For-profits vs not-for-profits

By Felix Salmon
January 16, 2012

When Mitt Romney started plugging his friend’s for-profit university as a solution to the problem of rising higher-education costs, he was surely doing well by a major campaign donor, while giving pretty bad advice to potential students: no one should enroll in an $81,000 21-month program in “video game art” if it has — as this one does — a graduation rate of just 38%.

But Romney’s staking out an important philosophical stance here, too, when he praises the for-profit education industry in general as an affordable alternative to traditional colleges.

How can a company which exists to maximize the profits for its shareholders, and therefore to extract as much money as it possibly can from its students, possibly cost less than a traditional college which is run on a not-for-profit basis and which might well have a substantial endowment subsidizing tuition fees? Most traditional colleges charge some students nothing at all, while at the extreme, Cooper Union has a flat tuition rate of zero. For-profit colleges can’t possibly compete with that.

For-profit colleges have a fiduciary obligation to, basically, take the money and run: once they’ve been paid their tuition fee, they’ve made their money, whether the student continues to show up for class or not. But still, there are two main ways in which they could, at least in theory, compete on price with traditional colleges.

The first is to take advantage of their high drop-out rates, and use the drop-outs’ tuition fees to effectively cross-subsidize the minority of students who actually finish the course. After all, if half your students have stopped showing up for class, they’re not going to cost you much money. The average student will still suffer, of course, but at least those who finish the course might benefit.

The other way that for-profit colleges can end up cheaper than their traditional competitors is by concentrating on costs: rather than paying enormous sums for prestigious professors and research institutes, they concentrate with a laser focus on their core business of teaching undergrads. After all, their concentration on profits means that they’re likely to be more efficient than flabby old traditional not-for-profits. Think of it this way: groceries are cheaper at Walmart than they are at the Park Slope Food Coop.

But does that hold more generally? If you have a for-profit and a not-for-profit in the same space, is the for-profit likely to be cheaper and more efficient? I’ve been wondering about that question myself of late, ever since I had breakfast with Betterment CEO Jon Stein a couple of weeks ago. I’d just written something less-than-flattering about the fees that he charges, comparing them unflatteringly to those charged by Vanguard, and he told me that it’s incredibly hard to even think about competing on fees with Vanguard when you’re a for-profit company and Vanguard is mutualized.

That rang true to me — but it’s also something I wanted to check out for myself. There’s no doubt that Vanguard funds have historically been much cheaper than other funds, but to what extent is that just a function of the fact that they’re index funds, and index funds by their nature are cheaper things than actively-managed mutual funds? Certainly if you look at Vanguard’s ETFs, there’s not much evidence that they’re any cheaper than their direct for-profit competitors.

And what happens in other areas where not-for-profit organizations compete directly with for-profits? Hospitals, of course, are one — are non-profit hospitals measurably more efficient than their for-profit brethren? Credit unions are another; the banking lobby isn’t shy about keeping their operations restricted on the more or less explicit grounds that it’s not fair for for-profit banks to have to compete with mutualized credit unions. And in fact consumer-facing credit unions are, nearly always, much better value for depositors and borrowers than the big banks are.

One useful distinction here, I think, comes from Larry Summers, who talks about how a huge part of the US economy is now accounted for by non-traded goods, where the normal rules of competition become harder to discern. “In many of these areas the traditional case for market capitalism is weaker”, he writes, adding that “it is surely not an accident that in almost every society the production of health care and education is much more involved with the public sector than the production of manufactured goods.”

Summers concludes that “it is not so much the most capitalist parts of the contemporary economy but the least—those concerned with health, education and social protection–that are in most need of reinvention.” Unhelpfully, he gives no hint as to what kind of reinvention he has in mind, or whether he thinks that for-profit companies can do these things better or more efficiently than not-for-profit institutions.

But I do think that it behooves Obamacrats like Summers to engage directly with the facile certainties of Mitt Romney when it comes to things like this. For-profit colleges are not a better and cheaper alternative to traditional colleges; in fact, their shareholder focus by definition means that they don’t have their students’ best interests at heart.

Instead of pushing back, however, the Obama Administration technocrats love to talk about what they can learn from the private sector, and talk about public-private partnerships (where “private” always means “for profit”), and generally give the impression that even if they disapprove of individual for-profit colleges or healthcare companies, in principle they think such things are a swell idea.

Ideally what I’d like to see is some empirical data here: where do for-profits compete effectively with not-for-profits? Where don’t they? And if that particular distinction turns out not to be very useful in some of these areas, then what are the kinds of things we should be looking for instead?

