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A red downward-facing arrow is juxtaposed against a $100 bill, illustrating declining stock prices.

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When investors are excited about an innovative business model in a new and potentially massive market, they will pay a multiple of revenue—even in the absence of earnings—with the expectation that in time, with scale, returns will justify such a forward-looking valuation. As market pioneers, Amazon, Netflix, Google and Tesla, were initially valued on revenues later justified and supported by earnings.

This approach also characterized the online program management (OPM) sector for more than ten years, as, in many cases, its participants reported no earnings but offered great promise. From the 2010 acquisition of Compass Knowledge by Embanet for 3.4 times revenue of $40 million to the peak valuation of 2U (TWOU) in the spring of 2018 at more than 13 times sales, investors were convinced that the size of the opportunity would ultimately yield healthy earnings from its leading players.

But today, that confidence has collapsed. Pearson, the eventual owner of Compass Embanet, recently sold its OPM business for the assumption of liabilities and a promised share of potential future earnings. Another major player, Wiley, has similarly exited the sector with little fanfare. And 2U, once the most prized OPM asset of all, has issued a going concern warning to its public market investors and currently trades at a fraction rather than a multiple of its revenue.

What happened? What did investors get wrong, and what does the future hold for this category? And what do the answers to these questions mean for the future of college-OPM partnerships?

What Investors Got Right

  • Consumers wanted traditional colleges to offer online programs. The existence of an untapped market for strongly branded not-for-profit institutions in the online degree space was proven correct. Pearson can rightly be credited with architecting and scaling one of the world’s most successful online degree program offerings, Arizona State Online. Furthermore, dozens of other examples of successful and well-regarded offerings developed through the auspices of private service partners.
  • Colleges wouldn’t enter the market on their own. Despite the demand described above, traditional institutions lacked the risk appetite to enter the market independently at the required scale. Those who did enter independently tended to underinvest to their detriment. The OPM model allowed colleges to finance the development of these programs through partners in revenue-sharing arrangements that avoided any impact on their credit market position. The revenue-share arrangements shifted all financial risk entirely onto the private sector partner. While the most prestigious institutions may have risked their reputations by launching unproven programs, they did not risk other resources.
  • Colleges couldn’t enter the market on their own. More germane than their willingness to risk resources, traditional colleges lacked the skills to successfully design and launch these programs. While there are dozens of internally developed online programs, apart from the singular case of Southern New Hampshire University (SNHU), as well as institutions like the University of Maryland Global Campus (UMGC) and Western Governors University (WGU), where distance education was part of their genesis, none of these independently hatched programs have attained significant scale or are producing substantial revenue for their institution. Some may believe that scale is a poor metric for evaluating the work of a serious higher education institution. Still, it indicates student enthusiasm as expressed through demand and student impact, which is typically a goal of universities, especially public institutions.

What Investors Got Wrong

  • Big TAM, small SAM. In the early days of the burgeoning OPM market, estimating the number of B.A. holders without a master’s degree, or even the total number of adults without any degree, indicated a substantial total addressable market (TAM) that could sustain billions of dollars in additional higher education revenue. Yet, the serviceable portion of that market (SAM) was smaller than investors had expected. As with the for-profit online market of the 2000s, early pent-up demand led to initial explosive growth that abruptly slowed when the market for early adopters became saturated, revealing that the pace was unsustainable. Acquiring students became increasingly difficult and expensive as the cyclical challenges of a robust employment market were compounded by a contracting number of high school graduates and a growing ambivalence among all prospective students toward education borrowing.
  • The model worked better for some colleges than others. OPMs successfully leveraged large and prestigious brands to bring already successful programs to an expanded audience. However, their track record in providing online salvation to struggling programs was more mixed. The University of North Carolina Kenan-Flagler online MBA program, offered by the University of North Carolina at Chapel Hill in partnership with 2U, catapulted the university’s MBA program to one of the largest in the nation and has generated hundreds of millions of dollars of incremental revenue. However, in cases where OPMs offered their services as a lifeline to save struggling programs at institutions with less powerful or more localized brands, they have proven less successful. One of the most high-profile OPM failures involved Concordia University Portland partnering with HotChalk, wherein Concordia, in a relatively short period, became financially reliant on an online master of education program, helping to force the university’s closure when the competitive dynamics in the more volatile online market shifted and enrollment declined.
  • Power balances shifted over time. The standard OPM revenue-share arrangement involved losses borne by a college’s OPM partner in the early start-up period, offset by more generous margins in the later years of a program’s lifecycle. However, while this arrangement made sense initially on paper, it didn’t sit well in the following years as the early losses were forgotten, and university constituencies increasingly resented the disproportionate benefit to OPMs. Given the increased number of players and options, leverage in these contracts shifted toward the university over time as deals were renegotiated in favor of the institution, sometimes multiple times. This meant that the significant returns promised in the industry’s early days became diluted as the OPM market matured. Additionally, new deals were negotiated at ever lower prices as the perceived risk around new program launches diminished in a more mature market.
  • Nonprofit partners proved an ineffective foil for regulatory pressure. Investors were initially enthusiastic about OPMs due to the exposure they promised to the rapidly growing online-degree market. This market had previously driven outsized returns in the for-profit college sector, albeit temporarily. The OPM market offered this same exposure, yet appeared free from the negative regulatory scrutiny that characterized for-profit colleges. However, once critics of profit-seeking education ventures witnessed the strong growth and high valuations in the OPM market, they began to campaign for new regulation of this innovative model. While no material restrictions have been implemented yet, the patterns are too familiar to investors who have assigned the group a permanent regulatory discount.

