Saturday, September 01, 2012

On the Economics of UK For-Profit Higher Education

The debate about For-Profit Higher Education is reaching a fever pitch in the UK. On one side, the Pro-Choice group, the predictable band of private equity, businesses, and politicians, the latter group being committed to a corporate state and reduction of public expenditure in Higher Education, at least in the medium term. On the other, the Pro-Life-as-usual group, the disaffected public sector teachers' unions (University and College Union, or the UCU), and most public universities, who are wholly unprepared for a competitive marketplace. Predictably, as is the spirit of the age, the rhetoric of choice is trumping the pleadings for status quo: By making this a battle for privilege and perks, the UCU has dealt themselves a losing hand. There is very little research and understanding on how For-Profits work (despite a large body of literature from across the Atlantic and other countries) among the ranks of the Public Sector universities. This is the context of setting out this sketch, from an insider's perspective, how the economics of For-Profit really works.

I have seen For-Profit Education from inside for at least fifteen years, in different countries, both in its corporate form and at a owner-operator level. I am a huge believer that the Higher Education sector in a modern economy should be diverse and innovative, and having seen a few of the lesser UK universities at work, I am wholly convinced that they have failed in that task completely. In some sense, the current policy drift towards the establishment of For-Profit universities and their expected rapid proliferation has been justified by the failure among the ranks of public sector universities to offer an alternative view, and defy the pack mentality which dominated the sector.

However, I am equally sceptical that the Private Equity or Public Capital markets help create a better model of Higher Education. In fact, reading the Harkin Report and other evidence coming out of the US For-Profit sector, the business looks like a cross between Russian Oligarchy, which made its billions on the back of public assets, and petty swindle, where money was made by seducing credulous and vulnerable students.

It is also notable that Harkin report squarely blames Wall Street and Corporate mentality, particularly unrealistic pressures of growth in returns, and decision making in distant corporate Head Quarters rather than campuses, which such investment structures invariably impose, for this over-reach.

In many ways, it does seem that the foundational assumption of For-Profit Higher Education is wrong: Karan Khemka, a Principal in Parthenon, a highly regarded consultancy specialising in Education, wrote in Harvard Business Review that Higher Education is an attractive business because students pay in advance and the business is always awash with cash. However, this undermines the need for capacity building and investment, both physical and intellectual, critical for a good educational experience and outcome. Contrarily, the For-Profit models are often based on on-demand intellect, aka adjunct tutors. In fact, I shall argue that For-Profits have so far made money on the back of public education system in two ways: First, by grabbing a share of public subsidy (as in the US), and two, by using a part-time teaching pool made of people moonlighting from the public institutions (a common practice in the UK). However, the key contradiction here is the dependence of For-Profit profitability on the existence of public education sector, and once the latter is comprehensively dismembered, which will happen if the corporate form of For-Profit Education grows unchecked, the profitability of For-Profit is also likely to disappear.

Unless, indeed, For-Profits help to innovate new ways to delivery, and converting non-users of education.

This is seen as the primary rationale behind For-Profits - that it helps to convert non-users, people who dropped out of Higher Education, through innovation in learning. Private education, as some commentators have pointed out, exist side by side with public higher education in almost every country in the world to satisfy one of the three needs: of MORE Higher Education, or of DIFFERENT Higher Education, or of BETTER Higher Education. This gives us a typology of sorts of the Private Higher Education, as conceptualised by Daniel C Levy, a scholar of Private Higher Ed in State University of New York in Albany, that of Demand-Absorbing, Religious/ Cultural and Elite/ Semi-Elite schools.

However, For-Profits find it difficult to fit into two of these three segments: Creating Better Higher Education means higher costs and creation of significant intellectual capacity upfront, and runs counter to the belief in Wall Street and elsewhere how Higher Education business makes money; similarly, most For-Profit ventures tend to focus narrowly on a few vocationally relevant areas of Higher Education, IT, Business, Law, Fashion, etc., and tend to concentrate on high density population areas and tend to be non-selective. This makes the Better or Different routes antithetical to For-Profit models. Henceforth, the For-Profit education's model so far solely depended on demand-absorption, but this is highly dependent on business cycles or quick dismemberment of public education systems. Indeed, such a volatile model will be grossly unloved by Private Equity or Public Capital Markets, and this forced most For-Profit Higher Ed businesses to be innovative about demand-creation.

This clearly caused the fragility of the current For-Profit Higher Ed business models in United States. Since the furore started regarding the default rates of Student Loans by students of For-Profit institutions, which is much higher than public institutions and often tops 40%, the recruitment practises of these institutions have come under scrutiny. It does seem that the For-Profits actively set out to create demand, not just by reaffirming the hypothetical value of college education but also making misleading promises and admitting unprepared students to higher courses of study. The whole saga is indeed very alike the Sub-prime mortgage problem. One would wonder, therefore, as the Student Debt in the US exceed credit card debt, whether in a few years time, barring access to Higher Education will become as acceptable as denying a mortgage to an aspiring home-buyer has lately become.

