Lessons from 2U and a Tough Market

Can you scale yourself out of a hole?

What’s Happening in the Market

• upGrad is in advanced talks of acquiring Udacity. UpGrad is an Indian-based platform, offering MOOCs from Deakin University, IIIT Bangalore, and others, aimed primarily at the domestic Indian market. The deal values Udacity at about $80M, a steep discount to their $1B valuation just a few years ago, off of $240M raised from investors like Alphabet and A16Z, and $75 million in debt. The deal would give upGrad access to Udacity’s rolodex of enterprise clients and academic partners, but it’s unclear how many of those partnerships will retain.

• Letrus, a Brazilian-based EdTech company, just raised $7.3M, led by Crescera Capital with participation from Owl Ventures. Letrus is an instructional platform that offers adaptive reading and writing instruction. It leverages AGI to adapt instruction and feedback for each learner, and provide teachers with insights into students’ progress. Currently in 680 schools, 20% of which are public.

What We’re Talking About

• Indiana introduced a new bill that would help with higher education completion rates. Senate Bill 8 would make it easier for students transferring from a two year college to a four year program to combine their credits and retroactively be awarded an Associate’s degree. So many students who transfer end up dropping out before they earn their Associate’s or Bachelor’s, but at least now they’ll have a degree-in-hand. The Bill also requires that four year public universities offer a four year Bachelor’s degree in three years. This is amazing–especially the passage about offering Associate’s degrees to reverse transfer students. Only about 70% of these students actually complete a program in six years, and so many are stuck with stranded credits.

• The US DOE Office of Civil Rights is investigating Penn’s legacy policy. The OCR is investigating a complaint that Penn’s legacy policy violates Title VI of the Civil Rights Act, which prohibits discrimination based on race, color, or national origin. Legacy admissions have a 4x higher rate of acceptance and make up 25% of Penn’s acceptance rates (source below: The Daily Pennsylvanian)

  

One Big Idea: Can You Scale to Profitability?

In a high-interest rate environment, the tide goes out, and you can see which startups have a viable path to profitability, and which were consuming debt to fuel growth–even over the course of a decade.

Take a look at 2U, for example. The company has $883 million in debt. Meanwhile, the company has burned through cash-on-hand, from $474M in 2018 to $182M in 2022. Revenue from 2021 to 2022 increased about 2%, from $945M to $963M. Meanwhile, total expenses are over a billion dollars. The cost to service 2U’s debt is eating up their cash, while their top-line revenue is growing at a crawl (and decreasing when considering inflation). They haven’t released their 2023 income statement, but USC (their largest and most prominent partner) canceled their partnership in November, leading to the resignation of 2U’s longtime CEO, Chip Paucek. The company’s valuation has plummeted from $5 billion (and $100 per share) to $77 million (and trading less than a dollar).

Last month, 2U announced partnerships with 6 new university partners, including King’s College and the University of Capetown. This is an attempt to expand its footprint internationally, but that doesn’t address 2U’s core problem, which is that its programs aren’t unlocking profitability the way everyone had hoped. In 2021, they generated $4.3K per full course enrollment. Last year, it was $3.5K. International students in South Africa and the UK won’t magically make those calculations better. 2U is trying to scale itself to profitability, when it seems the core product offering just inherently isn’t as profitable as everyone thought when interest rates were low and debt was cheap.

“An average day at work for me consisted of 6-7 phone interviews with students. You start by making them feel like they are special and a good fit for the bootcamp. You then rush them through the admissions process before they can think over anything. Any training us advisors actually received were sales tactics.”

- Former 2U “Admissions Advisor” on an AMA Reddit

The unit economics on MOOCs doesn’t seem to make sense, even with their crazy high retention and completion rates. It’s why providers advertise like boiler rooms, and why none seem to be successful, even after packing students into classrooms like sardines. MOOCs were, after all, originally started as open educational resources from MIT, not meant to be monetized.

The above slide comes from 2U, and shows that their degree programs—their most profitable product—are declining in volume and revenue. Meanwhile, their alternative credential product is almost the same size in terms of revenue ($119M vs. $102M), but has a -11% margin. Their profitable products are declining, and their unprofitable segment is growing.

The common piece of advice of “nailing it, then scaling it,” holds true now more than ever. You have to get your unit economics right at the start (“nailing it”) before scaling it. It’s crazy that so much money gets spent scaling a product that has negative margin (WeWork!). Some people think with enough runway, you can buy time to nail it, but that’s not always true. Having a ton of money can obfuscate the problem, and can throw good money after bad.

Low Floor, High Ceiling

The Nasdaq is trading ($70) at about half of its pandemic high ($134 in September 2021). The S&P, meanwhile, is trading at all-time highs. So this isn’t necessarily unique to EdTech, but it does bear out learnings, as EdTech has always been a historically difficult industry to navigate, despite all its promise. It’s why arguably the most successful player in the space, Khan Academy, is a non-profit. 

It’s obvious and we don’t have to say that hitting profitability is paramount in a high(er) interest rate environment. But it speaks to the importance of making sure unit economics are on your side, and that you have some control over your cost floor. You want to decrease costs as you scale. That’s almost impossible to do when your market is commoditized because now you have to acquire customers at higher and higher costs. Scale also means that you’re likely going to start targeting new and different customer segments, moving from early adopter to mass market.

By scaling to mass market, 2U saw lower completion and lower spend. In a differentiated market, you win on product quality. But there are millions of MOOCs, and every online program manager (OPM) has an Ivy League on their platform. Customer quality decreased in lock-step with program quality, which means higher churn, lower retention, and a brutal market (just like Blue Apron, which saw a similar market dynamic play out).

The reason it’s been hard for Udacity and 2U to hit profitability is because their floor for costs is so high, and their ceiling for revenue is cost-competitive. In the case of online program managers, there’s a floor to how low their costs can go, because it’s an intensely competitive environment, and you have to spend a ton on customer acquisition. The ceiling is also lower because they’re competing against the likes of UpGrad and others, who are dropping prices like a rock, and because OPMs have to share revenue with their academic partners.

And now, in their pursuit of scale as a way to climb out of their hole, OPMs have acquired high churn, lower retention customers which is kind of like squeezing blood from that rock.

We recognize that this is easy for us to understand in retrospect (even though people have called MOOCs overblown for years). When MOOCs were first introduced to the public, they were incredibly high-quality, high-value courses: Ivy League courses, “Human Anatomy” by Marion Diamond, etc. And Khan Academy and Udemy were at the forefront of that. But the commoditization of the MOOC happened quickly.

Over the past year, we’ve talked to quite a few founders and startups. The high interest rate environment has meant that they’re bootstrapping for longer, and trying to hit profitability earlier than startups in a low-interest environment had to. I think because capital is harder to come by, the startups popping up now will hopefully nail the unit economics earlier on before scaling.

Guest Post for January 29

We are thrilled to introduce a new and exciting initiative on The Talent Labs Substack – guest posts! This marks the beginning of a series of guest posts where we aim to learn and share valuable insights from prominent leaders in the EdTech and social impact sectors.

Next week we’re fortunate to have, Paul Burani, founder of Mission Flywheel, as our first guest writer. Paul founded Mission Flywheel in 2023, to help founders of early-stage, mission-driven companies prove their social impact to customers and investors.

Paul is an expert in various fields but we’re especially excited to hear his thoughts on the intersection of climate change and upskilling.