AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

Venturing to Affordability
Vance H. Fried Oklahoma State University

vance.fried@okstate.edu

Draft: Please do not cite without permission from the author.

Prepared for the American Enterprise Institute Conference, Stretching the Higher Education Dollar August 2, 2012

The collected papers for this conference can be found at http://www.aei.org/events/2012/08/02/stretching-the-higher-education-dollar/.

Draft: Please do not cite without permission from the author. Conversations on how to make college affordable are endless. Technically, we know how to significantly lower costs and improve quality, but little appears to be happening. Existing institutions are intransigent, and tuition keeps going up. However, the future for affordable education is actually very bright. This is because new ventures, not established institutions, are the source of disruptive educational innovation. Rather than worry about how to make the establishment more affordable, we should leave the establishment alone and take a venturing approach to affordability. We should promote new ventures to lead the way with disruptive innovation. As they become successful, the establishment can either follow along or perish. This paper looks at venturing in higher education. Venturing is the use of new ventures to drive innovation through a whole industry. 1 Venturing has been the cornerstone of economic progress in the United States over the last forty years. Venturing brought higher education to non-traditional students. Venturing brought online education. Venturing is the route to affordability.

Venturing and Innovation There are two basic types of venturing: independent business ventures financed by venture capital firms and corporate venturing, where a firm creates a stand-alone business unit and grants it the freedom to innovate. The non-profit sector adds a third venturing model to the mix venture philanthropy. Each of these models has been applied to higher education in the past to broaden access. Each is being applied today in the quest for affordability.

Draft: Please do not cite without permission from the author. Venture Capital in the Entrepreneurial Economy The venturing process for innovative new providers in the private sector is built around venture capital. 2 Venture capital provides equity to entrepreneurs to create and grow businesses. Although an organized venture capital industry 3 did not exist until after World War II, the last forty years have seen the rapid growth and institutionalization of the venture capital industry. 4 Most major business firms created in recent decades received early funding from venture capital. 5 A venture capital firm is a group of professional investors called venture capitalists (VCs). VCs manage pools of money from institutional investors and wealthy individuals. These investment pools have a limited life (ten to fifteen years) and are referred to as venture capital funds. The various ventures that a fund invests in are called portfolio companies. As portfolio companies progress, the fund begins to exit its investment by either being acquired by another company or going public. The cash generated from a portfolio companys exit is split between the funds investors and the VC firm. A VC firm often manages multiple venture capital funds. The investors in a fund are not involved in the funds investment decisions or operations. Because of the amount of uncertainty inherent in their investments, VCs invest in ventures with the potential for high rates for return. VCs often invest in a venture before it has revenues. In this case, their goal is to get a 10X return (10 times the amount they invested) over five years. VCs invest with a winners fund losers philosophy. They expect some ventures in a fund to ultimately prove to be total losses, many to be mediocre, but some to be big wins. Home run investments provide 100X returns. Before making an initial investment decisions, VCs perform extensive due diligence. They want to invest in ventures with significant growth potential. They do not invest unless they

Draft: Please do not cite without permission from the author. think the market is ready for a new concept. However, they do not expect ventures to develop linearly. Rather, the attitude is one of learning by doing with the assumption that the venture will adapt as it progresses. As a result, investments are often made in stages. After an investment is made, the VC remains engaged with the portfolio company, often serving on its board of directors. VCs do not get involved in day-to-day operations of the portfolio company, but often play several value-added roles: Strategic: The VC serves as a sounding board to the ventures top management on a variety of key decisions. Financing: The VC assists in arranging financing from other venture funds, banks, and institutional investors. Networking: The VC has an informal network of contacts that is a source of partnering opportunities, professional services, and employees. Interpersonal: Often the VC serves as a mentor, friend, and confidant to the entrepreneur. Reputational: The involvement of a VC, particularly one with a history of backing successful ventures, can provide a major reputational boost to a new venture. Discipline: VCs hold management accountable.

VCs put continual pressure on management to meet agreed-upon objectives. They are willing to remove managers who fail to perform. As a result, the VC portfolio companies are more focused and growth-oriented than other businesses. In higher education, VC firms have made investments in for-profit colleges and universities aimed at non-traditional students. Some VC investments have proven quite successful from an investors standpoint. For example, in 2003 Warburg Pincus funded

Draft: Please do not cite without permission from the author. Bridgepoint Education. Bridgepoint then purchased a struggling, regionally-accredited nonprofit, The Franciscan University of the Prairies, and converted it to for-profit status under the name Ashford University. After the acquisition, Bridgepoint grew Ashfords enrollment rapidly in the online market, and acquired University of the Rockies, an accredited graduate school in social and behavioral sciences. Bridgepoint went public in 2009. Today it has a market capitalization of over one billion dollars. 6 Bridgepoint and similar VC-backed higher education ventures from the last decade emphasize serving underserved markets, not affordability. Tuition at these for-profit colleges is generally set in the middle of the market. It is unclear how these older ventures will respond as they start to face competition from the newer, affordability-focused ventures.

Venturing in the Corporate World As the venture capital approach proved successful in creating innovative new companies, established companies began to use a corporate venturing model to encourage innovation. 3M, originally a mining company, was at the forefront in the development of corporate venturing (e.g. the Post-it note). Now corporate venturing is widely used by large, private sector organizations in a variety of mature industries as a means to successful innovation. Corporate venturing takes the principles of venture capital and applies them within the setting of an established firm. Corporate ventures are developed at the edges of the existing firm. These ventures have minimal contact with the rest of the organization. This increases the likelihood of successful innovation because the innovation cannot be blocked by forces of the status quo in the core. At the same time it protects the core from being damaged by unsuccessful innovation attempts. If

