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Charters: Diminishing Returns and Just Good Enough

I suspect many of us will be returning to the fascinating-in-a-car-crash-way transcript of the K12 Fiscal Year 2015 Guidance Conference Call transcript. But for the moment, I want to concentrate on just this one question from one of the conference call participants

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

 

So this is a related big-picture question. I mean, you're framing it up that mission #1 is always improving academic outcomes, which -- it's the good and noble thing to do, absolutely, no disagreement there. But I'm just wondering, is your view that -- you guys are deploying a lot of capital. Is this a business that is capable, while investing in academics at the necessary level, that you can return -- generate returns on capital in excess of your cost of capital? I just -- if you could comment on how you're thinking about that as you deploy a lot of capital and as you invest in academic outcomes.

 

What Meuler seems to mean is this:

It's nice that a school is interested in academic achievement and all, but you're not going to spend so much money on it that you cut into that sweet, sweet pile of money, are you?

Here are two major ways in which the free market is incompatible with public education.

broken-china.jpg
 

Diminishing Returns and Just Good Enough

Any operator of a business has to look at cost-benefits analysis. As the operator of a widget business, I look at my widget manufacturing and look not just at ways to improve the widgets, but ways to improve the widgets that will pay me back in revenue.

Ford could make cars that are objectively "better" by having all the upholstery hand-stitched with gold-infused thread. But that improvement would not allow the company to make more money from car sales-- certainly not in comparison to the additional production costs. So that improvement (and many others) will not make it into production.

Wal-Mart could have greeters who hand you a cup of cocoa and a scone when you walk in, and that would definitely make the experience of shopping there "better," but it wouldn't make Wal-Mart more money-- certainly not in comparison to the cost of cocoa and scones. So that's not happening any time soon.

Part of marketing is making a product that is Just Good Enough. Make it too crappy and people won't buy it. Make it too awesome and you won't be able to make money selling it. It has to be Just Good Enough, so that you can still market it effectively without cutting into your revenues. Excellence is expensive, but Pretty Good leaves lots of room to make a profit. 

So what Meuler wants to know is, "You're not going to pursue academic excellence to the detriment of finances, are you?"

At some point, a school that doggedly pursued top academic achievement for all its students would become financially unsustainable (unless it were a select private prep school that could charge Philips Academy style tuition). Charters need achievement numbers good enough to stay in the market, but not so good that they're spending too much money to get them.

The Enemy

In marketing there is sometimes a reverse boiling frog pot effect that kicks in. Can we lower the Just Good Enough bar without ill effects on market share? Customers will pay two dollars for a ten ounce box of Frosted Sugar Bombs. Will they readily pay the same if there are only nine and a half ounces in there? We all know this process-- I fully expect that my grandchildren will buy potato chip packages that are the size of a small labrador retriever but which contain one single potato chip. The product is the enemy of profit.

This is more true in education than in any other enterprise. Every dollar I put into the classroom is a dollar that does not go into my pocket. That's fine for public schools-- they don't need to have a penny left over at the end of the year. But if I'm working a for profit or a semi-hidden profit or just trying to pay my $500K CEO, every cent I spend on the students is a cent taken away from my backers, investors, owners, and other financially interested parties.

In free market schooling, students will not be the point. They will be an obstacle. In this model we often compare them to widgets or products, but actually, in the free market charter system, students are also the employees. Their job is to produce good data that can be used for marketing so that the revenue stream can be maintained, and so to that extent, spending money to teach them makes some business sense. But when they start clamoring for art classes or nicer lunches or more tutors, they are on the same footing as assembly line workers agitating for nicer food in the break room. They are asking the company to spend money on something that will not help the company make money.

An A+ student doesn't bring in more money than an A- student. The state pays a flat rate for all students, so past a certain point, spending more to get higher achievement is just throwing money away without hope of increased returns. The free market imperative is to find ways to do less and less for the students. The students don't need to be excellent. Just good enough.

Nothing Nefarious Here

It's typical to want to paint the businessmen in these free market charter scenarios as evil villains, and that's a mistake.

First, it's unfair, because I have no doubt that many if not all of them are reasonably decent human beings.

Second, it implies that if we installed virtuous morally upright CEOs at the top of this pyramid, everything would be okay. That's not true.

It's important to realize that asking the question about investment, trying to get to Just Good Enough, making sure that we're not spending too much money on the education part of the school-- those are all responsible behaviors for people in the investing and management world. Somewhere there are people managing your retirement portfolio, and you would be royally pissed if they weren't paying attention to these kinds of issues.

No, the takeaway here is not that businessmen are evil. The takeaway is that a free market is fundamentally incompatible with a public school system. Putting on pads and slamming other people to the ground is very appropriate on a football field; it's not so great in a China shop. Free market business guys in the world of education are fullbacks body-checking the China, and while it's perhaps frustrating for them, it is positively destructive for the China.

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