Archive for November, 2010

Tip and Ring: A Parable of College Tuition

November 30, 2010

The latest economic parable explaining why tuition at American colleges and universities has risen twice as fast as health care costs is aimed at supporting an insupportable value proposition: a university education is cheap at twice the price.  In my last post I talked about the danger to higher education in “clinging to myths”, as MIT’s John Curry put it.  Justifying the high cost of a college education rests on one of those myths.

Here is the basis of the economic argument: since college costs are driven by labor intensive processes that require high degrees of skill and are resistant to technological efficiencies, we should look to the value received in other specialized service markets like health care and banking where quality demands 1-1 contact with a highly trained service provider. The conclusion is that higher ed prices have fared no worse than prices in those other markets. Some of the comments to my last post also repeated this argument.

The problem with this line of thought is that virtually none of the assumptions underlying it are true.  Never mind that wholesale “mission creep” has systematically siphoned off value that should be delivered to students in the classroom in favor of dozens of other priorities. The basic underpinnings of the things-aren’t-so-bad argument are simply fabricated.

Running a university is like running a business.  There are denyers who dispute that claim, but the fact of the matter is that in higher education income has to balance expenses.  If expenses rise, then a university president has to search for new sources of income.  State subsidies are drying up. Endowment income has been shrinking. Research income does not help, and licensing income is, well, let’s just say it’s an unlikely source. The only source of new income is tuition, and the parable concludes by saying,  “Labor costs are high, so let’s get students to subsidize the increase.”

There are not that many different ways to bring costs down in any business: (1) you can deskill your workforce, (2) you can find a more efficient physical plant, or (3) you can use materials better.  There is no reason that a higher quality university education cannot be delivered to more people by applying one or more of these principles.

Let’s take on the we-must-use-high-cost-labor assumption. Even if you are not a believer in online education, only a stunningly short-sighted point of view  fails to recognize that ed tech is on a different innovation curve than classroom instruction. Compare the improvement in the educational blogging experience over the last six months with the rate of change in the classroom, where it can be argued that the last real technological innovation–one that became ubiquitous because of its obvious value–was the introduction of the chalk board in 1801.

I understand the thesis: university teaching cannot be deskilled because it is by definition undeskillable.  Higher education is artisinal by its very nature.  It has to be delivered by professors to individual students–or, at least, to small groups of individuals–in person. I agree with that:  given the premise of an artisinal workforce, deskilling makes little sense.  If we do nothing at all to change what and how we teach then what we have today is probably pretty close to the best that we can expect from the system.  But I reject the premise out of hand. Which brings me to a very different way of looking at the economics of higher education: the parable of  tip and ring.

Tip and ring is the technology that telephone operators used to manually switch telephone connections a hundred years ago. The tip and the ring of the plugs that operators used kept the twisted pair of copper wires in a telephone cable separated so that they could be inserted into the large patch panels of a central exchange switch.

Early studies of telephone operator efficiency by Western Electric indicated that a skilled worker at peak performance could switch up to 250 calls at one time. Everyone did the math.  Given projected population growth and even the most conservative estimates for network growth, the current method of switching was going to be very expensive.  Underlying labor costs would limit the extent to which Americans would have direct access to telephone communications. An investment banker in 1887, summarized the various Bell System technical memos on the subject very succinctly:

The possibilities of a private home telephone system throughout the country is out of the question. Almost the entire working population of the United States would be needed to switch cable.

Network engineers were aware of the current economic curve and a few brave souls piped up: “Well, what if we do things differently? What if we replace the human telephone operators with automated workings? Wouldn’t we be able to multiply the number of switching operations per minute by many fold?”  By 1918, rumors of the promise of deskilling in voice telephony reached the office of Theodore N. Vail, president of American Telephone & Telegraph:

Automated working is not adapted to our needs, any more than radiography will will ever supplant telegraphy by wires.

Human operators were eventually helped out by some technology, but it wasn’t until the first crossbar switch was installed in Brooklyn, New York, in 1938 that automation began in earnest.  It took a hundred years for the U.S. telephone systems to reach 700 million installed lines. In the next ten years, the number of lines doubled, while technology put voice call quality on its current growth curve. By 1986, fiber optic technology enabled Sprint to revolutionize the long distance telephone business with its “So clear you can hear a pin drop” marketing campaign. None of this would have happened if Theodore Vail had  his way and the telephone business had remained dependent on a highly skilled manual workforce to switch voice calls.