Indeed, the policy-makers in the UK have learnt little from the experiences of the United States and are currently creating their own version of the problem. The Student Loan Company (SLC) is duly in place, a new funding regime where money follows the students is in place and dismemberment of public universities have begun. The Private Equity interests have reached a peak, and a bubble is forming in education investment, as few good Higher Education assets (those with degree granting ability) are being snapped up at very high prices: This would, expectedly, lead to pressures on earning later and artificial demand-creation for education! The signs are already visible, with Student Loan funded networks coming in place, and businesses have seen the opportunity to get the funding and channel it to the unemployed, who, by signing up, can benefit from increased social security payout. This would surely lead to a problem of completion rates etc., but neither in stock-markets nor in democratic governance, such considerations have any place.

UK indeed had a thriving For-Profit Higher Education sector for at least two decades, contributing to the economy an estimated £2 billion at its peak, and though, unlike US, this sector received little public subsidy. Instead, the institutions survived on extracting 'rent', being the easy route to residency in the UK for applicants from overseas. I must stress that this is different from being 'visa colleges', as all these institutions are currently portrayed. They were legitimate For-Profit colleges, with massive infrastructure, staff and range of courses. However, instead of trying to compete with subsidized public universities, these colleges went after the most obvious opportunity: The International students ready to pay a premium for an UK education and access to UK job market. This is exactly what the businesses do in any society, exploit emergent and often risky opportunities. It is possible to see the resulting crisis, and tightening of visa, as one and the same as the problems with demand creation in America - the UK colleges made misleading promises and admitted the less able - and can be treated as symptomatic to the current For-profit business models.

It is important, therefore, to look for an alternative business model for UK For-Profit Education, because, believe it or not, the international student market has become more, not less, attractive in some sense. The universities have already scrambled to take advantage of this, and offered their sponsorship to the students coming to For-Profit providers; bigger For-Profit providers like BPP tried to take advantage of this attractive opportunity. From the 'rent' perspective, we should note that the 'rent' on UK visas have only increased, and the incentive to abuse the system has just gone up. This is what happens when supply is cracked down upon instead of penalizing the demand: By restricting which institutions could sponsor a visa, the government has raised the price that potential immigrants will pay for a visa and therefore raised the incentive of abuse; cracking down on illegal work and actual deportation would have penalized demand and create a disincentive for abuse. The government tried to, rather cleverly, mask the ineffectiveness of its own agency and its ability to enforce the immigration rules by shifting the blame and the responsibility of immigration control on the Higher Education sector in general and smaller For-Profit institutions in particular, but this has indeed made UK immigration only more susceptible to abuse, and the contagion, as evidenced in the recent events of London Metropolitan University, is now spreading wider.

However, the weak economy and job creation, which will dampen the legitimate international demand as well as demand at home for education, are more potent reasons to force a restructuring of the sector. The private equity interest in the sector is currently fuelled by perceived regulatory arbitrage, that the public money will now be diverted to private providers and the public universities will now have to engage on a level-playing field: But this is not a real business case and is unlikely to result in great expansion in student numbers as the country faces a difficult economic climate for years to come. In this climate, For-Profit providers, alongside their PE backers and investment bankers, need to look at sustainability of their business models, which must look at value creation, and not just arbitrage.

This brings me to the final point: How do For-Profits create value in the Higher Education sector? As I mentioned earlier, the usual expansion of choice argument is lazy and overused: In a contracting market for education, this may not even be economically viable. However, there are at least two areas where For Profits can make a difference, and create new opportunities in Higher Education.

First among this is by creating GLOBAL education, which standards-bound and usually risk-averse public universities fail miserably at. Despite the talk of transnational education, the governance structure and the priorities at the public universities are resolutely insular: It is extremely difficult for any of these institutions to effectively create a truly decentralized global network, offering all its students an education fit for global age. It is no surprise that private universities and business schools have a lead on this, and For-Profits can take this work further and create a truly differentiated offering.

Secondly, For Profits can make a difference in TECHNOLOGICAL INNOVATION in Higher Education, which not only falls in line with their own quest for efficiency, but also in their lineage as businesses to apply available technologies. Indeed, the most successful For-profits have already greatly enhanced the application of technology in education, and new and exciting offers seem to come upstream at regular intervals in this space.

So, to sum up, the current business models in For Profit Higher Education may not be sustainable, as they have so far depended on public subsidies, direct or indirect, or demand creation, which invariably leads to abuse and disaster.  The For-Profits can, however, move away from the demand cycles and create differentiated offerings, just as successful businesses in other segments will do: The two tools available to For-Profit providers in this respect are global certification and technological innovation. For-profits already do these things well, and instead of copying the strategies of public providers, or other not-for-profit institutions (which may be governed by a different set of priorities), For-profit Higher Ed should focus on these areas. We haven't yet seen a Google or Facebook in this space, but if we believe education is the killer app of our generation, it is time to bring about one.

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