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Educating the Market

Start-up business attempts to apply private-sector management to the public-school system.
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With Education Alternatives Inc., John Golle is determined to apply the ABCs of good private-sector management to the public-school system

* * *

If John Golle gets his way, return on investment may become education's fourth R. His plan: to take over public-school systems from stodgy bureaucracies and replace them with lean management, quality service, and satisfied customers.

But do entrepreneurs belong in the public-school system? "Absolutely," snaps Golle. "Take a look at what UPS did for the Postal Service. Show me a business that doesn't succeed or fail based on its ability to respond to customers. Why shouldn't education be held up to the same measure?"

That kind of thinking seems to be gathering support. This past April George Bush, the self-described education president, unveiled his comprehensive blueprint for overhauling the nation's school system. Among other recommendations, the Bush plan calls for the creation of new model schools -- an attempt to reinvent our educational system on a community-by-community basis. What the president's plan does not offer, however, is a significant infusion of federal funds. The job is supposed to get done within existing budgets and with the help of the private sector. Therein, Golle is betting, lies a budding industry rife with opportunity.

Focusing on elementary schools, preschool through sixth grade, Golle's Minneapolis-based Education Alternatives Inc. (EAI) is out to deliver an affordable, quality education to the ultimate consumers -- students -- and expects a 15% to 20% pretax profit to boot. Golle has spent nearly $7 million and four years perfecting his education business at two company-owned elementary schools -- one in Eagan, Minn., and the other in Paradise Valley, Ariz. Those two private schools have become the models for EAI's venture into the public-school arena.

To visit one of EAI's schools is to witness an entirely different attitude toward education. Walls between classrooms are gone. Computers are everywhere, from preschool on up. Desks are clustered rather than neatly lined up in rows. Everything from bookcases to cubbyholes rides on wheels, allowing the shape of the classroom to change to accommodate the needs of the children. Class size is kept small, and instruction is individualized. The result: standardized tests show EAI students outperform the national average by almost two grade levels.

Eye-catching, yes, but Golle knew he'd have to offer more to those who run public-school districts. First, his price had to be affordable. So he developed a cost structure that allowed him to implement the innovations for about the national average of $5,100 spent per student. Next, he settled on a comanagement approach, working side by side with school systems -- and preferably unions, too -- in hiring and management. "Educators get uncomfortable when businesspeople imply they know education better than educators do," he notes.

In June 1990 EAI was one of 7 entrants (from a field of 35) to win a contract with the fourth-largest school district in the country, Dade County, Fla. Under a five-year, $1.2-million contract, EAI will manage the South Pointe Elementary School, due to open in September 1991. News of EAI hit the front page of The New York Times, which heralded it as the first business/public-school partnership in the nation. Come success or failure, one thing Golle can count on is that all eyes are upon him.

* * *

Theoretically, entrepreneurs should be flocking to the education industry. At $600 billion, a full 12% of gross national product, it's one of the largest industries in the country, and it's in desperate need of reform. In 1981 average math scores for eighth-grade students put the United States third to last in a ranking of 15 countries. Sixty percent of high school graduates aren't prepared for entry-level jobs. And a single year's class of dropouts costs the nation more than $240 billion in lost wages and productivity.

Unfortunately, the education system is mired in conflicting interests -- from unwieldy school boards to possessive unions to restrictive laws -- that have kept most entrepreneurs at bay. "Sure, it's a big industry," Golle agrees. "The question has always been, How do you build a business in such a restrictive environment?"

Golle has been educating himself for the job for quite some time. Formerly a salesman for Xerox specializing in training and education, Golle left in 1970 with Robert Holmes to form Golle & Holmes, a designer of custom educational and training programs for Fortune 500 companies. But education was always more than just a business pursuit for Golle: his son suffered from learning disabilities and didn't benefit from a cookie-cutter educational approach. "My son was stripped of his self-esteem and finally gave up on learning altogether," says Golle.

So in 1986, when Control Data, a $3-billion data-processing company based in Minneapolis, abandoned its plans for a string of private schools stressing creative, individualized learning techniques, Golle jumped. For virtually nothing, he bought the research the company had compiled and set to work building EAI.

Originally, Golle planned to confine his business to private schools that would occupy a niche squarely between the pricey private school and the low-priced parochial or free public school. While a typical private school might charge $8,000 for tuition annually, EAI schools would charge $5,000 and yet offer a similar, if not better, education. Golle hoped that parents who found themselves frustrated with their public school but unable to afford hefty private-school tuitions would flock to EAI schools.