So, yes: if higher education remains dependent on the tip and ring process of using an unnecessarily labor intensive system, costs will continue to rise. There are many–perhaps a majority–in higher ed circles who would repeat Vail’s dictum: “Automated working is not adapted to our needs.” To be more precise, they say, “Higher Education remains essentially an artisinal industry.” There are others, however, who believe that fundamental change will not only bring costs down, it will bring the 1986 promise of pin drop quality to the 21st century university. And don’t get me started about how wrong Vail was about mobile telephony.

Picking Daisies for American Universities

November 22, 2010


One of the commercials broadcast during the NBC Monday Night  Movie on the evening of September 7, 1964 was a one-minute campaign ad for President Lyndon Johnson.  It began innocently enough with a child picking daisies and ended in the horrifying nuclear catastrophe that would be the inevitable result of electing Johnson’s Republican opponent, Barry Goldwater.  Johnson’s voice intoned: “These are the stakes!”

The Daisy Ad was broadcast only once, but it was in the view of many historians the decisive factor in Johnson’s landslide victory. Goldwater was at the time a sitting two-term United State senator and the rock-solid leader of American conservatives.  He was a fierce opponent of Roosevelt-era programs,which he considered financially irresponsible, but he was by all accounts anything but excitable.  Nevertheless, the Daisy Ad defined Barry Goldwater as the man who would recklessly plunge the nation into nuclear war. It was a dramatic illustration of the ruination awaiting public figures who allow their opponents to define them.

The number of “These are the stakes!” portents of disaster for American Universities is on the rise. Everything from tenure to the economic benefits of a university degree seems to be under assault.  Richard Vetter, Director of the Center for College Affordability and Productivity (CCAP),says that an economic nuclear wasteland is the price of ignoring the recklessness of American higher education:

The pell-mell investment in sheepskins is beginning to look an awful lot like something our economy has seen in real estate: a debt-fueled asset bubble. It might end just as badly.

How do American universities respond? Meekly. As reported in the Chronicle of Higher Education, university leadership has been slow to recognize the direction and force of prevailing winds.  A common mistake in business and politics is to focus on the feel-good stuff that is ultimately valueless, and universities are making the same mistake.  The Chronicle reports that former MIT vice president John Curry told a gathering of heads of public universities to stop clinging to “worn out myths about campus strengths.” Curry told the group, “We like our stories more than the truth.” That leaves a vacuum for others to tell their versions of the truth.  It was devastating to Goldwater and it will be devastating to higher education.

The CCAP has in recent months published a series of highly critical studies of cost and value in American higher education.  I have mentioned some of them here. CCAP themes have gone viral in communities that are to all appearances unfriendly to the overall goals of higher education, among them the conservative think tank The Heritage Foundation.

It is no secret that conservative groups are increasingly cool to the idea of an academic meritocracy, preferring to view the inevitable hub-and-spoke network of influencers within the academic community as unfair to arguments and causes that would draw relatively few advocates on their own merits–a “liberal tilt” they call it. Now CCAP’s Matthew Denhart has published a study for the Heritage Foundation that argues for less federal involvement in higher education.

You see where this is going. Taking themes that are deeply troubling to the future of universities, like the overreaching of accreditation agencies, and constructing a “Picking Daisies” story about the politicization of higher education, the silence of university leadership becomes the Goldwater response to the doomsday ad. Here’s an example of the disconnect. On my campus, as on many others, there is still serious debate about the use of online education.  We cling to the worn out myths about the value of classroom attendance when overall enrollments are growing at a paltry 2%. The most recent Sloan Survey of Online Education reports that during that same period online enrollments surged by 21%.  I did not drop a decimate point. That’s a factor of ten difference. It sounds to me a little like debating the desirability of damp weather as a tsunami is approaching.

Among the Sloan findings: class differences caused by increasing selectivity and rising costs in traditional public universities are driving a new generation of students toward online learning in unprecedented numbers. The unresponsiveness of public institutions to obvious trends like these clears the way for anyone who wants to define higher ed. What are traditional universities doing in the meanwhile?  We argue about the effectiveness of increasingly baroque systems of ranking our own hubris-driven reputations, we fight tooth-and-nail against a level playing field for traditional and for-profit universities, we are able to argue with a straight face that college costs that have rise at twice the rate of health care costs are not really out of control.

The general public does not care about any of this.  It’s no wonder that they have tuned out pleas for more funding and are willing to turn their backs on a great engine of wealth creation in favor of just about any story that makes sense to them. Richard Vetter’s story is that traditional higher education is the Goldwater who threatens the innocent daisy-picking American public.  It doesn’t make much sense, but it’s better than the story that we tell.

The Internal Start Up: Heading for the Exit

November 17, 2010

It’s not only the clash of investment cultures that tends to doom internal start ups. At least that’s what I told the Bellcore and SAIC CEOs at the post-mortem for the internal division that we had tried to run as a venture-backed business.