Draft: Please do not cite without permission from the author. the venture proves successful, innovations from the venture may be transferred to the core. In some cases, the new venture may even replace the old core. In essence, corporate venturing is conducting entrepreneurial activities within the framework of an existing corporation. Corporate venturing works best when pursued through a modestly structured process. 7 A successful corporate venturing process promotes major innovation while mitigating risk. Corporate venturing does not develop ventures in a linear approach where all learning precedes doing. Rather it mimics venture capital and assumes that much learning can occur only by doing. An emphasis is placed on taking action rather than falling victim to analysis/paralysis. Ventures are required to prove themselves by successful operations rather than extensive paperwork and bureaucratic approvals. A major issue in corporate venturing is determining the appropriate organizational design for the new venture. Ventures built around sustaining innovations can be closely connected to the existing core business. However, ventures pursuing a disruptive innovation should be placed in a separate independent business unit. Disruptive innovations require a new business model to be successful. Trying to fit the disruptive innovation into the old model will not work. 8 Successful disruptive innovation requires that all the elements of the modeltarget market, value proposition, operating system, organizational physiology (people, processes, and culture), and profit formulafit with each other. Corporate venturing is actually fairly old in higher education. It got its start in distance education, serving traditional students with a geographic access problem and those for whom a traditional semester schedule would not work (todays non-traditional students). Most universities managed these programs through extension units. They had their own administration but used regular university faculty who they paid on an overload basis. Arguably

Draft: Please do not cite without permission from the author. the most successful extension unit, the University of Maryland University College, operates as an independent virtual university with over 90,000 students (31,000 on an FTE basis). Many other public and private colleges have aggressively entered online education. Some have approached online through a partnership with a for-profit service provider specializing in online education. Accredited non-profit college/for-profit service provider partnerships are growing in popularity. The for-profit partner often provides the technology, some student services functions, and the necessary capital. These arrangements are acceptable to regulators so long as the accredited college retains academic control. 9 Some of these partnerships have been very successful. For example, Arizona State University made over $6 million dollars last year with ASU Online, its online partnership with Pearson, a for-profit publishing company. 10 While many public and private colleges have successfully engaged in corporate venturing, it has been kept away from their core businessundergraduate education for traditional students. The purpose of these ventures hasnt been to reduce costs to consumers, but rather to increase geographic or temporal accessibility. Financially, the goal is to increase revenue and make a profit that is used to subsidize research, graduate education, low enrollment majors, and a bloated payroll. 11 A notable exception to the high tuition approach is Western Governors University (WGU), an online, competency-based university founded in 1997 by nineteen governors. They were frustrated trying to get anything innovative done through the existing public systems in their states. Rather than try to tear apart the old model, they chose to create a new one. 12 WGU is competency-based, with no seat-time expectations. All courses are online and self-paced. WGUs development was funded by the participating states and the U.S. Department of Education. Today, WGU is tuition-driven and does not receive any government subsidies. Rather

Draft: Please do not cite without permission from the author. than pay by the credit hour, students pay a flat six-month rate. During that time period, they can take as many courses as they desire. Tuition at WGU is $3,000 for six months. Average time to degree completion is 30 months, which translates to under $17,000 for a degree. This compares quite favorably with the over $56,000 cost to state and student for four years at a public regional college. 13 This huge cost advantage coupled with the acceptance of WGU degrees by employers has led to rapid growth for WGU. 14 Today, WGU has 30,000 students and is growing at a capped annual rate of 30 percent.

Venturing in the Non-Profit World A venture philanthropy approach to charitable giving mimics the venture capital industrys approach to investing in for-profit entrepreneurs. The venture philanthropist invests in non-profit organizations run by social entrepreneurs with the returns to the investor coming in the form of the social good done by the non-profit. Rather than tied to a specific building or program, the venture philanthropist sees his donation as going to build the overall organization. The venture philanthropists relationship with the non-profit is long-term. He takes an active, but not day-to-day, role at the non-profit. Often this means a seat on the non-profits board of trustees. This hands-on approach to higher education goes back at least to John D. Rockefellers role in the founding of the University of Chicago in the 1890s. 15 A much more recent example of venture philanthropy was the $70 million donation by Mart Green and family to Oral Roberts University. The donation was made to financially stabilize and strategically

Draft: Please do not cite without permission from the author. revitalize the school. 16 Tied to the donation were the requirements to replace the university CEO, restructure university governance, and appoint a new board with Green as chairman. Sometimes donors pool their money and invest in a venture philanthropy fund, the nonprofit equivalent of a VC fund. A current example in K-12 education is the New Schools Venture Fund. New Schools pools money from several donors, like the Gates Foundation, and invests the money in organizations pursuing innovation, particularly charter school management companies.

Venturing in Todays World of Higher Education Opportunities and Barriers The current environment for new, affordability-oriented ventures is excellent. Higher education is a huge market. Established colleges are often ineffective and always inefficient. They have high costs and charge high prices. New ventures with innovative models can improve quality and drastically reduce costs. They can offer a substantially better value to students than the established non-profits, yet still be profitable. The barriers to innovation in existing colleges are also huge. Providing affordable education is not a goal of todays leading colleges and universities. 17 Most could cut tuition in half by simply returning to their business models of twenty-five years ago, but they have no incentive to do so. Even if affordability was a goal, todays higher education leaders, like the incumbents in any industry, face numerous barriers to innovation. An existing college wanting to innovate will have a great deal of difficulty because of these barriers. As a result, these barriers to innovation are negatives for incumbents, but positives for new ventures. 18 New ventures are

Draft: Please do not cite without permission from the author. not constrained by these barriers. They can innovate and know that the industry leaders will be very slow in offering a strong competitive response. While the opportunities are great, new ventures have two major barriers to overcome: branding and accreditation. Branding. The nature of education is very different from most products. It is an intangible product. Evaluating the quality of an educational product is primarily done by consumption. It is a large (both in dollars and time) purchase, and most consumers only consume education once. In addition to what the student actually learns in college, the value of a college education also lies in the credential the student receives upon graduation. The purchase decision is a big one with life-time implications. Thus, it is not surprising that brands are important in higher education. The development of a brand takes time and money to cultivate brand awareness and a positive image for the brand. When colleges first entered the underserved markets (nontraditional students, underrepresented groups), the concern was simply brand awareness. A lack of positive brand image was not much of an issue since none of the colleges in the underserved market had a strong positive brand image. However, new ventures entering the traditional student market go up against incumbents with established brand recognition among potential students. Many also have positive brand images. Lack of a brand is a problem new ventures must address, particularly if they are competing against the elitist institutions (e.g., the Ivies) or high selectivity institutions (e.g., the public research universities and many private colleges). Accreditation. There are three basic types of accreditation. One is programmatic accreditation where a specific program is accredited. Some programmatic accreditations such as