"Private schools are usually single-plant operations with no economies of scale," Golle explains. "We'd gain the efficiencies of buying pencils, desks, and computers in bulk." Although many private schools offer kindergarten through 12th grade, Golle figured elementary schools were his best bet: "In 12 years a lot happens to a kid. You need a bigger physical space and more hard-to-find, higher-paid specialists, from physics teachers to football coaches." Not only was grade school less complicated and less expensive than high school, Golle figured, but emphasis was swinging toward the lower grades, as studies linked early teaching to later performance. By year five, Golle estimated, he'd have 20 schools up and running, revenues of $30 million, and investors' returns of 30%.

* * *

His first school opened in September 1987, in an office-warehouse complex in Minneapolis. Symbolic of its unusual approach, the school was called Tesseract, a name derived from a children's tale by Madeleine L'Engle describing a "tesseract" as a fifth-dimensional corridor for traveling to unexplored territories. At this first Tesseract school, as well as those to follow, the principal was called an executive director, with all the authority that title implies. The number of specialist instructors was pared down. No art teacher. No phys-ed teacher. No science teacher. The aim was to push authority, accountability, and resources down to the classroom teacher. Although teachers made an average of $5,000 less than their public-school counterparts, they were encouraged to spend liberally on teaching tools.

If that was one reason Tesseract teachers willingly passed up fatter paychecks, the other came down to basic respect. They were used to being handed textbooks and told how to instruct; but here, teachers were set loose and asked to be the scientists in Tesseract's educational lab. Each was given a desk, a business card, a computer, and a phone. Their task? To take reams of educational studies and mold them for classroom use.

Grades were the first to go. Since studies show that children are primarily either audio, kinesthetic, or visual learners, each Tesseract student is tested and then given a Personal Education Plan (PEP). Parent and teacher huddle before the school year begins to discuss the child's needs, strengths, and weaknesses, and then agree on specific goals, both emotional and academic. They regroup three times during the year, revising goals and reviewing progress.

Textbooks became the exception rather than the rule. Frustrated with dry, lifeless teaching tools, Mike Erdman, a third-and fourth-grade teacher, developed alternatives like "Whole Math." Rather than start with a textbook swimming with fractions, Erdman begins with blocks or other "manipulatives" so his kids can feel and see the difference between a third and a half. Learning-disabled and gifted-and-talented children work side by side. "We start with the concrete, then move to the abstract," he explains. That philosophy also carries into English, where students pick from their favorite literature to learn rules about quotations or dangling phrases.

By September of 1988 EAI's students were outperforming national averages, and although expenses were worrisome, Golle was ready to expand. He opened his next school in Arizona. By late 1989 he had raised nearly $5 million through a series of three private placements. The problem was, he'd chewed through most of that to cover operating losses, and the goal of 30% compounded return to his 42 investors was ever more elusive.

One problem was expenses. Everything from teacher salaries to books was running higher -- 20% higher -- than budgeted. To head those expenses off, Golle raised tuition -- from $3,750 to $4,950. The result? Enrollments dropped 20%. But most damaging of all were the 1986 tax-code changes stripping limited partnerships of their favorable tax status. "It looked as if it were time to fold up the tent," Golle recalls.

But just as Golle readied to call it quits, he spotted an ad in a trade weekly. Dade County, one of the most-watched school districts in the country, was inviting proposals from education innovators eager to run some of its public schools. Golle figured he had an edge -- EAI boasted up-and-running schools, stellar results, and a cost-efficient management structure. For the next year, with the help of three bridge loans that raised $1.2 million, Golle recharted his company's course. Using the Dade County application as a prototype, he molded Tesseract for a public-school system. In June 1990 Dade selected EAI's plan and set the company on a new path. "EAI was the only applicant with a product we could see and touch," explains Frank R. Petruzielo, associate superintendent of Dade County.

* * *

Nevertheless, even if the company succeeds in Dade County, or any public-school district, selling EAI won't be easy. Depending on the district, EAI will have to win over the hearts and pocketbooks of multiple buyers: the school board, the superintendent, as well as politicians, local business leaders, and parents.

"Out of 16,000 districts in the United States, we're betting 100 will try us," says Golle. District budgets range from $2 million to several billion; if Golle is even in the ballpark, he'll have a $250-million business in five years. Now he's talking with half a dozen school districts; a $30-million deal should close by early summer.

Golle is particularly interested in the handful of progressively minded states, such as Maryland, Michigan and Minnesota, where ground-breaking referendums permit the district to contract the management of schools out to vendors like EAI. Of course, he's also targeting customers whose plans might be foggy but whose needs are urgent. So he's packaging his educational product in three ways:

* * *

Management Deals Where possible, EAI would take over the school's entire budget and manage a minimum of five schools to pick up economies of scale. Sticking to the national average, EAI will spend about $5,000 per child per year, but it will spend that money very differently from the average public school.