I know full well that a lot of not-for-profit organizations are run in a dreadful fashion; I’m just not convinced that introducing a profit motive is always or even often the best way to fix that problem. Sometimes it might be: I’m thinking for instance about the way that American Homeowner Preservation, in Chicago, spun off a for-profit hedge fund in order to raise the kind of money which could buy up whole portfolios of distressed mortgages at a stroke. But I very much doubt that for-profit education is ever a good idea. I just don’t see how the incentives there could possibly be aligned.

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Comments
22 comments so far

The way to align the incentives would be a system where the institution loans the student the tuition and the loan is subject to an income based repayment system.

Posted by Basho213 | Report as abusive

For-profits are missing out on the opportunity to garner good-will with these first generations of students, by screwing them over with dismal grad rates and employment rates.

I think MIT and other non-profits will largely crush these competitors with the expansion of online virtual classrooms, technology being the main hurdle. I do think that some reputable for-profit entity can exist, but it must be very good, and it must deliver results.

Posted by marantz | Report as abusive

You completely missed a main point: the for-profit industry relies absolutely on government subsidy. If not for government loans and government loan guarantees and government grants, these schools could not charge so much. The median debt in the example given by Romney was something like $59k. Much of that was directly enabled by the federal government and the rest partially relies on the government – for lots, including the basics of processing need info to qualify for aid. These subsidies enable these companies to exist and to charge higher prices than an actual competitive market would. These schools would need to charge much less if they were actually competing without government subsidy.

Posted by jomiku | Report as abusive

The waste in so-called non-profit education is so great that it would be child’s play to provide the same product at a much lower-cost and still make big profits. The Walmart versus Park Slope Co-op is the right one (I’m assuming this co-op is very expensive). I use that qualifier non-profit because what is actually going on is that the non-profits are most definitely interested in maximizing revenues and cutting costs, just like a for-profit, except the difference between revenues and costs is sucked up by the administrators rather than being paid out to shareholders. If you think of the administrators as the true owners of non-profits, then there is really no difference between the two forms of organization. And this is generally true. Think of the government bureaucrats in general as being the owners of their bureaucracy and you will get a much better insight into what is really going on.

Anyway, there are lots of cheap and excellent for-profit education programs. For example, the CFA program in your own line of work has a very good set of study books and isn’t that expensive. Certainly far less expensive than an MBA from Wharton. The credential you get if you pass the CFA exams is not a piece of junk, but on the contrary widely respected. There are lots of similar programs in the computer industry. There are lots of private for-profit schools that provide hands-on training for pilots, scuba divers, beginning automobile and motorcycle drivers, people who want to learn karate and yoga, etc. Sure, the non-profit military will train pilots for free, but the cost to society is something like $5 million per student. For-profit schools can do an adequate job of training pilots who only want to fly civilian aircraft for far less than that. Obviously, there are also rip-off schools in the private sector. But then paying $200K for a bachelor’s degree from a non-profit university is also a ripoff, IMO.

Posted by revelo | Report as abusive

If you want to see for-profit education to its logical extreme, look to Chile, where there are very few public institutions and almost all private. Among the privates, many of them are effectively for-profit. Just like the San Francisco Art Institute, these faux-non-profits have a nonprofit operating side that pays exorbitant rents and sometimes other fees, too, to a private, for-profit side that happens to be it landlord.

The result: last year, six months of nationwide turmoil as students at many public and private universities and high schools sat in, blockaded and otherwise took over their campuses, effectively shutting down much of the educational system. The basic demand: no more profit. As a prior commentor said, the entire enterprise is built upon the low-interest public loans. It’s the same as the housing-and-mortgage industry was 10 years ago.

The issue isn’t who provides the same education for cheaper. The issue should be maximizing opportunities for students. If for some students that means skipping university altogether, great. Instead, in both the US and Chile, we increasingly see university degrees required for the most menial jobs — leading to a debt trap.

Posted by Setty | Report as abusive

“How can a company which exists to maximize the profits for its shareholders, and therefore to extract as much money as it possibly can from its students, possibly cost less than a traditional college which is run on a not-for-profit basis ” By paying a semi-retired CPA $15/hour-no-benefits to teach accounting and economics instead of paying two tenure track professors to have their grad assistants teach it.

“For-profit colleges have a fiduciary obligation to, basically, take the money and run…” -no they don’t Felix. They have a fiducary obligation to grow their business in a way that is both profitable and sustainable. By fleecing a bunch of people and making a killing in the short term they have virtually destroyed their business in the longterm.

Posted by y2kurtus | Report as abusive

I’ve seen enough of public/semi-public higher ed from the inside to be cynical, but they’re nothing compared to a lot of the for-profits. Especially online ones. The business model there relies mostly on a combination of subsidized loans and grants, high drop-out and non-completion rates, and low-priced instructors; jomiku and y2k are right. That’s why these schools are fighting tooth and nail against new rules tying loan eligibility to graduation rates. Unfortunately they’re making enough money now that they can afford the very best in lobbying so they might still get their way.