Draft: Please do not cite without permission from the author. those for business and music may be beneficial but are not required. Others are required in order for graduates to achieve professional licensure, such as law and psychology. The second type of accreditation is commonly referred to as regional accreditation. Whether or not they hold programmatic accreditation, almost all colleges are accredited indirectly by the U.S. Department of Education. The Department of Education does not directly accredit but instead designates approved accrediting organizations. A school must be accredited by one of these approved organizations in order to qualify for federal student financial aid, primarily student loans and Pell grants. The only approved accrediting agency for most colleges is the regional accrediting organization for their geographic region. Thus, holding regional accreditation is necessary for a venture that wants to tap federal student aid. The third type of accreditation is state accreditation, sometimes referred to as licensure. This is mandatory in most states if any type of degree is offered. How state accreditation works is a matter of state law, which leads to between-state variance. A state board or agency usually is in charge of the process. Many states grant automatic accreditation to institutions that hold regional accreditation. Institutions without regional accreditation can be directly accredited by the state under processes and standards promulgated by the state board or agency. While this route is available, state boards strongly promote regional accreditation. For example, the Oklahoma State Regents Policy and Procedures Manual states: Unaccredited Private Institutions. State Regents standards, policies, and procedures are modeled on those of the HLC [Higher Learning Commission]. Accreditation of a college or university by the State Regents means that standards and policies prescribed for accreditation by the State Regents policy have been satisfied. Institutions accredited pursuant to this policy are encouraged to be accredited by the regional accrediting agency, HLC. HLCs ERs [Eligibility Requirements] establish baseline benchmarks for institutions seeking accreditation by the State Regents. To achieve accreditation without qualification, an institution is required to meet the HLCs ERs and each State Regents Standard of Educational Quality as well as address the HLC Criteria for Accreditation in the institutional self-study report and the evaluation visit. 19 10

Draft: Please do not cite without permission from the author. As the accreditation system currently works, regional accreditation is vital for most colleges. Unfortunately, the current system poses three major problems from a venturing standpoint. 1. Overregulation. By its nature, government regulation limits innovation. While some regulation may be necessary to protect students, too much harms students by stifling innovation. Our current system over-regulates. For example, the provost of Princeton recently testified that the cost of regional accreditation can exceed one million dollars and hundreds of hours of staff time, and the president of Dartmouth has complained of accreditation staff substituting their own judgment for that of the institutions trustees and administrators. 20 2. Cartel Behavior. The regional accrediters are legally owned by their member institutions. Often, regional accrediters use their accrediting power to keep new entrants out (e.g. new for-profit institutions need not apply) and limit competition between member institutions (e.g. a faculty member can only teach twelve hours a semester). 3. Slow Process. The process a school goes through to achieve accreditation is long and cumbersome. For example, Western Governors has always been lead by experienced educators. It is a non-profit with significant political clout. Yet it took it six years to gain accreditation. It is much easier to get approval to start a bank or surgery center than a community college. So far higher education has been entrepreneurial in addressing the underserved markets, but remains very bureaucratic in its core markets. Going after new markets with high prices has been successful for many schools. However, it appears that we are at a point where the focus is shifting to affordability in the core market.

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Draft: Please do not cite without permission from the author. Venture Capital and Low-Cost Models The last year has seen venture capital firms begin to invest in affordability-focused higher education ventures. This trend is led by some of the biggest names in the industry, including the VC firms that financed the start-up of Amazon, Ebay, Facebook, Google, Netflix, Skype, and a host of others. While not omniscient, these firms have a history of placing correct bets on disruptive innovations. They dont invest until they think the market is ready. When they invest, they expect action. VC firms have invested in MOOCs (Massively Open Online Courses). MOOCs provide online lectures broken into segments as short as ten minutes and offer quick online quizzes as part of each segment. Students can participate in an online community while taking a course. An optional assessment at the end of the course leads to a credential, but not college credit. Access to the basic content is free with revenues generated by charging for premium content and services. To date this consists of charging a fee for assessment and credentialing. 21 Some argue that MOOCs are just a new form of publishing. 22 However, MOOCs have the potential to be disruptive in the overall higher education market if their certificates become a valuable market place credential. Cousera, a MOOC founded by two Stanford professors, received a $16 million investment from two of the best-known Silicon Valley VC firmsKleiner, Perkins, Caufield, Byers (KPCB) and NEA. Cousera is partnered with Stanford, Michigan, Penn, and Princeton. Cousera courses are adapted from a broad range of courses at those universities and feature their faculty. However, certification will be done in Couseras name, not that of any of the partner universities.

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Draft: Please do not cite without permission from the author. Another major VC firm, Charles River Ventures, is backing a competing MOOC called Udacity. Udacitys founder is Sebastian Thrun. Thrun was a tenured computer science professor at Stanford and a research fellow at Google. Thrun quit his tenured position at Stanford to start Udacity. Udacity differs from Cousera in that it does not use a partner college approach for branding and course development. Rather, it features rock star faculty from around the world teaching courses focused on computer science. For example, Thurn is the teacher for Introduction to Statistics and Artificial Intelligence: Programming a Robotic Car, while the director of research at Google teaches Design of Computer Programs. In addition to charging for certification, Udacity plans to offer job placement services for a fee. 23 Recent VC investing is not limited to MOOCs. FirstMark Capital led a $10 million dollar expansion round for StraighterLine. Founded in 2009, StraighterLine provides thirty-eight different lower division courses delivered online, self-paced, and on-demand. Start/stop dates are totally flexible. Courses are delivered completely online through traditional textbook readings coupled with ten hours of on-demand live tutoring. An individual StraighterLine course costs $399, but lower prices are available through subscription agreements like freshman year for $999. At that price StraighterLine costs 96 percent less than the average private college and 66 percent less than the average community college. 24 StraighterLine offers coursesnot degreesmaking it ineligible for regional accreditation. As a result, students dont qualify for federal financial aid. However, that isnt an important issue because the price is so low. The major issue is whether students can use StraighterLine courses to meet requirements for a degree. StraighterLine deals with this issue in two ways. 25 First, all of StraighterLines courses have been evaluated by the American Council of Education (ACE) and recommended for college credit. Since most colleges accept ACE

