Published on 2012/06/28
Online universities are certainly a disruptive force in higher education, but their value proposition is different from that of traditional institutions and it is reflected in the weight that is allotted to the degrees they award. Photo by Hellolapomme.

Many of my friends in the education world are fond of talking about how the University of Phoenix is not in fact a disruptive innovation.

They don’t just stop this statement with the University of Phoenix of course. I’m using the University of Phoenix as shorthand. What they mean are many of the distinctly online universities that have emerged over the last couple of decades—everyone from Kaplan University to DeVry to Bridgepoint.

They are wrong. These online universities are disruptive innovations relative to traditional universities. They are now on their own sustaining innovation track, which every disruptive innovation moves to as it grows, expands, improves, and marches up market. It’s also true that not all of them will succeed in these endeavors.

The fact that I’m saying they are disruptive innovations in the face of many saying they aren’t strikes me as ironic, given that I often find my job is to correct people who want to declare nearly everything disruptive and misapply the term. I also readily admit that online learning isn’t inherently disruptive; when it’s used in a hybrid format to complement or extend traditional brick-and-mortar learning, chances are it’s being used as a sustaining innovation. No technology is inherently a disruptive innovation, as all technologies can be applied to sustain or disrupt the industry’s incumbents.

I’ll explain though why online universities are disruptive in a moment, but one more word. Just because these universities are disruptive relative to the traditional universities doesn’t mean that what they do is for the common good per se. For a variety of reasons, I personally tend to think that is often the case, but disruptive innovation isn’t a normative term; it doesn’t imply that something is morally good or bad.

Nor does the term imply that these universities are the end-all be-all of disruption in the higher education space. Over the last couple of years—and in a flurry in the last few months—we’ve seen another wave of disruptive innovations launched in higher education that I suspect may disrupt the first disruptors. Combined with continued up-market movement by some in the first wave, I suspect this new wave will have far reaching consequences for the higher education sector over the next decade.

But let me first explain why the University of Phoenix and its peers are disruptive relative to traditional institutions.

A disruptive innovation is one that transforms a sector by introducing a product or service that is more convenient, simple to use, and/or affordable than the existing products or services in a market. Disruptions tend to start as not as good as the existing products or services as judged by their historical measures of performance, and then, over time, they are able to march up market such that they are able to handle more complicated tasks. Many people flock to the disruptive innovation over time as it becomes good enough, as the customers are delighted by something that carries this new value proposition around convenience, simplicity, and/or affordability. As a result of these dynamics, disruptive innovations first serve nonconsumers (people who previously could not participate in the market) or people who have been overshot by the incumbents in the market. A critical thing to keep in mind is that this process does not occur over night; sometimes it occurs over several decades. And not every incumbent or traditional institution will be wiped away. Some will continue to perform important jobs for which a, relatively speaking, small set of customers are willing to pay.

Lastly, for something to be a disruptive innovation, it has to have two components: a technology enabler and a business model that together allow it to extend a low-cost value proposition up market.

In Disrupting College, we discussed that this is why land-grant universities and community colleges have not in fact been disruptive innovations. Although they have many of the characteristics of disruptive innovations—entities more affordable than their higher education predecessors that extended access to populations previously unable to participate in higher education—they didn’t have a technology core that allowed them to take a low-cost value proposition up-market. To move up market and serve students at the higher end, these institutions instead had to replicate the costs of the existing institutions—research faculty, buildings, and so forth—which meant they ended up taking on the same business model as the incumbents and, as they went up market, ultimately offered the same value proposition.

We asserted that online universities, however, had this technological core that allowed them to extend their new value proposition around, in this case, the disruptive attributes of convenience and accessibility, up-market.

Many have been quick to take a swipe at this assertion. Kevin Carey, who authored an insightful piece in the New Republic recently about the next wave of disruptive innovation, said that because these online universities were still offering degrees, they were ultimately offering the same value proposition.

I don’t think this is true.

When minimills disrupted integrated steel mills, for example, they were still offering steel ultimately. It was simply at a lower cost.

“Aha!” skeptics claim. That’s just it. Look at the prices that the University of Phoenix and others charge, and you see that it’s not all that different—and sometimes it is even a bit higher—than their traditional competitors. Doesn’t that mean they are not disruptive?