It’s also what I said to Bob — who you will recall — wanted to incubate an internal venture inside his Fortune 10 company that would match in excitement and star power the coolest gang of Sand Hill Road funded misfits. He would have to be willing to sacrifice a boatload of management principles that had served him well in his career. I didn’t think he would do that.

Like a generous parent, Bob was in a position to give the new kids everything they needed for success: mentoring, time to succeed, and ample resources. What he did not have was a clear idea of which exit to take. Bob’s idea of a venture failed the value test.  A new venture succeeds when the right leadership team focuses on a market need with staged funding.  The idea was doomed as soon as Bob said,“Look, I’m in charge of new technology and platforms and I’m going to be the venture capitalist funding a new product, so that when it succeeds we’ll be able to fold it back into our current business.

The moment someone in a large company forms a thought like this, the options for maximizing the value of the investment are narrowed to one.  The only exit is one in  which access to internal resources can be used to shoehorn a fit into existing businesses. I had seen the danger of this kind of investment strategy at other companies, and the results were not encouraging. This thinking had infected our Bellcore start-up, but I have been in the executive suites of a dozen West Coast technology companies when the discussion turned to how the value of an internal start up was going to be captured by an existing business line.  It always turned out the same:  because there were no choices to a successful exit, backers literally threw money at the new company. They were thinking way down the line about how to succeed.

There are other options, but they do not necessarily align well with Bob’s goal of internal commercialization:

  1. Sell the technology: it’s always possible that the upside does not justify continued investment.  But if you’ve made a large up front commitment–as opposed to small increments that are tied to market tests– it is hard to execute this option and capture value.
  2. Licensing: the main reason for choosing  licensing as an exit is that there are differing value expectations in the marketplace.  The technology may be used in many different applications by many different players, for example.  You can maintain a central IP position and benefit from this diversity.
  3. Resell your R&D effort: if the technology is a critical product component, there may be other vendors who would like to benefit from your near-term “deliverables.” An R&D contract gives up a little IP in the short run, but you not only recover your development costs, you also continue to expand what you know about the technology and its applications. This is such an interesting–and seldom used–exit strategy that it deserves a post all by itself.  Watch for it!
  4. Sell the right to market or form a joint venture to market and sell: this is a range of exit possibilities that allow you to keep the option of bringing the technology in-house at some later point.  Of course, the attractive thing about such partnerships is that they generate revenue while spreading the risk around several players.
  5. Spin-out/IPO: the obvious counterpoint to the internal start up is to kick the baby bird out of the nest to see if he can fly on his own. I don’t know why our Bellcore start up was not conceived from day one as a spin out.  Bellcore, after all, had a history of spinning out companies to commercialize research technologies.  Some of those companies (Telelogue for voice menus, Elity for CM analytics, and a host of companies for communication network traffic monitoring and tools) were quickly picked up by angel and venture investors who went on to ride the businesses to their own successful exits.

Why Bob was determined to retain ownership in an incubated business says as much about internal corporate culture and priorities as Bob’s own approach to innovation. What seems to be missing when managers fixate on internal startups is the recognition that there are other worlds involved in the success of a new business, and they often  have very different rules.The internal start up is an opportunity for worlds to interact rather than collide. Here is the value chain that Bob had to work with:

  • Creative engineering: internal R&D interacts with a larger, external innovation community.  It  is very good at coming up with gap-filling concepts that need to be externally validated
  • Venture funding: is useful for establising performance metrics based on value and focusing funding to meet performance goals based on those metrics
  • Corporate resources: the company itself is in the driver’s seat.  It sets out the strategy for value capture and makes the option calls that start chains of transactions that are key to success. And by the way, the creative engineers call it home.

This all started because Bob was worrying that normal, internal product R&D would not lead to  “breakthrough product ideas that do not align well with their core business.”  It is a common problem, but there are three fatal errors that doom most attempts to solve it. Here’s how to avoid those errors.

First, don’t set the new venture up for failure by limiting the end game to only those ideas that align well with the core business.  That was what got you in trouble in the first place, and can be avoided by considering up front the full range of exit options.

Second, don’t pretend that you are a venture fund.  The fundamental belief systems are different, and it is simply not possible for a large corporation–one that has to worry about quarterly results and long-term growth–to capture value in the same way that a VC does.

Finally, recognize the role that interacting worlds will play in the success of your venture.  External innovation networks, market-validating communities and the relatively heavier weight corporate resources and processes have a tendency to collide, when what is really needed is a strategy for working together.