What the next multibillion-dollar edtech company will look like

Education companies nationwide are raising funds, and eyebrows, as they receive more and more attention from the national media. In the past few months, more than $110 million has flooded startups like 2tor, Coursera, The Minerva Project and StraighterLine. In 2011, VCs invested nearly $430 million in edtech companies, and by 2015, the market size for U.S. education could reach $1.2 trillion, according to recent estimates.

We’re in something of an edtech “venture bubble” — investors are realizing that there’s a proliferation of education-focused companies for a reason. But that doesn’t mean all of these approaches are set to succeed. So, how can you assess which of these new companies will become the next Facebook or Google of education? Like any large, complex industry with an influx of capital, the company’s business model (and the investment pattern) will make all the difference.

Right now, there are three major types of business models emerging within education technology companies: alternative institutions, new products, and services. Of these, alternative institutions and newer products may have larger presences right now, but ultimately, companies that serve existing college institutions are the ones that will be the most profitable, and have the most potential for long-term impact and growth.

Alternative Institutions
From the Minerva Project to UniversityNow (and even Devry, Apollo and KIPPS), there are many companies that are re-thinking institutions from the ground up. Their fundamental assumption is that current institutions are either broken, not competitive, or not sufficiently meeting market demand, leaving room to create entirely new educational institutions, both on and offline.

While this is a legitimate type of model that’s spreading in India, China, and other growth countries, it is capital-intensive and, in general, cannot gain enough traction to meet the growing demand for education, even in the U.S. In the past 10 years, the for-profit sector of higher education in the U.S. has still only serviced 10 percent of students.

New Products
New and better products for education – such as new educational content, software, games, widgets or tools – are certainly hot right now. Inkling, Kno, Piazza, Knewton, and DreamBox are just a few examples that come to mind; they’re building slick tools and applications for use in educational environments.

These businesses look and feel like typical Silicon Valley software startups; their first round of funding is usually small, and the first $5 million goes into product development and getting initial beta customers. However, their “go-to market” plan is often complicated, and in the current climate, it’s difficult to gain enough momentum to achieve mass adoption of new products in either K-12 or higher education.

So, these companies often find themselves in the limbo state of having a great product but no revenue. In that case, the most likely outcome is that major publishers like Pearson or McGraw-Hill have to finance their distribution and eventually end up buying them. A great example is Knewton – they’re now being distributed by Pearson and most likely will be bought by that company, as most of their revenue will be coming from that channel. This is not a bad venture investment, but it’s not a “home run.”

Services
A select number of businesses are instead offering improved services and infrastructure to the large number of existing educational institutions, creating platforms that tackle a range of issues, from IT to distance learning.

Only a few of these businesses are out there right now, but the ones that have found a way to partner and empower education institutions, like Blackboard, HigherOne, Ellucian, CBORD, and Sodexo, have seen great success. By working directly with universities, these companies have built significant solutions and will have great outcomes for their investors.

The number of students applying to brick-and-mortar colleges has increased 38 percent between 1999 and 2009, according to the Institute of Education Sciences. It’s clear that the traditional model of education that has persisted for hundreds of years isn’t going away any time soon, and most of these institutions are looking for technology partners to help serve their growing student body.

The next Google-like outcome in education will come from this type of business. It will be able to fundamentally offer advantages to existing educational institutions on a global basis — without competing with them — and it will most likely disrupt the market in a way that existing large-scale players won’t be able to.

Some Big Questions
Whether you’re an investor looking to fund an education company or you’re an entrepreneur honing a business plan, you need to ask yourself some important questions. Are you starting a business that is going to sell to a company like Pearson or Blackboard, or are you going to disrupt their business models? Will there be companies in this market similar to Google and Apple that will eventually make Pearson and Blackboard look like Yahoo and RIM?

Mehdi Maghsoodnia (@mmaghsoodnia) is CEO of Rafter, which provides a cloud-based software platform that empowers educational institutions to better manage the distribution and cost of required course material to their students. Rafter is also the parent company of textbook rental service BookRenter.com.

[Top image credit: wavebreakmedia ltd/Shutterstock]