Not necessarily. When the minimills were disrupting the integrated steel mills, prices only really fell in a given tier of the market each time the minimills succeeded in chasing out all of their higher-cost competitors. So long as there are high-cost competitors in the market, there is little incentive in place to price significantly lower. Once the integrated mills were gone, for example, prices collapsed by 20 percent in the market—which represented the cost advantage that the minimills held over the integrated players.

A typical traditional university today incurs operating deficits of 10 percent of revenues, even as the disruptive online players report operating profit as a percentage of sales to be roughly 30 percent. In other words, these online players have a cost advantage of roughly 40 percentage points. Western Governors University—one of the few disruptive institutions that truly prices its offering lower—shows how much room the leading online institutions likely have to price lower if they had to (although Western Governors University likely actually costs less than many of the other online universities because of its innovative teaching model that leverages technology in some more purposeful and innovative ways).

Stay tuned in other words—although it is important to acknowledge that this picture is complicated by the role that the government (at the state and federal level) plays in propping up costs and prices in the market through its subsidies, grants, and loans. Carey also does an excellent job of capturing this dynamic in an article he authored in the New Republic. In the case of the online players, because of the existence of Pell Grants and because institutions are unable to limit the amount of loans students may take out, the government has in essence created a price floor below which it hasn’t historically made much sense to price oneself (although some of the newer disruptive players like New Charter University, which will not take any federal funding, will change that). In addition, the picture has been complicated because traditional universities receive a significant amount of funds from these and other sources, which means they have historically been able to keep tuition prices relatively low, even as their costs have increased rapidly. As the fast-rising tuition prices in California and elsewhere suggest, however, that game is nearing its end, particularly as government sources of financing continue to dry up in the years ahead.

Indeed, when disruptive innovation takes hold in a market, as Clayton Christensen wrote in The Innovator’s Dilemma, often the basis of competition goes through several phases—from first competing on functionality, then to reliability, then to convenience, and then finally to price. Today’s dominant online universities do seem to compete much more heavily on convenience than anything else, which signals that the price competition is still to come.

Furthermore, there is one other critical difference in the value proposition that many of the online universities offer compared to their traditional university peers. For the traditional colleges and universities, the way they go up market is by climbing the Carnegie Classification “ladder” to gain prestige—and more money. How do they climb the ladder? By looking more and more like Harvard. Becoming a research institution is a good jump for many. As a result, a critical—one might even say overriding, as judged based on what faculty tend to prioritize—value proposition traditional institutions offer is around knowledge creation.

For the online universities, however, this isn’t their path to greater returns and more money because adding a research mission would in fact cause their margins to decline. As we identified in Disrupting College, one of the critical reasons for climbing administrative costs in traditional universities is the complexity of managing the fundamentally different business models of research and teaching under one umbrella. Taking on this complexity for focused online universities therefore makes no sense, which ensures that their value proposition will continue to be built around proliferating knowledge and learning—not research.

Even though both traditional and online colleges and universities offer “degrees,” they have different value propositions in some critical respects.

I do tend to agree with Carey, however, that the disruption that will, in many cases, have more weight across the entire sector when all is said and done is from the entities that are starting to offer certificates—and are modularizing the university and eating away at the monopoly on credentials that the market has historically valued. As any industry becomes more modular, the brand that is valued in a market tends to shift to the component level—so those institutions offering courses (like an MITx) will begin to be what is valued. The parallel will be similar to what happened in the computer industry where there was a transition period in which people swore by the power of their Silicon Graphics server and just couldn’t imagine a Dell server ever being good enough. And then all of a sudden Silicon Graphics filed for bankruptcy protection, but what mattered in the server market wasn’t the fact that what replaced it was a Dell, but rather the Nvidia processor inside.

Indeed, there are a substantial number of students today for whom a degree doesn’t matter, which is why the focus out of Washington, D.C. and other quarters on bolstering the percentage of Americans with degrees is somewhat worrisome. More than that, the “job to be done” that many students hire education institutions to do today isn’t even to get a credential per se, but to help them get access to a better or different job, get promoted—or hang on to the job that they have now. A credential is merely a key attribute of the solution for many, but not all.

But that doesn’t mean that the University of Phoenix and its brethren aren’t in their own right disruptive—and won’t necessarily have something to say about all of the exciting entrepreneurial action taking place in the market now either. Stay tuned because the disruption in higher education is heating up.

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