Why For-Profit Colleges Are Like Health Clubs

They spend more on recruiting and less on instruction than their nonprofit counterparts do, a scholar's model shows

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Chart: Differences in revenue and spending

Article: A Model of For-Profit Higher Education: 5 Other Views

Forum: Join an online discussion about whether for-profit universities are as starkly different from traditional ones as a model by a Stanford University business scholar suggests.

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By GOLDIE BLUMENSTYK

In many ways, for-profit colleges, like the University of Phoenix and American InterContinental University, are not all that different from public universities or private colleges. All of them seek out students, collect their tuition, and then use that money and other revenue to pay for the costs of instruction, counseling, and other activities.

But one business-school professor's analysis of the way the three kinds of colleges use that revenue reveals a striking difference: From a financial perspective, for-profit colleges have a lot more in common with a chain of Bally's health clubs than they do with, say, Arizona State or Emory Universities.

"The for-profits are motivated to devote themselves to 'student acquisition' and retention," says Samuel C. Wood, a former assistant professor of business at Stanford University who is now a lecturer there. "It's more like a gym model."

Mr. Wood assembled his model as a lesson plan for a course he co-teaches at Stanford called "Business Opportunities in Education."

The idea, he says, was to look at the past decade's most significant success story in that field — the growth of for-profit higher education — and find a way to show students that "these aren't just universities that make a profit. They're different."

At a time when many for-profit colleges are seeking greater legitimacy among students and educators, and on Capitol Hill, the big distinctions made visible by his model also serve as a reminder that some of those differences matter more than others.

In Mr. Wood's model — which compares revenue sources and spending by nonprofit public institutions, nonprofit private institutions, and for-profit institutions in a broad-brush picture — the most striking difference occurs in the percentage of revenue spent on advertising for and recruiting students.

As he has calculated it, public and private nonprofit colleges spend the equivalent of 1 percent and 2 percent of their revenue, respectively, for recruiting, while for-profit institutions spend 23 percent.

"They are going to spend the money on getting you, and a little bit on keeping you around," says Mr. Wood of the for-profit colleges. "Once you've acquired a student, it's like you've acquired an annuity."

Key Differences

The model also highlights some other key differences: For-profit colleges appear to rely almost exclusively on tuition for their operating revenue, spend negligible amounts for research, or to pay taxes, and, of course, earn a profit on the revenue they take in (15 percent, on average). Nonprofit colleges appear to rely far more on government support and on income from donors and investment earnings to cover the gap between tuition revenue and expenses.

The model also shows that nonprofit colleges spend a greater percentage of their overall revenue on instruction and on services and support, a category that typically includes such things as the registrar, cultural and athletics programs, and career counseling.

But Mr. Wood says the varying percentages in his model do not necessarily mean that the instruction or the services at a for-profit college are not as good as they are at a nonprofit college, because the percentage comparisons may not account for things like greater efficiency at for-profit institutions.

Even so, Mr. Wood says, it is safe to assume that for-profit colleges do appear to spend less than nonprofit institutions on salaries for faculty members and on facilities. (Many for-profit institutions operate out of leased office space.)

Likewise, he warns against drawing too many conclusions about for-profit colleges' higher spending percentages for recruiting. From a business perspective, he says, the only clear conclusion that can be drawn without further study is that in the markets that the for-profit colleges serve, describing your product to prospective students "is much more important" than it is for most nonprofit colleges. Otherwise, he says, they wouldn't spend the money.

Limitations of the Model

Mr. Wood drew his model from data that the colleges provided to the U.S. Department of Education, from consultants' reports on college spending on recruiting, and from corporate reports and Wall Street analysts' reports on three of the largest publicly traded higher-education companies: the Apollo Group, the parent of the University of Phoenix; the Career Education Corporation, which owns American InterContinental and numerous other institutions; and ITT Educational Services Inc.

As with any simple analysis based on rough numbers, averages, and estimates, Mr. Wood's model has limitations. Because institutions categorize revenues and expenses differently, and because the model includes data from many more nonprofit colleges than for-profit ones, he says, the percentages are perhaps best looked at as approximations.

And he is the first to acknowledge that this very unnuanced look at the $400-billion higher-education industry presents just one snapshot of a complex enterprise.

Still, he believes, and other experts contacted by The Chronicle agree, that this model can be instructive. The for-profit institutions are still a small portion of the overall market, but they are growing much faster than the education sector as a whole, says Mr. Wood.

Not only can the model show how they differ from nonprofit institutions, says Mr. Wood, but it may also help nonprofit colleges better understand which for-profit strategies they might want to avoid.

For example, he notes that many nonprofit colleges are beginning to spend more money on marketing. Yet the amount they spend on instruction and related services is often more than what they receive in tuition, which means that adding students might actually be costly to them. So unless each additional student adds to the profit margin, as is the case for the for-profit colleges, the decision to go gung-ho on marketing might be a big mistake, at least from a purely financial point of view.

Mr. Wood, who is himself looking for business opportunities in education — he is the founder of a company that sells educational software used in M.B.A. classes — says comparisons of instructional costs also can illuminate differences in the sectors.

He points out that one of the ways for-profit colleges have held down the cost of instruction is by redefining the role of the faculty member. At most for-profit institutions, individual faculty members don't design courses; they teach a curriculum that is provided to them and, as a result, tend to be paid lower salaries than faculty members at traditional colleges, who play a greater role in creating the courses.

Mr. Wood says the system, in some ways, reminds him of the automobile industry at the turn of the previous century, when Henry Ford found unskilled laborers and paid them low wages to put together cars on his assembly line.

Today for-profit colleges have found a way to hire a relatively low-cost corps of faculty members to provide "a product that is at least high-enough quality" to attract students, he says. "Culturally, the not-for-profits couldn't get away with that," he says.

The Effect of Unions

These days, of course, the American auto industry isn't exactly a model of profitability. For automobile manufacturers, the profit equation changed because "the labor movement happened," says Mr. Wood, and their costs went up. At traditional colleges, too, higher salaries are one of the main causes of increasing costs.

Mr. Wood doubts that a wave of labor activism will overtake for-profit higher education because its labor pool is so scattered, particularly now that online education allows colleges to hire faculty members who could be living anywhere. Furthermore, he notes, most faculty members at for-profit colleges are contractors rather than employees.

The risk to for-profit colleges that faculty members will start to unionize "is just nil," says Mr. Wood.

He may find it necessary to adjust his model sooner than he imagines. In March, just a few weeks after he made that prediction, faculty members at Kaplan University, an institution owned by the Washington Post Company, began making known their plans to form a union, although they said their concern was academic freedom, not pay. Coincidentally, the organization working with the professors is the United Automobile Workers.

DIFFERENCES IN REVENUES AND SPENDING How income sources and spending vary among nonprofit and for-profit four-year colleges as a proportion of their overall budget. NOTE: Samuel C. Wood developed this chart for a class at Stanford U. using data on four-year colleges supplied by the institutions to the U.S. Department of Education, from corporate reports of higher-education companies, from various analyses of nonprofit and for-profit colleges conducted by consulting companies and Wall Street analysts, and from interviews with people in the industry. The model excludes revenues and expenses related to hospitals, and auxiliary services like housing and dining.