Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.

Many of our readers will have children/ grandchildren or at the least know those who do. And for all parents (including your author), getting the education of their children right is an absolute priority. Benjamin Franklin’s words that “an investment in knowledge always pays the best interest” remain particularly appropriate, and the figures would seem to speak for themselves, with the average OECD country spending at least 6% of its GDP in this area, a 30% leap over the last decade. However, the traditional models of education are being increasingly challenged by a combination of factors – not only growing ‘brain competition’ globally, but also rising educational costs and innovative technologies. Numerous companies have already begun to exploit these dynamics and many more will likely come to the fore. The incumbents will correspondingly be challenged. The winners are not yet clear, but disruption set to become the norm.

The reasons behind the growth in educational spend are clear and can primarily be attributed to an aspiring middle-class population in emerging markets combined with the strong correlation between successful education and subsequent employment. In 2009, the world’s middle class comprised 1.8bn people according to the Brookings Institute. Yet by 2020, this figure is set to reach 3.2bn. A brief look at household income spent on education shows just how much emerging nations are spending ‘catching up’ with their more developed peers. The Chinese allocate more than 13% of their disposable wealth to education, the Indians over 11% and the Brazilians close to 10%, in contrast to figures of closer to 2% in the US and the UK, based on recent data from Credit Suisse. The correlation between educational spend and economic returns is compelling: 90% of the fastest-growing jobs in the US economy require a tertiary degree, and a college graduate will, on average, earn over their career lifetime, $0.9m more than a high-school drop-out according to the US Government (rising to $1.3m for those with a Master’s degree).

Demand for educational services will likely only continue to expand, with numerous studies forecasting compound annual growth of 5-7% through to the end of the decade, close to double the rate of GDP. Against this background, it seems logical to consider whether supply can match demand. Put simply, heavily indebted governments are struggling to fund education and with price-conscious individuals/ households therefore now increasingly being forced to do so instead, a free market for teaching talent, paid according to the demand for appropriate skills, is emerging. Moreover, many students now want or need to learn on their own terms (whether for financial or personal reasons) and hence the format of a typical undergraduate degree, committing to a fixed course for a set price, looks much less tenable than in the past.

Two clear trends are set to emerge as a result of this dynamic, both of which challenge the established model for tertiary education in particular and for which many establishments may be unprepared: increased unbundling and the growth in digital services. In the future, different providers could compete to offer tuition, research services, curriculum design, content generation, assessment, certification and even student placement, with the market place for most of these being located online as opposed to in the physical world. The market for ‘smart education’ – perhaps best thought of as a range of technologies that may be used to transform traditional systems into a more automated virtual learning environment – is already worth $74bn (according to Markets & Markets, an independent research firm), and could be worth $220bn in 2017, a compound growth rate of 20%.

Flexible learning, of course, is not an entirely new phenomenon. In the 1920s, over 4m US citizens – far more than those attending conventional colleges – were enrolled in correspondence courses. New York University even opened its own radio station in 1922, with plans to broadcast all its courses. With the emergence of the Second World War, radio had virtually disappeared by 1940 as an educational medium although TV-based services did gain some popularity in the post-War era. Digital or online learning offers many clear benefits both relative to the conventional class-based tuition model and also to its earlier, more rigid precursors. Electronic courses can be undertaken anywhere (with access to the Internet and/ or a Wi-Fi connection), escaping time zones and physical boundaries, allowing students easily to cross disciplines, while lowering the barriers (costs) to student entry. The scope to learn over one’s lifetime is also markedly enhanced.

Academics seem gradually to be accepting (if not embracing) the logic of digital education. While fewer than 50% of all chief academic officers surveyed in 2002 at 2,800 US colleges and universities believed that online learning was “critical to their long-term vision”, last year the figure had risen to close to 70%. Over this decade-long period, the Babson Group’s (an education-focused research organisation) study also showed that the proportion of US students taking at least one online course had risen from less than 10% to over 30%, close to the equivalent of 7m students during the last academic year. Further endorsement was provided by a 2010 US Department of Education report that conducted a meta-analysis of 45 published studies comparing online and face-to-face learning. The work demonstrated that, on average, students in online learning conditions performed better than those receiving face-to-face instruction. Online study should be seen in the context of what may be viewed as the emerging paradigm for the world of smart education, namely competency (or outcome-) based learning, an instructional system that is performance-based. Students demonstrate their attainment in one subject area before moving on to the next. In this environment, learning and not time is the key metric of student success.