For-profit has a place in well-defined fields that need specific qualifications and that attract strongly motivated students– the ones revelo points to. Those for-profits will do well and do well for their students. But average students with little real motivation or persistence don’t get attracted to them. Instead they tend to go for mostly-online schools that promise the moon in their ads. For these students online is the worst possible choice (hence many online schools rely on getting these students to enroll, so they’ll just fade away).

Most non-profits, especially the publics, at least have the vestige of an ethos of trying to motivate these students and get them to finish at least a 2-year degree. They’re not perfect by any means and state funding cuts mean they’ve had to chase student numbers for a couple of decades now, so they’re learning only too well how to play in a money-maximizing context. But they are the place in our society where you can argue a responsibility to the user/student/customer and not get laughed out of the room. Try that in just about any commercial situation and see what reaction you get.

Posted by Altoid | Report as abusive

Revelo has it right: check out “The Fall of the Faculty” by Benjamin Ginsberg. Non-profit universities and colleges are in a rat-race that incents inefficiency. It’s pay-for-service rather than pay-for-outcome, just like health-care.

There are lots of good for-profit educational models: the CFA program, homeschool curricula, the Educational Testing Service and College Board for SATs and AP Exams, the CFP program, etc. Open your eyes. $200m / year for a BA is too much!

Posted by Publius | Report as abusive

The crunching sound you hear is a wide variety of business models and individual businesses attempting to fill a market need.

Felix, you know this much better than I do; why are you making such a silly argument? Some of these businesses are reading the market very poorly; a few constitute fraud. Many are run by smart people trying to fill a need left woefully unfilled by traditional hidebound academics. To those who note that for-profits depend on government education subsidies, note that so do the non-profits.

I heard a very compelling argument by Clayton Christensen a couple of years ago that offered the prognosis that the more successful innovations being pursued by for-profit education would in time be thought of as highly or more so than traditional non-profit approaches.

Non-profit education is worse than inefficient – it is patently unable to respond to the market needs of our changing society. The for-profit solutions are varied and messy right now, but those without staying power won’t last.

Posted by Curmudgeon | Report as abusive

“For-profit colleges have a fiduciary obligation to, basically, take the money and run:”

Felix, why do you keep repeating this myth? It is absolutely not true. Unless a company’s board wants to maximize short term profits at the expense of the long term health and viability of a company, they do not have to make decisions that only address this year’s profits. If the execs did that, they would be called banks.

Posted by KenG_CA | Report as abusive

For all these folks saying “why would anyone take the money and run?”, were you guys, like, alive the last twenty years? What is the incentive for them to think long term? Why not start a mortgage broker selling liar loans to misfeasant banks to turn into nothing backed securities? Y2Kurtus is in a near-religious frenzy with his misplaced faith. It’s weird. Pop the bubble.

Posted by Ursus_Arctos | Report as abusive

It’s not a matter of EITHER ‘for profit’ OR ‘not for profit’.

A surplus over agreed costs may be made and then reinvested in the service providers (aka staff/management) and service users (pupils and parents) in terms of agreed quality of remuneration and agreed quality of education.

Such a ‘not for loss’ or ‘profit for purpose’ is what Dr Yunus of Grameen Bank fame means when he refers to ‘social business’.

The challenge is a suitable legal and financial framework.

Posted by ChrisJCook | Report as abusive

For-profit incorporation provides a high-quality product at a cost-efficient price **IF** there is competition in the market. But there are plenty of examples demonstrating that in the absence of competition, for-profit is worse than non-profit.

Is there effective competition in education? There is on some level… Colleges compete vigorously for talented students, for high-profile faculty, for donations and research grants. Yet on the consumer end, there is a troubling lack of transparency. How many students can fairly assess their likelihood of completion when they enter? The economic value of their degree?

The government subsidies definitely need to be revisited, but I would also look to improve transparency in this market. Without quality information, there can be no real competition.

Posted by TFF | Report as abusive

Jon Stein, founder of Betterment.

I agree with the comment about incentives/subsidies to education via loans, that we have perhaps inflated the price of education via cheap credit (that can’t be washed away in bankruptcy).

And we’ve inflated the cost of healthcare via the tax subsidy for health insurance.

I would advocate for less promotion of private education and healthcare via these government subsidies – and rather see investment into low cost public alternatives to private versions.

Same could be said for investing. Rather than encourage everyone via tax breaks to invest in IRAs, why not provide a low-cost government option to everyone? It may not be the best option for everyone – but could lead competition in the right direction.

