. However, as an investor and an entrepreneur with a long-term time horizon, I welcome it. It’s not just the barriers to entry that protects my business. It’s that the sector is much cleaner than it was years ago. Business professionals working with government funds always have the temptation to maximize federal dollars at the expense of stakeholders. I welcome scrutiny as it provides me the comfort that my team is incentivized to do the right thing, such that my institutions are running properly. What better way to have a truly objective third-party review of management’s execution?
For the past two years I’ve heard nothing but complaints regarding regulators and accreditors who are positioned as acting out against for-profit institutions. I understand the criticisms. But the fact is that regulators have responded to real problems at select institutions. For better or worse, when it comes to matters of public policy, statements are made in broad brushstrokes — thus the attacks on the "for-profit sector" when really speaking to the worst offenders. I’ve found based on my years of experience in the sector that well run for-profit postsecondary businesses have nothing to fear from regulatory bodies if the business has a commitment to academic and business quality. If anything, the mission of regulators is aligned with businesses as it relates to the focus on student quality. My personal heroes in the regulatory world are leaders like Dr. Ralph Wolff, Dr. Sylvia Manning, and Dr. Belle S. Wheelan of the Western Association of Schools and Colleges, the Higher Learning Commission, and the Southern Association of Colleges and Schools, respectively. They are the true innovators in the regulatory world encouraging new forms of governance, compliance which benefits students, stewardship of student loans, and new academic models to help lower costs.
I am slightly less complimentary regarding the U.S. Department of Education – I would give them a grade of a C+ to the solutions they have come up with to date. My hope is that Secretary of Education Arne Duncan will continue to listen to all of the education providers to move the Department of Education’s grade from a C+ to an A+. To be clear though, I also hope that operators listen to the Department of Education and the concerns expressed over the past two years — I find the demonization of the Department as unacceptable. Solutions are available if entrepreneurs, academics, administrators, and bureaucrats work together in a civil society respecting each other’s goals and objectives.
One thing is clear — there is no doubt in my mind that the firestorm of the last two years is over. Institutions are in the process of self-regulating. Government appears much more willing to engage the private sector in thoughtful conversations. The country’s fiscal crisis will necessitate strong collaboration between the public and private sector, which will benefit all, including investors.
Tying it all together… entrepreneurs and investors can innovate in partnership with government to create institutions that offer lower cost models to those seeking education without a substantial debt burden.
As a society, we have the people, processes, technology, and capital to increase access and affordability for students. Unfortunately, we haven’t had the will. Student debt has been a side note for policy makers, regulators, operators, investors, and even students. The economic expansion we witnessed over the past thirty years ensured that ever escalating investments in education would be well rewarded with employment and high income. The Occupy Wall Street movement represents the new reality — that students take on too much debt given job prospects, which can manifest itself into social unrest. Let’s not dismiss the protestors. I suspect we will see more of them over the coming year or two. Rather, let’s listen to what they want. While debt forgiveness might be a stretch, affordable education to avoid drowning in debt is rather reasonable.
Change in higher education takes time. Let’s plant the seeds in terms of investing in Version 3.0 operators to support tuition deflation.