Learning on the job
Pearson has had a rough time, but is well positioned for growth.
UK-listed global educational publishing and services company, Pearson was once the owner of esteemed publications such as the Financial Times and the Economist. However the business has shifted its focus to education, and is now the largest global player in this field.
It specialises in courseware development, teaching facilitation and assessment – enhanced by new digital technology and artificial intelligence – and is at the cutting edge of modern educational services. However, the last five years have been tough for Pearson shareholders, with its share price underperforming the FTSE 100 Index by more than 50% over the period.
We discuss the reasons for this poor performance, and why we believe Pearson is now positioned for growth as its past investments benefit from a rapidly-changing global education context.
Pearson share has languished over five years
The world’s largest education company
In 1998, Pearson acquired the educational publishing assets of US-based Simon and Schuster, becoming the world’s largest education publisher. Since then, the company has made a series of acquisitions in developing countries and in the education technology space, while disposing of non-education assets.
The business operates in 70 countries and its offerings can be broadly split between two segments: It has a large market share in the established education segment in which it is under pressure to accelerate digital migration; and it has first-mover advantage in the growth segment in which it is positioned for near-term growth.
The acquisition of Simon and Schuster in 1998 converted Pearson into the worlds largest education publisher.
Established education segment
Pearson’s higher education business accounts for 30% of its current group revenue, with an established presence in the US, UK and Australian markets. In particular it has a leading US market share (40%), with scale advantages that reduce its costs.
The business receives 50% of its revenue from digital and service channels. Pearson partners with academic authors to produce courseware content, which, if chosen by faculty, becomes compulsory course material.
In addition to e-book textbooks, Pearson offers digital platforms to assist students and lecturers. It assists students with mastering course material – providing tailored engagements such as interactive graphing and videos, audio content, appropriate hints, feedback, examples, flagging of common mistakes, and assessments. It assists lecturers with interactive real-time student monitoring.
Adaptive learning is another key feature, with the IBM Watson system (IBM’s artificial intelligence suite) embedded into the platforms since 2016. Its access to continuous large-scale student interaction data will enable Pearson to innovate and improve the efficacy of its platforms more quickly than other edutech companies.
Pearson’s assessment business manages formalised testing (test formulation, processing and scoring) mostly for schools in the US and the UK, accounting for 16% of group revenue. These services are provided as a bulk package with contracts typically secured at local government level. The frequency and sophistication of standardised testing is increasing in these markets in line with a growing emphasis on improved foundational learning outcomes.
After years of restructuring, the assessment business is well placed versus competitors as its digital business model creates a cost advantage, is better able to cope with fluctuating demand patterns, and can provide richer data analytics to customers. Combined, these established education segment businesses account for 45% of Pearson’s total group revenue.
Pearson has a leading US market share in the higher education segment, with scale advantages that reduce its costs.
"In addition to e-book textbooks, Pearson offers digital platforms to assist students and lecturers - it assists students with mastering course material and lecturers with interactive real-time student monitoring."
Growth education segment
Pearson is an early investor in the fast growing US virtual schools market. Virtual schools provide digital schooling for learners, which enable high levels of teacher and peer engagement, in a sector with high regulatory scrutiny and quality standards.
Long-term US market growth will depend on increasing home schooling, and stronger evidence of positive student outcomes (a PwC study released in March 2018 indicates that like-for-like student outcomes are similar to or slightly better than physical schools).
A further growth area is the provision of online programme management (OPM) for universities. An OPM service provider manages online degree offerings, assisting with digital content creation, student recruitment, admission, enrolment, progress tracking, support and assessment. The outlook for growth is robust as Pearson’s services enable universities to meaningfully expand potential student reach. However, the upfront investment required to set up new courses means that recent growth is not yet reflected in profit margins. The focus has been on postgraduate courses in the US and UK. Eventual success in the undergraduate OPM market will mean much richer cross-sell opportunities with Pearson’s courseware offerings.
