New higher education regulations discriminate, block established organizations from innovating

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Jun 10, 2011

Just last week, the Department of Education released its final regulations designed to crack down on the practice of colleges incentivizing recruiters based on either the number of students they were able to enroll in postsecondary institutions or the number of students they were able to help secure Title IV financial aid. The intention is to eliminate the abuses in which institutions enrolled students who had little hope of graduating or paying back their student loans and in essence were enrolling under the guise of what was a false hope.

The regulations go into effect in July of this year—and as that date has approached since the initial draft regulations were released last year, confusion and uncertainty over what will and will not be allowed have grown.

To deal with this, the Department of Education issued a letter in March clarifying the intent of the regulations and giving specific examples as to what would and would not be permissible. In clarifying the regulations though, the Department appears to have lashed out and stacked the deck unfairly against the early innovators and leaders in the online learning world of higher education, who—like all incumbents facing the innovator’s dilemma—already have internal reasons working against them in making this transformation. With the right leadership at the helm, however, these institutions could make the transition, which means that the Department of Education’s actions are at best short-sighted, as they will prevent those institutions that have far-sighted leaders from taking their institution’s know-how into the next evolution of online learning.

In the beginning of most industries, the leading providers tend to be vertically integrated and offer products and services with proprietary, interdependent architectures. The reason is that the product’s components must be tightly woven together to maximize the immature technology’s functionality, which is not yet good enough to satisfy customer needs.

As the rise of online universities demonstrates over the past decade, this wisdom has largely held in the field of higher education. Universities such as the University of Phoenix, DeVry University, and Capella University have been tightly integrated, proprietary, and highly successful as the early leaders in the field of online learning.

But as an industry matures and products and services improve, there is a shift. The leaders become those that supply less integrated, more modular products. This shift happens as a product’s raw performance becomes good enough to get the job done, so customers start to prioritize the flexibility that modularity offers over the increased performance that integration makes possible—and insist on customized products.

The classic example of this occurring happened in the personal computer industry. At the outset, vertically integrated players like Apple rose to dominance. But over time, the industry shifted to a more modular one, and Microsoft and Intel captured the lion’s share of the profits. Modular computer manufacturers—like Dell—ultimately disrupted the vertically industry desktop-computer makers.

In higher education, there are signs that this modular world may be emerging. More and more, traditional non-profit universities are partnering with for-profit actors that bring the know-how to take the traditional universities’ offerings online and reach many more students with innovative and modular revenue-sharing models. Embanet, Altius, and 2tor are some of the hot companies leading the charge.

2tor, a darling in the venture capital world as of late, for example, has partnered with USC to offer an online teaching program; Georgetown to offer an online nursing degree; and the University of North Carolina, Chapel Hill to offer an online MBA. In our paper “Disrupting College”, we wrote about how a critical reason for the cost overruns in America’s traditional universities wasn’t administrative bloat per se, but instead the root cause was that these universities had commingled fundamentally different business models—research and teaching—inside of their institutions and therefore introduced a layer of complexity that required significant overhead to manage. 2tor seems to be solving this problem for the institutions with which it partners, as it in effect separates these two fundamentally different business models. The division it sets up in partnership with the university is a business model that “just” focuses on teaching—pure and simple. And it spins off cash that feeds the traditional university faculty members’ research agenda.

The challenge for the leading online university players—University of Phoenix and the rest—of course is if this is the next wave of growth in the industry (and we still don’t know if it is for sure), will they be able to catch it? The track record of the leading organizations being able to disrupt themselves is not particularly good. To do so, the incumbents have to create an autonomous division that can create a new business model around the next disruption—and leaders have to studiously protect it from the rest of the organization that would rather kill or co-opt it. If the leaders can handle the transition, however, they bring enormous resources to the table, which is tremendously positive for everyone. For example, in the case of the University of Phoenix, because of their vast resources, were there a viable market opportunity in front of them, they could make an enormous investment in a next-generation platform to help traditional universities make this shift.

The odds of this happening may not be good, but the Department of Education appears to have made them far worse, as it has barred the University of Phoenix or other entities like it from creating these types of modular, revenue-sharing models—but specifically (and one supposes thankfully) said that the arrangements that 2tor and companies like it set up are allowable. The specific language appears on page 12 of its clarifying letter when it approves of just such an arrangement with “a third party that is not affiliated with the institution it serves” but excludes one where that third-party is affiliated with any other institution that provides educational services.

Helping pick de facto winners and losers in a market is never a good idea for the government. Even as the Department’s final regulations are predictably attracting criticism from all sides for its inevitable compromises, this issue in particular has received far less attention, as the Department has already given some institutions permission to enter into these innovative arrangements to help traditional higher education–just not all institutions. Perhaps the team at the Department of Education should rethink its decision and ask itself one more question: Who is it actually protecting here?

Michael is a co-founder and distinguished fellow at the Clayton Christensen Institute. He currently works as a principal consultant for Entangled Solutions.