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Draft: Please do not cite without permission from the author. recommendations, StraighterLine courses count at most colleges. However, the ACE credit transfer process is rather awkward, not well-understood, and poorly promoted. Further, colleges often seriously limit the number of hours of ACE credit they will count towards graduation. Second, instead of going through the ACE process, a StraighterLine student can count their courses for credit if they enroll in a StraighterLine partner college. A partner college is a regionally accredited college that has a formal agreement with StraighterLine. The agreement provides a smooth credit transfer process and transparent articulation of StraighterLine into the partner colleges degree requirements. Partner colleges include for-profits like the University of Phoenix, but also a small but growing group of non-profits. They include private non-profits like Western Governors and publics schools like SUNY Empire State. StraighterLine has recently entered into a partner college agreement with Liberty University. With close to 100,000 students, Liberty is one of the largest non-profit providers of online education. Other VC firms are investing directly in start-up colleges. Benchmark, an old line Silicon Valley firm, invested $25 million into a start-up college dubbed the Minerva Project. It plans to be the first elite American University to be launched in a century. 26 Ben Nelson, the entrepreneur behind the Minerva Project, sees a huge untapped market, especially internationally, for undergraduate liberal arts education at the elite level. Harvard says that 8085 percent of its applicants are fully qualified for admission, yet they have a 5.9 percent acceptance rate. We think, conservatively, there are 250,000 English-fluent, smart, driven young people who aren't able to get into an Ivy League university or equivalent in their home countries, and if we capture 1 percent of that market, we'll be self-sustaining. 27 Minerva will be a pure online college, but with optional living clusters for students scattered around the world. Students watch a pre-recorded video while participating in a live video discussion with other students and

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Draft: Please do not cite without permission from the author. a faculty discussion leader. Minerva plans a substantial career services program for both current students and alumni. Tuition will be $20,000 a year, almost half that of Ivy League schools. Its not just old-line firms that are interested in higher education. University Ventures was created in 2011 to invest only in higher education ventures. 28 University Ventures first fund has over $125 million in invested capital, with media giant Bertelsman AG the largest investor. University Ventures recently led an investment of $17.3 million, with other investors including established venture funds like Novak Biddle, Charles River, and Greylock, in an affordability-focused start-up called University Now. 29 University Now owns New Charter University, a school that offers both bachelors and masters degrees. New Charters president was formerly provost and chief academic officer at WGU. New Charter takes a pure online, competency-based approach like WGU, but only charges $1,600 year tuition for undergraduates. With its heavy use of adaptive learning technology, it is higher tech than WGU. New Charter uses a freemium approach to marketing. Anybody can watch the videos, but you have to register to fully participate in class and take exams. New Charter is accredited by the Distance Education Training Commission, but chooses not to participate in federal financial aid programs in order to keep costs down. 30 In July 2012, the Western Association of Schools and Colleges (a regional accreditor) approved University Nows acquisition of Patten University, a struggling non-profit. University Now will run Patten, stressing competency-based, online education at a price of $2,600 per year. 31 While University Now is building a system of degree-granting institutions, University Ventures is also interested in ventures that partner with existing colleges to provide next generation online education. There are two basic VC strategies to approaching higher education:

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Draft: Please do not cite without permission from the author. own an accredited institution or partner with an accredited institution. Historically, VC firms have taken the ownership approach. They fund an entrepreneur who acquires a struggling nonprofit college, converts it to a for-profit, and then expands it, stressing online delivery. The reason for acquiring an existing college rather than starting de novo was to immediately gain regional accreditation and qualify for federal student financial aid. Regional accreditors seemed to have put this practice to a halt in 2010, 32 but the 2012 conversion of Patten by University Now shows this route to accreditation is available to for-profits. However, even though Patten is regionally accredited, it has chosen not to participate in federal student financial aid programs. University Now is approaching the market at a low price point. To them, federal financial aid is a nuisance, not a necessity. In fact, University Nows stated vision is a world in which students can obtain recognized college degrees that improve their futures, without taking on the burden of student debt. The partner strategy is an alternative way to deal with the accreditation barrier. But there is more to it than that. It is also a way to avoid having to build a major consumer brand. The accredited partner provides the brand and the for-profit service provider provides the skills and capital. For example, online provider 2tor has attracted over $96 million of venture capital investment from major VC firms like Bessemer, Highlands, and Redpoint. 2tor partners with universities to take selected degree programs online (e.g. USC education masters, UNC-Chapel Hill MBA, Washington University in Saint Louis masters in U.S. law, Georgetown masters in nursing). 2tors role in each partnership is to provide technology, instructional design, online student support, practical learning experiences around the world, global marketing, and all the necessary capital (about $10 million per partnership). 33 While 2tor and its partner universities

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Draft: Please do not cite without permission from the author. are not affordability-oriented, the same partnering approach can be used by accredited institutions to provide affordable, online, competency-based programs.

Corporate Venturing to Affordability: Institutions and State Systems To stay competitive long-term, most colleges need to change their business model. While their current business model is a huge liability, most existing colleges do have significant assets in their physical campus, endowments, and brands. In fact, many existing colleges may have strong enough brands to compete effectively against lower priced competitors with weak brands. However, they will have significant problems when colleges with a similar quality brand adopt new business models. Corporate venturing is a way for established institutions to transition to a new model.

Private schools. EdX is a corporate venture between two of the biggest names in higher education, Harvard and MIT. They recently announced that they had created a new entity called edX. EdX apparently will be a MOOC similar to Cousera, but built around MIT and Harvard courses. EdX is owned 50/50 by the two schools. Each has committed to providing $30 million in institutional support, grants, and philanthropy to launch edX. While some prestigious name-brand privates are involved with MOOCs, they currently show no interest in making their core more affordable. Perhaps the prestigious privates have the option of ignoring the affordability problem, but most privates do not. Many private colleges have been successful with ventures aimed at underserved markets. To date, these ventures have been able to charge the same high prices as they do for their core.