In the last five years a plethora of new (mostly private, and typically venture-capital funded) businesses have emerged to target the changing educational market. These can be broadly split into three categories: for-profit organisations with a direct fee model; non-profit – i.e. charitable – establishments; and pure-play educational technology businesses. Udacity was born out of an experiment at Stanford University where two professors offered an ‘Introduction to Artificial Intelligence’ course online to anyone for free in 2011. Some 160,000 students in 190 countries signed up. Correspondingly, the organisation now offers a range of paid-for online courses (sometimes known as MOOCs – or Massive Open Online Courses – based on the large participation rate). Its first full MOOC-based degrees launched earlier this year with prices starting from $7,000, a fraction of the cost of a typical US degree ($40,000 in on-campus fees alone). Other players within this field include Coursera, which now has over 5m students signed up to its online courses globally, and raised $65m of new funding earlier this year, and StraighterLine.
Within the non-profit field, edX and the Khan Academy offer similar propositions to the businesses mentioned above. edX emerged from the OpenCourseware Movement spearheaded by MIT in 2011, where the university began to record all of its courses and make them available online. Several other universities including Harvard and Berkeley have now signed up and edX currently counts 1.3m enrolees. The Khan Academy was founded in 2006 by Salman Khan, a graduate of MIT and Harvard Business School, and its stated mission is to provide a “free world-class education for anyone anywhere.” The website features over 700 lectures and has a global user base of more than 6m. At both these organisations, even if the courses are free, students still often need to pay for exams or to receive certification. Similar establishments currently exist in the UK, Germany, Spain, Finland and Japan among others.

The courses offered by any of these organisations may not immediately substitute for a conventional degree, but at the least complement it or provide many aspiring students globally with the ability to access and learn from information that may be directly relevant to their future career choice. Such a focus is also consistent with outcome-based learning. In many ways, the transition online should therefore be thought of as a necessary, but not sufficient part of how education will evolve. This is where more dedicated pure-play education technologies businesses have the scope to flourish. Pearson’s Embanet business was established 20 years ago and is now one of the leading educational technology companies partnering with schools and universities to offer online degree programmes, working on technology, coursework design and infrastructure support. 2U (formerly 2Tor) is another similar operation, based in the US with a five-year history. Other educational businesses focused on dedicated niches have the potential to benefit as the market evolves. Chegg, a recently listed provider of textbooks in both a hard-copy and online format is such example.

Digital learning is not, however, without its critics. Many academics, unsurprisingly, fear the risk of potential displacement and even those who have been more open-minded remain highly risk-averse, preferring wherever possible to work with established (and scalable) providers rather than aspiring new entrants. One additional obvious concern in the online world is clearly that for students there is an increasing need to self-regulate in terms of how they learn and set their own goals. Related to this remains the importance for some structure and ultimately transparent assessment where the scope for potential abuse (via cheating on the student’s part, for example) is minimised. At the very least, it would seem that many academic organisations will need to increase their investment in digital infrastructure.

The rate at which the education market has already changed in recent years has seen a number of businesses that were previously listed taken private (most notably Blackboard in 2011 and McGraw-Hill in 2012) owing to their poor relative positioning and corresponding share price performance. Many of the remaining listed businesses also lack scale and those with more traditional (non-smart) business models will clearly remain challenged. While identifying the most obvious ‘new’ winners remains hard, particularly given the relatively short track records of many, Pearson, with over 20% annualised shareholder returns over the last five years, stands out among the more established businesses. Beyond being the largest provider of educational services globally, with over $7bn of sales (more than 1.5x its nearest rival), some 50% of its revenues now derive from digital services, a figure it hopes to grow to 75% by 2015. Elsewhere, in the emerging world, several businesses have arisen catering for naturally growing demand and lacking legacy infrastructure and systems. Those that have enjoyed some success include Anhanguerra, Brazil’s leading learning network, and China’s New Orient Education, listed in the US. Their respective annualised five-year shareholder returns of 32% and 18% demonstrate the clear potential of embracing the shift towards smart education.

Alexander Gunz, Fund Manager


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