How Can OPMs Regain Their Investor Appeal?

  • Revise the model. The ability of OPMs to help institutions utilize technology to innovate in ways that enhance financial sustainability and enrich the student experience remains a core value proposition unaffected by the decline in valuations. However, for the reasons described above, and despite continued market demand, business models based on revenue-share agreements that involve front-loaded financing and risk assumptions borne by the OPM partner are not sustainable. Because tech-enabled services offered in teaching and learning will continue to be viewed by traditional university stakeholders as controversial, the business model behind them must be conventional. Straightforward fee-for-service business models will rule the day. If that means financially challenged institutions cannot participate on that basis, then that new reality should also strengthen the OPM market.
  • Explore other functions to outsource. With the emergence of increasingly complex technologies that have the potential to disrupt and improve how universities serve students (advances in artificial intelligence being but one example), the demand for expertise from private players will only grow. Universities will increasingly be called upon to leverage technology to support their students, and they will need to outsource many of these functions to private partners to be effective. Designing and marketing courses is only one small area in which private players will continue to play a role. Solutions related to retention, student and faculty engagement, innovative instructional design, performance dashboards, private-pay short courses, and other areas of change management represent domains where institutions will increasingly depend on the private sector to implement suitable and effective solutions.
  • Focus on operational excellence. Given more challenging demand conditions, student acquisition costs will likely remain elevated. For this reason, future success for OPMs must come through adopting the best business practices from other types of business outsourcing: maximizing the impact of new technologies, rigorously seeking out operational efficiencies across partners, and minimizing costs. Another best practice must be to make the price of those outsourcing services more explicit. While there may be nothing insidious about an arrangement that embeds the cost of financing and servicing an online program into a contractual share of revenue over time, it obscures what is being paid for and permits misunderstanding, particularly at a program’s maturity when an OPM's margins are high during a period of less visible effort. Explicit fee-for-service pricing also helps to defuse (though it likely does not eliminate) outside criticism of the spending of federally financed tuition dollars on profit-seeking service providers.
  • Seek out scale. Scaled operations support low-cost models, especially in the crucial area of student acquisition, and enable the utilization of investments in cutting-edge technologies across multiple programs and partners. Other benefits include the perception of increased stability when competing in the notoriously risk-averse market of traditional colleges and universities and an enhanced ability to absorb increased regulatory costs (though scale may increase the risk of becoming an explicit regulatory target). While consolidation may be delayed as players reluctantly accept new valuation realities, the forces described above make it inevitable for long-term survival and success.

What Does This Mean for College-OPM Partnerships?

  • The competitive environment for online programs should stabilize. One of the great appeals of the OPM partnership model for colleges has been the off-balance sheet financing and risk absorption provided by private partners (or, more properly, their financial sponsors). This subsidy drove a significant proliferation of competitive online programs. For both the business model and regulatory reasons described above, this model will soon end, and the stakes surrounding the launch of new programs will increase. The net effect of this change should slow the expansion of competitive programs and yield better performance for those already in the market. Furthermore, the coming consolidation of vendors should similarly reduce market volatility in a way that most colleges are likely to appreciate.
  • The scope of collaboration should expand. The accelerating proliferation of technology in higher education—most notably related to artificial intelligence—will present ever-increasing challenges for administrators that they will be hard-pressed to address with in-house resources. Tech-proficient private partners are likely to become more, not less, important over time. Moreover, the exposure these partners have to various parts of colleges’ teaching and learning missions will likely expand as well.
  • Haters must make peace with this new class of vendors. The role of private partners in supporting universities’ core academic missions will become ever more central in tandem with the adoption of and reliance on new technologies in the instructional process. Those inside the academy who tend to resent this incursion by private companies will have to make their peace with this phenomenon or risk being rendered partially or fully obsolete.

Trace Urdan is a managing director at Tyton Partners and a long-time financial analyst who has followed companies serving the education market for more than 20 years.

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