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Draft: Please do not cite without permission from the author. As a result, the successful ones have been profitable. These profits are then spent in the moneylosing core. This financial model will change as disruptors push prices and profits down from noncore markets. An even more dire threat to private colleges is from disruptors entering their core markettraditional-age, residential college students. To survive, they must transition to a lowercost model. As the market for higher education unbundles, existing privates start with a major cost disadvantage in instruction. However, many have good brands, alumni and community networks, and attractive campuses. They have clear advantages in providing blended education and the supervised coming of age aspect of undergraduate education. Further, as non-profits they have the ability to serve as the nexus of a values-based community. To survive, private colleges need to eliminate the negatives and accentuate the positives. Their task is not venturing but reinvention. This will be a difficult task. Some may be able to do it on their own, but more likely they will need to partner. Partners might be new non-profits that they create in consortia with similar non-profit colleges or for-profit providers like StraighterLine or one of the new service providers University Ventures intends to create.

State colleges and universities. At first blush, public schools have little reason to move to disruptive models. They have a huge advantage over privates because they are directly subsidized by the state. Average state subsidies have varied between $6,300 and $7,900 per student over the last twenty years. 34 The subsidy means that the state school can have a higher cost, yet charge a lower price. However, publics have raised their tuition to the point ($8,244 average in 2011-12) that an unsubsidized private can undercut their price. 35

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Draft: Please do not cite without permission from the author. The big state research universities dominate higher education in most states. They have big brands, networks, campuses, and endowments. They have less to fear initially from innovative new providers, but still must worry about the long-term. Because of their research mission and identity, they will not have much interest in converting to a new model of undergraduate education. Even if they wanted to, converting rapidly would be difficult. The current model works well for the time being. A public research university could corporate venture today by creating an online, competency-based, disruptor college focused on lower division general education. Public research universities already operate as multi-college institutions with all the instruction actually delivered by semi-autonomous colleges and departments. So it is easy to fit another semiautonomous college into day-to-day operations. The new college would need little from the university. In the eyes of most undergraduates, what makes the public research university distinctive is not what transpires in the classroom but rather the overall size, diversity, and energy of the university milieu. Students attending an online, competency-based disruptor college would be in this milieu simply by being physically located on the big university campus, and having access to university-wide student life such as student organizations, speakers, intramurals, intercollegiate athletics, community social life, and the like. The new college would pay the university for use of facilities so it would not cost the university anything. It could charge a substantially lower tuition that the other colleges in the university, yet not require any state subsidy. The result would be a huge win/win for student and state. However, to make it work, the new college must be given freedom from the academic administrative structure of the rest of the university as well as the ability to set tuition at a significantly lower level than tuition for the rest of the university. This level of autonomy is

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Draft: Please do not cite without permission from the author. almost certainly a deal breaker for most of todays public research universities. Perhaps this attitude will change in the next few years as they start to feel price pressure from WGU and others. The threat of disruptors is much more immediate for public regional colleges. While they have brand awareness, most do not have strong positive brand images. What happens to a regional when a private with a similar or better brand image adopts a new model and begins to price compete? WGU is significantly cheaper than in-state tuition at most public regionals. Regional colleges, particularly those serving commuter students, need to be making major changes now to meet the threat of low cost competitors. However, the barriers to change are quite high at regionals and most are unlikely to take steps to change until competitive pressure becomes immense. 36

The State as a Venture Funder Many in state governments are frustrated with their public schools. They see the current model as badly broken, yet their schools dont show any interest in lower cost models. In fact, they just keep on raising tuition. Some advocate forcing state schools to take specific actions to increase affordabilitythings like increasing teaching loads, capping faculty compensation, participating in a central purchasing system, or capping administrative costs as a percentage of total spending. While perhaps good ideas, forcing them on state schools isnt the best route to affordability. Venturing is. Trying to fix the high cost problem overnight without massive disruption to the system is impossible. The existing business model of state colleges and universities needs to be radically changed. These changes have to happen at the individual school level. You cant intelligently

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Draft: Please do not cite without permission from the author. mandate what each school needs to do. Centralized decision-making to achieve local level innovation is impossible. Successful innovation requires local knowledge and local action. 37 The best course of action varies from one locality to another. Much of the most important knowledge is tacit. That means the knowledge is personal to the holder and it is hard, if not impossible, for the holder to explicitly communicate to another person. As a result, most viable opportunities for innovation are recognized and/or created at the local level. Successful innovation also requires action at the local level. While a governmental educational authority may be able to regulate bad behavior, it cannot mandate good behavior. Regulation certainly cannot mandate innovation. Actually, states may not even have the legal or political power to make individual colleges do things they really dont want to do (like cut tuition). 38 But even if existing publics wanted to change radically, they cannot. The difficulty that incumbents have in changing is not just a higher education phenomenon. In his studies of the history of hundreds of industries, Christensen observed that it is extremely rare for the leaders under the old model to be leaders under the new model. In the few instances they have, they did through a wholly autonomous business unit. Christensen concludes that the disruption of higher education at public universities will likely need to be managed at the level of state systems of higher education, not at the level of the individual institutions, which will struggle to evolve. 39 A state system includes 1) individual institutions that actually deliver education, 2) an entity that coordinates the individual institutions, and 3) an entity that licenses and regulates private institutions. How state systems are organized varies from state to state. A common approach is to combine the coordinating and licensing activities in one entity. For example, I am a professor at Oklahoma State University. It is a separate legal entity created by statute. We have

