Tech Companies Angle for Big Bucks in Education

Enthusiasm to change education from an old-school, paper-based model that most adults are familiar with from their time in school, to a dynamic, personalized experience for kids is fueling innovative ideas and attracting a lot of money.

Both in policy and in practice, education leaders are calling for student access to useful tools and skills. At the same time, entrepreneurs and investors see a market ripe for penetration, in the same way that technology upended models for offering news, music, and retail purchasing.

“Education feels like the last frontier of the internet,” said Trace Urdan, a research analyst for Wells Fargo focusing on education markets. “Investors are excited for what they see as the inevitable transformation of education through technology and the use of the internet as a distributive tool in that process.”

The challenges to becoming a profitable and sustainable education business are formidable. Education is highly political and funding ebbs and flows in cycles that can be unpredictable. It’s a bureaucratic, slow-moving system, especially when public funding is involved. Purchasing power is dispersed across various levels of the system, from individual classrooms all the way up to the federal office. These are all challenges to any one business breaking into what has become a market dominated by three big textbook publishers with large, on-the-ground sales forces: Pearson, McGraw-Hill and Houghton Mifflin Harcourt.

“Technology alone can’t solve the politics,” Urdan said. “There’s this sense among tech investors that the politics and all this other process stuff will fall away the way that it has in some other consumer markets.” Urdan thinks that’s a naïve view, but he admits that the education market has changed since the dot-com boom and bust and that perhaps the time is ripe for innovative technology to lasting in-roads with schools.

What’s different now? Teachers are more comfortable with tech use than they were in the 1990s. Schools have also begun to catch up with the hardware, and are regularly making big-district wide purchases, as with Los Angeles Unified’ s announcement that it’s giving away 31,000 iPads to students at 47 district schools.

Integration of Common Core and the standardization of content goals also make it more possible for individual products to fit the majority of state markets. And perhaps most importantly, students are accustomed to using tech in all aspects of their lives and expect it from school.

David Hoverman, who's focused on the education market at the Parthenon Group, also suggests that the tough economy over the last few years might have actually helped smaller companies get a foothold in classrooms. During the recession, many schools all but eliminated buying new materials from big publishers, he said. Instead, teachers went out looking for tools to serve their needs. They found start-up ed-tech products that have become staples in their classroom. And now, hooking teachers before trying to sell to schools or districts has become a common business strategy.

LESSONS FOR START-UPS

Many ed-tech start-ups are learning from successful commercial business strategies that preceded them. A common one is to seed the product for free with users and when a certain level of absorption has been achieved, try to sell an enhanced version to management. Another, similar model that many ed-tech companies like ClassDojo, Meograph and Tynker have embraced is the freemium model, where the basic product is free, but more advanced features come with a fee. A third is to simultaneously sell a product to schools while offering an advanced product to parents that unlocks supplemental material.

“The sense that I have in speaking to investors is that at some level the potential that they see is so large -- in that you have this paper-based, old-fashioned way of doing things that could really benefit from reinvention -- and they think that’s such a big opportunity that they are willing to give some of these companies a little bit of slack as they work out how they are going to attack the market,” Urdan said.

No one knows which product or model will ultimately strike it big. And in the meantime, investors keep pumping money into products that seem promising. “Everybody is waiting for the Facebook of education to come along,” Urdan said.

Investors are looking for real solutions to complicated problems -- and there are many in education --  because that’s where big money can be made. Venture capitalists seeding the money for ed-tech companies often expect a return on investment that's 10 to 20 times what they invested, in order to compensate for the risk. At the same time, most expect that some ventures won’t pan out.

“The problem that we often have in the education field is that investors see the problem, they see the solution and they figure it’s all going to happen really quickly and then they get frustrated when it doesn’t,” Urdan said. If that happens, he predicts the big publishers will swoop in and buy up innovative companies, further consolidating their hold on the market.

“The textbook publishers are absolutely paying very close attention to every little start-up that’s funded and every application that’s out there that’s going into the classroom, whether it’s directly related to content or is as far afield as bus scheduling,” Urdan said. “This is not that large a market and they are paying very close attention because obviously their future is at stake.”

Traditionally the two best ways to make the kind of money that investors want to see is to either take a company public or be bought by a bigger company. Many entrepreneurs say they're in the business because they want to be part of changing education for the better, but despite their best intentions to remain independent companies, becoming part of a company with a larger platform and longer reach might prove irresistible.