Why profit-maximization at virtual charter schools is incompatible with high-quality education

In most industries, the profit motive generally maximizes economic efficiency.  However, this assumption is unlikely to hold true for private operators of public schools, such as those operating virtual charter schools (VCSs) in North Carolina.  Financial incentives for North Carolina’s VCSs emphasize the maximization of enrollment via aggressive marketing, at the expense of providing high-quality education to students.

For most businesses in a competitive market, profit is maximized when marginal revenue (the amount received by the firm for producing an additional widget) equals marginal cost (the cost incurred by that firm to increase output by one widget).  For most competitive firms, marginal revenue is constant, while marginal costs increase at some level of output as materials or labor become increasingly expensive.  As a result, there is some level of output for which profit will be maximized in a typical competitive firm.

For a VCS, marginal revenue is the amount of State and local funds received per student.  The marginal cost faced by a VCS is

 MC = (1/y x ATC) + AMC

where y is the average class size, ATC is average teacher cost, and AMC is average marketing costs.

To provide an illustrative example, consider a VCS that receives $5,000 per student (marginal revenue), pays its teachers $40,000 per year, and has average class sizes of 1:50.  Such a VCS would have a marginal cost of $800 ($40,000/50).  Under this simplified model of a VCS’s output decisions, marginal revenue is always greater than marginal cost.  Therefore, a VCS maximizes its profit by maximizing enrollment.

There are essentially two avenues by which a VCS can maximize enrollment, both of which increase a VCS’s marginal cost:

• Quality: if a VCS does a better job educating students, parents are more likely to enroll their children in the VCS.  In this simplified model, the VCS can potentially increase quality by decreasing average class size (y) or increasing average teacher cost (ATC).
• Marketing: the VCS can convince parents that the VCS is a better placement for their child whether or not that is actually the case. That is, the VCS would increase its average marketing costs (AMC).

North Carolina’s policy objective of maximizing the educational attainment of students is aligned only with the quality differentiation strategy.  The marketing strategy is likely to lead to poorer performance, as the VCS enrolls students for whom a virtual setting might be inappropriate and diverts funds away from instruction.

The implication of the above is that private market incentives only lead to improved educational outcomes if investing in quality does a better job of increasing enrollment than investing in marketing. 

Theoretically, investments in marketing are more likely to increase enrollments in the short run.  Differentiating on the basis of quality requires time for the gathering and dissemination of quality information before it can impact student enrollment decisions.  For example, a VCS that begins operations in the 2015-16 school year will not have school-wide test results until after students have made enrollment decisions for the 2016-17 school year.  As a result, a quality differentiation strategy, if successful, would only begin paying dividends in the third year of operation.  Meanwhile, a marketing strategy can yield immediate benefits to allow the VCS to maximize profits.

Presently, there is little academic research indicating which strategy is better at maximizing student enrollment over the long term.  However, evidence indicates that VCSs primarily seek to maximize enrollment through marketing, rather than by differentiating along quality.

In Ohio, Jeff Shaw, the former Head of School of Ohio Virtual Academy describes K12’s enrollment strategy as such: “it wasn’t so much about academic achievement but on delivering the promised enrollment numbers to shareholders.  [K12’s] call centers that were encouraging enrollment and enrolling students who were obviously ill-suited for learning in a virtual environment… K12 oversold students’ potential to be successful and obligated teachers to do things they wouldn’t likely to be able to do.  Eventually, it seemed as though K12’s enrollment strategy was to cast a wide net into the sea of school choice and keep whatever they caught regardless if the catch was appropriate for virtual learning or not.”

According to Bloomberg Businessweek, K12 dedicates a floor of its headquarters to a recruiting call center.  Their “enrollment sales consultants” are compensated based on success in enrolling students.  While the U.S. Department of Education has banned this practice at for-profit colleges, the tying of recruiter pay to enrollment is still allowed at for-profit charters.

Luis Huerta, Associate Professor of Education & Public Policy at Teachers College, Columbia University reports that K12 focuses its recruitment efforts on at-risk students.  “Virtual providers like K12 are now mostly going after at-risk kids,” he reports.  “They will sign up anyone – as long as that warm body signs in periodically, K12 can draw enrollment money from the district.  It isn’t for some noble reason – it’s because these kids demand the least amount of education.”  An investor lawsuit filed against K12 (K12 settled in July 2013 for $6.75 million) alleged the company aggressively recruited as many students as possible, including some who weren’t prepared to succeed in K12’s full-time online schools.  These reports are consistent with a description of the recruiting efforts of the K12-run Tennessee Virtual Academy, which expands its enrollment “through information sessions aimed at parents in struggling districts and through extensive television advertising.”

Research indicates that the existing online product is only educationally appropriate for a minority of students.  According to the International Association for K-12 Online Learning (iNACOL), “Succeeding in an online course requires additional technical skills such as facility with technology and personal dispositions such as self-motivation.”  The National Association of Charter School Authorizers describes success full online students as having, “high capacity for and commitment to independent, self-regulated learning without the daily face-to-face guidance and support of teachers or the social engagement that traditional schools offer.  Likewise, it typically requires a particularly high degree of home support and parental involvement for student success.”  If the school is focusing on student performance, it should instead be selective in its enrollment policies.  Instead, the profit motive creates the incentive for open enrollment policies, since profits are maximized when enrollment increases.

Inappropriate enrollment reveals itself in national data showing high withdrawal rates and poor student outcomes at VCS.  Nationally, around 30% of virtual charter students withdraw from the school before the end of the school year.  Student performance at VCSs has been shockingly bad.  The most careful, comprehensive study of VCS performance found that virtual charter students achieved the equivalent of 180 fewer days of learning in math and 72 fewer days of learning in reading than students in traditional public schools. In the words of lead researcher Margaret Raymond, the math results are “literally as if the kid did not go to school for an entire year.”  Not surprisingly, the average graduation rate at online schools is 40%, less than half the national average graduation rate of 82%.

The early indication is that North Carolina’s VCSs are similarly pursuing a marketing strategy, enrolling large numbers of students for whom online learning is inappropriate.  Through the first five months of the school year, over 25% of students have withdrawn from both North Carolina Connections Academy and North Carolina Virtual Academy, approaching the national average of 30% for a school year.

Given the current incentive structure that rewards enrollment over high-quality education, it’s only a matter of time before North Carolina’s student achievement results at VCSs mirror national data as well.