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Draft: Please do not cite without permission from the author. our own board of regents appointed by the governor. There is a separate entity called the State Regents for Higher Education. They serve as the overall coordinating board over Oklahoma State University and the other state-owned colleges and universities. In addition, they have licensing power over private institutions. So if the state of Oklahoma wants to promote venturing, the entity to take the lead is the State Regents for Higher Education. A state might create a new institution to drive disruption through the state. For instance, it could create a new state college that is strictly online and competency-based, a state-owned version of WGU. This is happening in Wisconsin. Recently the Governors Office announced that the University of Wisconsin System is developing an online, competency-based degree. 40 It will be coordinated by UW-Extension, the unit in charge of coordinating all online education for the multi-institution UW System. While a specific price isnt mentioned in the announcement, the announcement states, The unique nature of the Flexible Degree will allow the UW to lower the net tuition cost 41 The new model wouldnt have to be purely online. It could offer some courses in a blended manner and still deliver quality at a low price. For example, UW Flexible mentions, By combining these new [online competency-based] learning options with traditional face-toface courses and online programs already offered by UW campuses, this model would let students select the right mix of education content and delivery methods that are most appropriate for them. Start-up costs for a new online institution would be relatively low, plus there are forprofit service providers willing to cover them if a state desires. The keys to success with a new institution are to make sure than the new college is able to run independently from most of the system and can charge low tuition.

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Draft: Please do not cite without permission from the author. This approach could also be tied to a residential campus. The residential campus is unlikely to totally disappear for traditional age students. As Michael Staton points out, the coming of age function of college is best performed in a residential setting. Most states have at least one residential campus that is on life support. Why not take it and convert it overnight to a new model? There would be no need for new facilities. While faculty opposition would be high, supporters of the struggling college might be interested since the overall role of their campus will be elevated in the state system. A major move to affordability appears in the offing at UNT-Dallas. It is a young institution that started as a branch campus of the University of North Texas (in Denton) in 2000. In 2009, the state of Texas made UNT-Dallas an independent institution in the UNT system. Its president, John Price, was an accounting professor and department chair at the University of North Texas before the launch of UNT-Dallas. A critic of higher education for its high cost and lack of focus on students, Price is leading an attempt to create a new-style university. Because it is a young and small institution, it is in a position to pursue disruptive innovation. It has sworn off pursuing a national research reputation to focus on providing affordable, high quality education to the Dallas area. In 2011, the 21st Century Commission was created to develop a direction for its future. The report is due in fall 2012. With Clayton Christensen as a commission member, it is expected to stress disruptive innovation. It will likely include competency-based education with some programs priced at close to $2,000 a year. 42 Rather than create or convert a state-owned college, a state system could create a charter college arrangement with private colleges. Under this approach, the state would give a tuition subsidy to its citizens who are attending a private charter college. To be approved as a charter college, a private college would have to agree to have a sticker tuition that is less than in-state

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Draft: Please do not cite without permission from the author. tuition at the states private colleges. If the state subsidy was set at the current subsidy levels (national average is $6,300), this would mean state students attending colleges like WGU would be going to college tuition-free. In many states, the charter college approach would just involve a redesign of existing private school subsidy programs. These programs are often limited to low-income students. However, in some states all students are eligible, but the amount of their subsidy is much less than the state subsidy to public college students. Current programs allow private colleges to participate even when they charge high tuitions. This needs to change if the goal is to push tuition down. Why subsidize expensive private schools? However, a state might wonder why it should spend tax dollars on a subsidy for any private college. WGU and other new ventures are willing to offer low cost education without a state subsidy. In fact, some argue that the advent of low-cost models could even lead to the phase-out of the state subsidy to the state-owned colleges. 43 At a minimum, state systems should pursue a strategy of encouraging low cost, unsubsidized privates to operate in their state. One thing the state might do is give the disruptors local credibility. For example, WGU is developing relationships with several states. The first was WGU-Indiana. WGU-Indiana is a private, non-profit institution established by the state of Indiana in partnership with WGU. WGU-Indiana has a chancellor and an advisory board who reside in Indiana and provide guidance on the most effective ways the university can meet the needs of Indiana residents. Academically it is run by WGU. The curriculum is a slightly customized version of WGUs standard curriculum. However, Mitch Daniels, the governor of Indiana, is one of its pitchmen. He refers to WGU as the eighth state university. Beyond that, WGU has an

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Draft: Please do not cite without permission from the author. articulation agreement with the state system that defines how WGU credits can be transferred into the state system. In return, WGU gives Indiana students a 5 percent tuition discount (and state employees 10 percent). So students in Indiana have access to a $5,700 a year education without the state having to pay any subsidy. State systems often provide articulation and easy transfer from one state-owned institution to another. For example, a state research university must treat Calculus I and Accounting I credits from state community colleges as if they were earned at the research university. If state systems provide articulation and easy transfer from a community college to a public research university, they should provide articulation and easy transfer from private colleges into the public research universities. Finally, a state could offer a venture-friendly accreditation system. Rather than pushing institutions towards regional accreditation, a state would offer institutions the option of stateonly accreditation under a clean, open, and efficient system. Schools with state-only accreditation could not participate in federal student aid programs, but would be allowed to do business in the state. The sidebar is an example of such a system. Getting accredited under a system like this would take a matter of days, not years. It would benefit students by increasing competition. It would also provide a higher level of consumer protection than regional accreditation.

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Draft: Please do not cite without permission from the author. Sample Accreditation System 44 Financial assurance: An institution must demonstrate that it is financially solvent. This is to ensure that all enrolled students can be supported to the completion of their degrees. Consumer information on key measures of quality: An institution must provide a set of basic information on its homepage that presents key data for quality and affordability in a clear and accessible format: Tuition, fees, cost of attendance, net cost, and available financial aid Degree programs offered Graduation rates, disaggregated by demographics; transfer rates as available Retention rates Student loan default rates Student outcomes: licensure test results (as appropriate); value-added assessments of collegiate skills, if utilized; job placement rates. Institutions may, at their discretion, include other information for consumers such as alumni and employer satisfaction data; graduate or professional school placement data; and the nature and requirements of their degree programs. Enforcement: Providing misleading consumer information may result in loss of accreditation

Philanthropy and Affordability Private individuals and foundations acting as venture philanthropists can play a major role in venturing to affordability. The key is to fund disruption rather than the status quo. To date, major donors have not invested in disruptors. Large gifts are regularly given to higher education. But the money goes to existing players to upgrade their existing programs or fund

