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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