Early Warning Signs

Business competition is always interesting, in part because smart companies figure out how to avoid competition by specializing and differentiating their product or service. When Sun Tzu admonished his generals against assaulting walled fortresses, he understood that head-to-head competition is a sure path to a headache.

Many US universities ignore Sun Tzu: they compete head-to-head for the same students. In normal markets, schools would specialize. Some would seek students with strong quantitative skills, others would focus on training people who are especially empathic. Some might cater to students who write well, or are poor, male, female, interested in fashion or language studies, or born in another country. This happens of course (except for the male part: the US has no men’s colleges left and only nine all women’s colleges), but most colleges recruit for the same student profile: high grades, high test scores, compelling outside activities. They are assaulting a walled fortress. What accounts for their failure to differentiate?

One problem is that universities are a consumption good like a restaurant — but you only consume it once. Worse, the results are hard to measure, since good students do well in life regardless of the university they attend. This leaves universities free to compete for students who will be successful even if the university is not. These are selection effects: the ability of elite universities to compete for students with traits that strongly predict future success regardless of education. When those young people proceed to be professionally and often economically successful, their alma mater is always there, hand outstretched, with a gentle reminder of their formative influence.

Employers contribute to this of course. Desperate for a shorthand method of segmenting talent markets, they reinforce these effects by preferentially hiring graduates of “good” colleges. Pretty soon, your college becomes a critical part of your personal brand. It’s a racket, and one in which I enthusiastically participate, benefit from, and perpetuate as a parent, student, employer, and advisor to university leaders.

Selection effects lead to a second market failure: universities don’t scale. What other business deliberately limits access to a compelling service? Can you imagine a law firm declaring that they would only accommodate the first 100 clients? Unthinkable — they will grow to meet demand and maybe a bit more. For top universities, being selective is not a necessity, it’s a choice. Most elite schools admit about the same number of students today as they did 100 years ago — that’s what makes them elite schools. They could easily double or triple in size without compromising quality — but they prefer to double and triple prices instead, because they can.

As my younger son starts to think about college, I have begun to pay attention to how colleges are thinking about him. He will be a major catch (translation: they will compete for him because he shows every sign of being a kid who will do just fine in life with or without their help). So how do colleges compete for talent? In particular, how do colleges compete for the students that they all think they want?

When competing for talented high school students, universities worry either about their selectivity or their yield. Selectivity is the share of applicants that a school admits. Yield is the share of admits who enroll. To boost selectivity, you do more marketing to increase the number of applicants. But to boost yield, you actually have to improve your school. Boosting yield is really hard in a competitive market, which is why yield drives college rankings (which helps to improve their yield — a longer story). US News, the FT, the Economist and others that have jumped into the college ranking game realize that yield is a very strong market indicator of quality. After all, a school that could admit 1,000 students and then enroll all of them would have to be seen by every student as their very best choice.

Except that most schools try to get a jump on yield by offering students the following deal: don’t force us to compete for you and we won’t force you to compete for us. They call it early decision but they should call it yield improvement. They tell students that if they apply early to their school only, the school will lower the admissions bar. Careful research suggests that students who apply for early decision receive an advantage equal to an extra 150 points on their SAT score. (Universities deny this, but the numbers are unequivocal.) Colleges enforce severe penalties against students who are admitted early and do not enroll. They collude to blacklist the offending student — a practice that should arguably be challenged in court.

Early decision is marketed as a way to reduce the stress of applying to a dozen colleges — and it does that. But it has a benefit that few seem to have noticed: it boosts the school’s yield. Every student admitted under early decision programs will attend: that’s the deal. The yield on early decision admissions is thus 100% — small wonder that they are growing as a share of total admissions. Nor is there anything wrong with this: it allows applicants into better schools than they would on average get into if they applied later. Businesses do similar things all the time, ranging from no-shop agreements during M&A discussions to exclusive distribution deals in exchange for preferential pricing. Negotiated exclusivity is a battle-tested element of many walled fortresses.

In the last decade however, the most selective schools have started to rethink early decision. They have decided to compete on selectivity instead of yield, so they are removing exclusivity. They say to students: “apply early, get an early decision and you are not bound by our offer”. Today Harvard, Princeton, Yale, Chicago, Stanford, and MIT offer non-binding “early action” programs and a handful of other schools do as well. These schools realized that they were the top choice for the overwhelming majority of those they admit — they already had great yields. So they decided to increase their selectivity by signaling that they want every strong student to apply. With no reason not to take a shot at it and no obligation to attend, applications skyrocketed and schools that were already preposterously selective became even more so, at least on paper.

The result of these two strategies is exactly what you would expect: applications have skyrocketed, driving admission rates down. Acceptances went out today and this year, Yale accepted fewer than 7% its applicants, the lowest acceptance rate in its history. It offered 1,991 seats to 29,610 applicants for an entering class of about 1,300. Harvard admitted 5.8%, Princeton 7.3%.

There are actually three reasons that Ivy League applications are up. First is early action. Second is the Common Application, an online form that makes it easier for students who do not apply for early decision to apply to many more schools than they used to. When Harvard or Stanford say that they are twice as selective as they used to be, remember that each student they consider is also applying to twice as many schools. When I was seventeen, I applied to four schools and hand typed each application. Few kids today who are serious about college apply to fewer than eight and many apply to more. When the music stops, most kids who have prepared themselves for college still end up with a chair.
The third reason that Ivies are attracting interest is more mundane: they pay better. Harvard, Yale, Princeton and Columbia are “need blind” schools, where the ability of a student’s family to pay isn’t considered by the admissions office. Harvard has announced that it will boost its financial-aid budget to $182 million, a 5.8% increase. For many students, it actually costs much less to attend an expensive, elite school than it does a local state university. The trick, of course, is getting in.

Over the next decade, early decision will not solve the core problem facing America’s weakest universities: they are a high cost, high risk investment. Universities operate medieval business models designed for a core purpose that has disappeared. As late as the 1970s, universities accounted for a huge share of knowledge creation, storage, and transmission. They earned the right to certify who was smart and talented because they held a near monopoly on skill and knowledge. This monopoly has now vanished as knowledge creation has diffused and fragmented, information storage has become free and ubiquitous, and skill transmission has taken many forms — some even teacherless. The main privilege that colleges cling to is certification — and that too is increasingly under challenge.

The assault comes not mainly from online education, which has been widely discussed and over-hyped, but from enterprises that treat education as a business opportunity. Hult International Business School trains several thousand students from outside the US each year on campuses in the US an five other countries. 2U now builds large scale, fully credentialed online degrees that produce thousands of graduates each year in partnership with major universities. The Mozilla Open Badge Initiative and dozens of social startups want to supplant traditional degrees with more specific and timely credentials. There are literally hundreds of enterprises devoted to disrupting higher education — whose walled fortresses will not withstand the siege for long.

Education mattered to me, it matters more to my kids, and will matter even more to my grandkids. But thanks to competition and innovation, it will cost less, deliver more, and signal actual capabilities much more precisely than today’s universities do. A combination of economics and technology are attacking an industry that has resisted change since medieval times. Grab the popcorn — should be fun to watch.