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Draft: Please do not cite without permission from the author. add-ons. However, this may be changing. In 2009-2011, the Bill & Melinda Gates Foundation contributed $6.45 million to support the development of WGU-Washington. 45 Perhaps more donors will emerge with an interest in affordability. In particular, venture philanthropy should be attractive to donors who view the current higher education establishments values as out-of-kilter with the fundamental elements of traditional American education. Currently, their funding goes to established colleges and faculty and does nothing to improve affordability. Venture philanthropy would let these donors kill two birds with one stone: dramatically increase educational value for students, and increase mindshare for the donors worldview. As college unbundles, the role of outside service providers will grow. Content delivery and transitioning to adulthood are parts of the value chain that should interest venture philanthropist. Venture philanthropists could fund a content delivery provider whose content in the humanities and social sciences is in keeping with the philanthropists values. Venture philanthropists could also invest in non-profit colleges that want to run under a lower cost model. Less than $2 million (mostly severance pay for unneeded faculty and administrators) would fund all the cost of a small college converting to the new model. And $515 million is enough to create a college de novo or take control of an existing college that is struggling financially. 46 The payoff is potentially huge, not just the positive from the college funded but from the overall value to society of disruption. Venture philanthropists funding individual colleges need to be careful that the colleges they fund truly want to operate under a low-cost model, and dont just want money to prop up the old model. They need to approach colleges as an active, value-added investor. Providing

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Draft: Please do not cite without permission from the author. strategic counsel and oversight is vital. Rather than doing all the work themselves, like-minded donors could band together and create a venture philanthropy fund.

Venturing and Federal Public Policy The Obama administration has proposed a Race to the Top for College Affordability and Completion: a proposed $1 billion competitive grant program that will reward states who are willing to drive systemic change in their higher education policies and practices, while doing more to contain their tuition and make it easier for students to earn a college degree. 47 This is misguided. First, the objective shouldnt be keeping costs under control. It should be radically reducing them. Second, as the history of disruptive innovation shows, cost reduction will not come from the incumbents. Giving incumbents money in the hope they will deliver game-changing innovation is a waste of taxpayer dollars. Third, state systems that really want to improve quality and affordability dont need federal money to decrease cost. While the government might be good at funding basic research, it is a lousy venture capitalist. The technologies and learning systems necessary for affordable higher education are not in the research stage, but rather are ready for immediate commercialization. This is happening now without any federal money. Rather than fund ventures, federal policy should address the primary barrier faced by these ventures. Accreditation, not cash, is the major barrier to venturing today. Fortunately, the last year has seen a marked improvement in accreditors attitude towards new ventures. 48 Regional accreditation is no longer a total roadblock to affordability. However, much remains to be done. The current system needs to be seriously overhauled or eliminated. Reforming accreditation at the federal level is technically straightforward, but

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Draft: Please do not cite without permission from the author. politically challenging. While much of the problem is with the regional accrediting agencies, at times the Department of Education has actually stifled accrediting agency attempts to foster innovation. At this point, rather than trying to aggressively regulate the regional accrediters, the focus should be on creating alternative accrediting organizations. This can easily be done by allowing voluntary new accrediting organizations to spring up based around principles similar to those suggested for the states in the sample accreditation system. The Department of Education does not need to create the new accrediting organizations, rather just make the schools they accredit eligible for student financial aid. Colleges could then be accredited through one of many voluntary associations rather than being forced to seek regional accreditation. The federal government has a huge financial stake in the success of affordability ventures. Currently, total federal government support to higher education is over $80 billion a year. 49 Affordable higher education means that all this government spending could be permanently eliminated sometime in the not-too-distant future. Students wont need it!

The Horses are Out of the Barn Education ventures stressing affordability are already gaining market acceptance. New ventures are popping up. Smart money is flowing to these ventures. Industry incumbents must switch or face extinctionsome in the very near future. Tuition will come down substantially. Affordable higher education is on the horizon.