Posted by Jonbbckstein | Report as abusive

Mr. Salmon – Your post asks about places where for-profits compete with not-for-profits. One fascinating case to examine is the world of sport.

In European football (soccer), top teams from each nation’s league compete annually in the UEFA Champions League. Some of the top national leagues, such as England’s Premier League or Italy’s Serie A, have teams that are investor-owned. Others, most notably Spain, are comprised of teams that are mutualized not-for-profits, somewhat similar to the Green Bay Packers in the NFL.

Both models seem able to support top-quality teams; the last six Champions League titles have been split 50/50 between mutualized teams (Barcelona, 3 times) and investor-owned teams (A.C. Milan, Inter Milan, and Manchester United).

But the for-profit model may be performing better in creating a commercially-dominant league, as the English Premier League is solidifying its place as the most-watched league in the world, while many other top nations’ domestic leagues are dominated by a few top teams and draw less international interest. Of course, creating a commercially-dominant league is much more consistent with the goals of a for-profit structure, so perhaps this is no surprise.

Sports ownership structures may be interesting to examine but, due to the unique characteristics of this business, may not hold many lessons applicable to other businesses.

Mark Slavonia

Posted by MarkSlavonia | Report as abusive

I would disgree with Walmart & the Park Slope Food Coop. You can’t buy the same groceries at the two. Try buying an organic head of lettuce at Walmart that is so fresh you can let it sit for 2 weeks before you finally get around to eating it. And still be able to eat it.

Posted by colinr | Report as abusive

Like the mortgage/housing industry a few years ago, the higher education industry (both for-profit and non-profit) is encouraging students to take on massive amounts of debt that may never be paid back. For-profit universities are some of the biggest offenders… but this is rent-seeking behavior associated with bad government policy. Government subsidies are (primarily) enriching producers, rather than lowering the effective cost for consumers.

In the absence of distorting public policies, I see no reason to think that for-profit universities can’t provide a valuable service to students.

You claim that their profit incentives are *by definition* misaligned with those of students. Then how does Apple (or GE or Trader Joe’s) produce goods that people like? Presumably their profit motive is just as strong as a for-profit ed provider.

Posted by timder | Report as abusive

@colinr,

Given the choice of the same non-organic milk for $2/gal. at a store where the “use by” date is a week away and another store where the “use by” date is a two weeks out for $3/gal., I’ll gladly accept that I need to finish my milk within 7 days for a 33% saving. Procrastination is a luxury few will pay for once they “understand”.

Also, I have found Walmart to be responsible. When their milk department is out of their Great Value Lactose Free Fat Free too frequently, they have been willing to substitute the same thing “organic” (which normally costs around 10% more) for the non-organic price. Not everyone has the “Whole Foods” mentality or financial priorities.

Posted by OneOfTheSheep | Report as abusive

@revelo,

My compliments on a well thought out post. Hope you have the time and inclination to become an ongoing commenter.

Posted by OneOfTheSheep | Report as abusive

If only it were that simple.

For-profit colleges exist ONLY because of guaranteed student loans, a subsidy that makes risky loans available to non-credit-worthy teens, provided courtesy of the Bush administration.

Is it any wonder that the majority owner of the largest network of private colleges, Art Institutes, is owned by Goldman Sachs? (Okay, technically, it’s the largest shareholder in AI’s parent company, Educational Management Corp.)

So when will Goldman Sachs endow a chair in economics at Harvard, do you suppose?

Posted by Cornichon | Report as abusive

I don’t think you can restate Cornichon’s comment enough: the for-profit educational industry exists ONLY because of the existence of federally subsidized student loans. The scandal is that even when the student defaults, there is no penalty to the institution, which makes its money all at the front-end, sometimes even when the student quickly disenrolls.

Yes, educational loans also go to not-for-profit institutions, but the percentage of loan to other assistance is much smaller — 90% of the revenue received by for-profits comes from federally guaranteed loans. Calling what for-profit universities do part of a free market approach to education is simply perverse.

Posted by rb6 | Report as abusive

Do you feel ripped off by your for-profit school? Has your experience left you near bankruptcy? Do you have huge student loans to pay off after going to a for-profit school?

I’m a grad student doing a project on the best way we can legislate changes in (1) accreditation, (2) disclosures to students, and (3) accountability/oversight of these schools. Please get in touch and share your stories. We may even ask you to testify in front of state legislatures. Mostly, we’re just collecting stories for a “story book” that we can hand to California State Senators or Assemblypeople.

Get in touch!
forprofitschooldebtstories@gmail.com

Posted by StudentLoanDebt | Report as abusive
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