Wall Street PhD: for-profit education can be good for business - and for education.

For-profit education can be good for business -- and for education.

THE "education industry" was born as a news story in the New York Times this January. Few of the companies that make up the industry are yet household names -- Sylvan Learning Systems, DeVry, ITT Educational Services, KinderCare -- but they're now officially on the map.

This spring, two major investment houses -- Lehman Brothers and Smith Barney -- hosted conferences to introduce institutional investors and investment bankers to the leaders of roughly thirty for-profit education companies looking to raise capital in the equity markets. Their interest in education should be warmly welcomed.

John McLaughlin, editor of The Education Industry Report (based in St. Cloud, Minn.), has developed an index to rate the performance of 25 publicly traded education stocks. Last year, the Education Industry Index climbed a whopping 65.5 per cent (the Dow Jones Industrials were up 37 per cent). During the first eight months of this year the index rose another 38 per cent.

Why has Wall Street taken a sudden interest in education companies? For the same reason Wall Street is interested in any industry. America spends roughly $600 billion per year on education, or roughly 10 per cent of our gross national product. That's second only to health care (14 per cent) and more than twice as much as we spend on national defense (4 per cent). As media mogul turned education entrepreneur Chris Whittle reminds us, one point of market share in the elementary - secondary market alone equals $3 billon.

Analysts compare education today to the health-care industry twenty years ago. Until the 1970s, health care was inefficiently managed and dominated by the public sector and non-profit entities that had little direct competition and little incentive for innovation. Costs rose markedly without corresponding improvements in the quality of care. Doctors and boards of directors of non-profit hospitals were the "gatekeepers" in those days, much as local school boards and unionized teachers have a lock on service delivery in education. Then along came HMOs, and a multibillion-dollar industry was born.

It is no coincidence that investment banks have created the notion of "Education Management Organizations" (EMOs) in their investment literature as one of several sectors of the education industry. Companies like the Edison Project and Education Alternatives, Inc., have been the big players in the K - 12 arena, but the sector also includes management companies in pre-school and higher education. The biggest performer in the latter sector is the Phoenix-based Apollo Group.

Apollo operates the University of Phoenix, a chain of stand-alone for-profit universities, and it also contracts with smaller universities to provide students with specific degree offerings. Catering to the schedules of working people, most of the schools operate from 8 A.M. to 8 P.M. An on-line component is also offered, either as a stand-alone means of earning a degree or to augment campus-based offerings. Apollo's stock was offered for $11 per share when the company went public two years ago (with adjusted current value of about $2.40 after a secondary offering and four stock splits). Today, it trades in the mid-20s. When asked if the University of Phoenix has to spend time on "fundraising," founder John Sperling replied, "We don't need an endowment. We have Wall Street."

In addition to education-management groups, the education industry includes sectors such as educational services (learning centers, test-preparation companies) and educational products (textbooks, software).

Sylvan Learning Systems is one of the fastest-growing companies in the educational-services sector. In addition to offering tutorial services (focused on reading, math, and school readiness), Sylvan is now also operating remedial-education programs for 9,000 students in 62 school systems around the country. The company is also expanding into the growing area of testing.

For the market to exist, there have to be buyers. Who's buying and why? First among reasons for private-industry success is widespread dissatisfaction with the current systems, both at the K - 12 and the post-secondary levels.

But there are other forces at work as well. Companies like Apollo and Sylvan are taking advantage of a trend concomitant with the rise of the knowledge economy: while the premium paid for intellectual capital is at an all-time high (ask Bill Gates), many are questioning the value of formal academic credentials (again, ask Bill Gates).

Michael Prowse, writing for the Financial Times in November 20, 1995, argues that "Higher degrees serve a function akin to that of the exotic plumage of birds: they are primarily a means of attracting attention, of signaling that you deserve special attention." In today's world, as Sylvan Learning Systems knows well, "simple tests of cognitive ability can be administered in less than 30 minutes. Such tests, which can be tailored to the needs of particular companies, are a better guide to job performance than academic degrees."

THE growth of for-profit education comes in the context of the whole reform movement that sprang up in response to the Nation at Risk report. Many reform initiatives have been tried since the Nation at Risk report.

These reforms (charter-school legislation; vouchers, whether publicly or privately funded) are vital in that they establish the policy framework within which real progress can occur. Deregulation has helped to create an atmosphere in which private companies have been able to enter the education arena. If such reforms are allowed to flourish, a free (or much freer) market in education should lead to the same increases in quality, diversity, and freedom that have touched American life in every other domain.

Of course, market forces can frighten producers -- and the teachers' unions and education bureaucracies are practiced at protecting their turf. But corporations by profits will move in slowly, looking for market niches by identifying areas that are underserved. Currently, education companies are nibbling around the edges, taking on aspects of school operations that are grossly underperforming, or areas that the traditional system would just as soon cast off: reading remediation; alternative schools for troublemakers; testing; maybe busing and food service. As businesses prove themselves and the public becomes more comfortable with the intermingling of public and private goods, policymakers will be forced to allow more opportunities.

More and more progressive educators and administrators are embracing the idea of "contracting out" for various school services as a way to allow them to focus better on their core mission. Others see "privatization" as a means of trimming overhead or controlling costs. Both of these are desirable outcomes, but fail to grasp the far greater potential of the private marketplace to transform public education.

As new products and services are developed with new "value added," consumers -- through their rational spending decisions -- expand the industry. Call it "the Starbucks factor." Because of increases in quality, variety, convenience, and atmosphere, people have been willing to shell out $3.50 for a caffe latte instead of the usual buck and a quarter for a cup of Maxwell House.

The potential for new educational services and products is as limitless as the creativity of the human mind and the dynamism of a competitive marketplace. Michael Heise, law professor and director of Indiana University's Center of Education Law and Policy, puts it this way: "Investors are chiseling away at the dam of the last remaining government monopoly in the world. Were the dam to break, I expect there would be a flood of investment in educational research and development."

As education shifts from a political to an economic model, overall education spending is likely to rise, not fall, contrary to conventional prophecy. There is every reason to expect that consumers will expand the market for education -- once they are assured they are getting what they pay for. Such a shift will create increasing opportunity for investors -- and for students.