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Amar Bhide, The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World, (Princeton, NJ: Princeton University Press, 2008). 2 Paul A. Gompers and Josh Lerner, The Money of Invention: How Venture Capital Creates New Wealth (Cambridge, MA: Harvard Business School Press, 2001). 3 Sometimes the term private equity is used instead of venture capital. Private equity means investments through private transactions rather than the stock market. Private equity includes firms that do large company leveraged buyouts. Venture capital is used to describe investments in start-ups and growth stage ventures. 4 Garry D. Bruton, Vance H .Fried, and Sophie Manigart, Institutional Influences on the Worldwide Expansion of Venture Capital, Entrepreneurship Theory and Practice 29, no. 6 (2005): 737-760. 5 Dirk De Clerq, Vance H. Fried, Oskari Lehonten, and Harry J. Sapienza, An Entrepreneurs Guide to the Venture Capital Galaxy, Academy of Management Perspectives 20, no. 3 (2006): 90-112; Gompers and Lerner, The Money of Invention. 6 51.7 million shares outstanding at $21.57 a share on July 2, 2012. 7 Robert A. Brugelman, Managing the Internal Corporate Venturing Process, Sloan Management Review 25, no. 2 (1984): 33-48; M.H. Morris, D.F. Kuratko, and J.G. Covin, Corporate Entrepreneurship & Innovation 3rd ed. (South-Western CENGAGE Learning, 2011); Z. Block and I. MacMillan, Corporate Venturing (Harvard Business School Publishing, 1993). 8 Clayton M. Christensen, Michael B. Horn, Louis Soares, and Louis Caldera, Disrupting College: How Disruptive Innovation Can Deliver Quality and Affordability to Postsecondary Education, Center for American Progress and Innosight Institute, February 2011. 9 Daniel Pianko and Josh Jarrett. Early Days of Growing Trend: Nonprofit/For-Profit Academic Partnerships in Higher Education, Game Changers: Education and Information Technologies, ed. Diana G. Oblinger, (Educause 2012), 91. 10 Smith Burck, The Degree A Standard or an Asset?. CEO Corner. June 21, 2012. http://ceo.straighterline.com/ 11 Vance H. Fried, Better/Cheaper College: An Entrepreneurs Guide to Rescuing the Undergraduate Education Industry (Washington, DC: Center for College Affordability and Productivity, 2010); Vance H. Fried, Federal Higher Education Policy and the Profitable Non-Profits, Policy Analysis No. 678, Cato Institute, June 15, 2011 12 Sam Smith, interview by Vance H. Fried 13 Donna M. Desrochers and Jane V. Wellman. Trends in College Spending:1999-2009 (Delta Project on Postsecondary Education Costs, Productivity, and Accountability, 2011). 14 In a recent Harris interactive survey of employers, 98 percent ranked WGU graduates as equal to or better than graduates of other universities. http://www.wgu.edu/about_WGU/student_success_data 15 Ron Chernow, Titan: the Life of John D. Rockefeller, Sr. (Vintage Books 1998). 16 Ziva Branstetter, An angel for ORU, Tulsa World, November 28, 2007. 17 Fried, Better/Cheaper College; Fried. Federal Higher Education Policy and the Profitable Non-Profits. 18 Fried, Better/Cheaper College. 19 Oklahoma State Regents for Higher Education. Academic Affairs Procedures Handbook. Chapter 3 Academic Affairs. 4-24. July 8, 2011. http://www.okhighered.org/state-system/policyprocedures/2011/AA%20Procedures%20Handbook%20December%202011.pdf. 20 Anne Neal and Arthur Rothkopf, Alternative to the NACIQI Draft Final Report, March 16, 2012. 21 Steve Kolowich, How Will MOOCs Make Money? Inside Higher Ed, June 11, 2012 http://www.insidehighered.com/news/2012/06/11/experts-speculate-possible-business-models-mooc-providers 22 Ryan Craig, Adventures in Wonderland, Inside Higher Ed., February 3, 2012, http://www.insidehighered.com/views/2012/02/03/essay-massive-online-courses-not-game-changing-innovation 23 Udacity, 2012, http://www.udacity.com/ 24 How StraighterLines Tuition Compares to Other Programs, 2012, StraighterLine http://www.straighterline.com/courses/compare-to-other-programs.cfm 25 StraighterLine, 2012, http://www.straighterline.com/. 26 Minerva Project, http://www.minervaproject.com/philosophy.html 27 Anya Kamenetz , Minerva Project Scores $25 Million In Seed Money To Build A New Elite University Online, FastCompany, April 4, 2012, http://www.fastcompany.com/1829636/minerva-project-scores-25-million-in-seedmoney-to-build-a-new-elite-university-online 28 University Ventures, 2010, http://universityventuresfund.com/

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UniversityNow Secures $17.3 Million Funding to Build Network of Low-Cost, Accredited U.S. Universities, Education News, June 21, 2012 https://educationnews.com/2012/06/21/universitynow-secures-17-3-millionfunding-to-build-network-of-low-cost-accredited-u-s-universities/ 30 New Charter University, http://new.edu/info/ 31 Doug Lederman, Still a Viable Exit, Inside Higher Ed, July 10, 2012, http://www.insidehighered.com/news/2012/07/10/accreditors-decision-shows-profits-can-still-take-over-nonprofitcolleges 32 Pianko and Jarrett. Early Days of Growing Trend: Nonprofit/For-Profit Academic Partnerships in Higher Education. 33 2tor, http://2tor.com/ 34 Andrew Gillen, The Decline in State Appropriations Has Been Greatly Exaggerated, Center for College Affordablity Blog, March 29, 2012, http://centerforcollegeaffordability.org/archives/8092 35 Trends in College Pricing 2011-12, The College Board, 2011, http://trends.collegeboard.org/college_pricing/overview/highlights 36 Fried, Better/Cheaper College. 37 Friedrich A. Hayek, The Use of Knowledge in Society, The American Economic Review, no 35 (1945):132-152; Jeffery S. McMullen and Dean A. Shepherd. Entrepreneurial Action and the Role of Uncertainty in the Theory of Entrepreneurship, Academy of Management Review, no 31(2006):132-152. 38 Fried, Better/Cheaper College. 39 Clayton M. Christensen, Michael B. Horn, Louis Soares, and Louis Caldera, Disrupting College: How Disruptive Innovation Can Deliver Quality and Affordability to Postsecondary Education, Center for American Progress February 8, 2011, http://www.americanprogress.org/issues/2011/02/disrupting_college.html/ 40 UW Flexible Degree, Office of Governor Scott Walker, State of Wisconsin, June 2012. 41 Scott Walker, UW Flexible Degree, June 2012 p8 http://walker.wi.gov/Images/News/6.19.12%20UW%20Flexible%20Degree%20Proposal%20Packet.pdf 42 Mean Green, DMagazine.com (I cant find..), February 2012; Kevin Kiley, Building Something Different, Inside Higher Education, October 17, 2011; http://www.insidehighered.com/news/2011/10/17/building-somethingdifferent G. Blumenstyk. Business Advice Meets Academic Culture, The Chronicle of Higher Education, April 29, 2011, http://chronicle.com/article/article-content/131736/ ; John Price, interview by Vance H. Fried 43 Smith Burck, The Degree A Standard or an Asset?, CEO Corner, June 21, 2012, http://ceo.straighterline.com/ 44 Anne Neal and Arthur Rothkopf, Alternative to the NACIQI Draft Final Report, March 16, 2012. 45 Grant Search, Bill and Melinda Gates Foundation, 2012, http://www.gatesfoundation.org/grants/Pages/search.aspx 46 Fried, Better/Cheaper College. 47 FACT SHEET: President Obamas Blueprint for Keeping College Affordable and Within Reach for All Americans, The White House Office of the Press Secretary, January 27, 2012, http://www.whitehouse.gov/thepress-office/2012/01/27/fact-sheet-president-obama-s-blueprint-keeping-college-affordable-and-wi 48 E.g. the approval of the Patten acquisition of University Now and the Higher Learning Commissions informal encouragement of the Northern Arizonas competency-based programs. 49 Education Finance Council, 2012, http://www.efc.org/cs/root/resources/resources.

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