English language proficiency assessments are increasingly necessary for living, working and studying in Western countries (with significant growth in the number of students from emerging markets studying in the US, UK and Australia). Because it is cheaper and quicker for a user to pay for the most widely-recognised service provider, success in this market is self-reinforcing and only a handful of players dominate. Pearson’s strong digital delivery options differentiate its English Language Teaching from competitors and is gaining market share. Pearson’s growth education segment businesses make up 33% of total group revenue.
At the cutting edge of industry changes
Pearson is leading the industry’s shift from physical to digital products. However, digital volume growth has not yet offset declines in physical product sales, putting pressure on revenue. The company embarked on three costly rounds of restructuring and cost-cutting over the last seven years, aimed at decreasing physical cost structures and boosting digitisation. Despite this, profit has decreased and the share price has underperformed. The greatest challenges have been in its US higher education courseware business where particular market dynamics have created operational headwinds.
Firstly, enrolments are countercyclical and inversely correlated with the unemployment rate as the demand for up-skilling increases during periods of economic stress and is often supported by government subsidies. The extent of this boost during the financial crisis was underappreciated, and the business was ill-prepared for the subsequent normalisation and incurred painful losses due to overstocking.
Increasing popularity of book rentals has driven publishers to raise their prices, further stimulating the book rental market.
Secondly, in response to revenue erosion caused by a rapid increase in textbook rentals (in particular from Amazon) and used-book sales, publishers increased textbook cover prices. This further incentivised the consumer to switch to the rental market, which now represents 30% of the total textbook market.
Pearson has begun to roll out a plan to effectively respond to this competitive threat posed by its own content in the secondary and rental markets. It is incentivising the take-up of digital offerings (which have no secondary market) and by limiting print options to its own rental platforms. At present, Pearson’s content has a 35% usage share in the US textbook market but the company only has a 20% share of revenue due to secondary markets. This situation means that the company can afford to meaningfully decrease prices as it takes back control of its content and still see revenue recoveries.
The changing global context for education
Global income inequality has accelerated during the recovery period following the financial crisis. A key determinant has been the skill premium in labour markets, which has risen markedly in advanced economies and even more so in emerging economies (Brazil has a 135% wage premium for bachelor degree holders versus upper secondary school finishers, versus the 48% OECD average – see chart). Taking into account the cost of tertiary education, forgone earnings during the study period and subsequent lifetime earnings, the value of a good education has never been higher.
A number of current structural trends mean that future investments into education (by governments, learners, service providers and shareholders) will have to be more carefully considered:
• Funding pressures. Government educational spending relative to GDP in developed markets has peaked. Global educational spending (9% of world GDP, roughly 50% funded by public sector) is the second-largest spend category after healthcare. Facing medium-term cash flow pressures due to ageing populations (rising healthcare and pension provision costs) and already-high debt levels, developed market governments are trimming education budgets – most notable has been the USA with meaningful policy retrenchments since 2015 including a cutback on funding for student loans.
• Workplace education needs will change rapidly in the medium term. Trends towards digitisation and automation will require more investment in education and skills. However, the demand will likely shift away from once-off large investments in traditional degrees, towards flexible and frequent vocational training and reskilling programmes.
These dynamics require that education delivery systems become cheaper and more flexible - creating a significant impetus for digital service provision over physical educational material, teaching and assessment.
Learning on the job should mean a payday ahead
Pearson’s share of digital and services revenue has steadily increased to just under 70% of group revenue. It has used long-standing customer relationships to nurture valuable digital pedagogy - a major competitive advantage against new entrants into the fast-growing digital education market. In time, profit growth will inflect materially positively due to the benefits of digitisation. These benefits include lower working capital needs, much reduced physical costs and market share gains resulting from greater product efficacy.
In addition, many of the digital businesses that are being developed and perfected in the US and UK can eventually be rolled out to emerging markets (the immersive digital higher education courseware, virtual schools and online programme management).■
Jihad Jhaveri is head of Process at Kagiso Asset Managment.