While the average public school spends 37¢ of every dollar on the student, Golle will spend 80¢. How? Administrative positions are cut almost in half. Stand-alone positions such as librarian, school nurse, and phys-ed instructor are rolled into the job of a classroom teacher. Food, janitorial, and other contracted services are put up for bid. Supplies, from desks to pencils, are bought at local discounters rather than expensive school-supply houses.

Golle hires union teachers, paying whatever the agreement calls for. However, to maintain the Tesseract system, waivers from the union are crucial. At the top of the list: the right to offer three teaching levels in the classroom and to let go of teachers who fail to perform. Having more teachers in the classroom cuts the teacher/ student ratio to 1 to 15, from a norm of 1 to 30. To keep costs in line, a master teacher is teamed up with a teacher's associate and a teacher's aide, most of whom are accredited professionals who are willing to accept less money in exchange for flexible work hours or graduate school credits. As for his right to fire poor teachers, Golle declares, "Like any good business, we need to reward star performers as well as weed out the weaker ones."

Efficiencies garnered at the top are almost totally eaten up by more expenses in the classroom. Although Golle expects management deals to constitute a full 60% of his business, with pretax margins of 10%, only 2% to 3% of that is expected to result from cost-saving tactics. The rest is supposed to come from efficient investment of EAI's bank balances, the "tuition" money paid by the school districts. Golle will depend on nothing more than good cash-flow management to keep his investors happy.

Ultimately, EAI's report card to the district will be both quantitative (measured by how well children perform on standardized tests) and qualitative (using information from the Quality Service Index, a questionnaire filled out quarterly by parents). In one scenario, teacher bonuses are also tied to those measurements.

* * *

Consulting For schools not ready to hand over everything, EAI offers a consulting contract. For a fee, school districts may buy EAI's expertise -- from classroom training to cost-saving management tactics -- à la carte. Golle sees this segment as 20% of the business, producing pretax margins between 25% and 30%. "But make no mistake," he emphasizes. "This is strictly a marketing tool designed to warm customers up to the notion of entering a management partnership down the road."

* * *

Proprietary Products In any management or consulting deal, clients also agree to buy EAI's teaching tools. So far EAI offers 15 proprietary products; many -- such as Whole Math or the Personalized Education Plan -- were created by Tesseract teachers. This business, as the final 20% of EAI's package, is expected to offer a pretax margin of 20%.

The manufacturing of these notebooks, videotapes, and books will be farmed out. EAI is also pursuing other distribution channels for its learning tools, such as trade shows and regional network distributors. Leading manufacturers, including IBM, are currently negotiating to carry the products in their educational-product lines. Big Blue has already agreed to team up with EAI, lending Tesseract schools the latest in its software and hardware arsenal in exchange for EAI's agreement to provide feedback.

* * *

Will Golle be able to weave all this into a profitable business? And will he be able to transfer the Tesseract methods from the private-school arena to the more daunting environment of public schools? In Dade County, for example, he will enter a world very different from his suburban Minneapolis roots. More than 85% of the students are eligible under federal law for free or reduced-cost lunches. Reading scores hover well below the national average, and more than 89% of the children are minorities -- many of them recent immigrants who speak little or no English. Many of these kids go home every night to broken or poverty-stricken homes. What's the chance that a parent struggling to put food on the table can take an active role in his or her child's education -- a linchpin of the Tesseract approach?

Another question looms. In Dade, EAI will work with a new school, but in most deals EAI will be called in to turn around entrenched school systems. How will Golle deal with kids who've patterned their learning to fit report cards, not PEPs, and with teachers who've taught the same way for 20 years?

Then there are the teachers' unions to consider. How will they greet EAI's concept? As thrilled as Dade County is to welcome EAI as a partner, one official warns that relations between his district and the teachers' union are unusually cozy: "In Dade, we've worked together for years to develop a collaboration between district and union, but you'd be hard-pressed to find this consensus in other districts." Without such teamwork, teacher unions may feel threatened by EAI and refuse their support. And as this official is quick to point out: "No educational concept stands a chance without union backing."

In some ways, the question gets down to the whole notion of a business profiting from education. "It's a very touchy area," Golle admits. Which is one reason that this past April Golle took EAI public, raising $7.5 million for operating capital and debt retirement. While the initial public offering gives some of EAI's investors a long-awaited exit, Golle claims another reason as well: "For this company to be able to grow and sustain itself, there must be public disclosure detailing how we contract, how we operate." He adds, "When you're dealing with people's children, you have to be honest, open, and above suspicion."


EXECUTIVE SUMMARY

THE COMPANY

Education Alternatives Inc. (EAI), Minneapolis

Concept: To sell its management and teaching techniques to public-school districts fed up with poor student performance and cost overruns

Projections: Revenues of $2.7 million, with a pretax loss of $1.1 million in fiscal 1991; revenues of $22.6 million, with pretax profits of $1.1 million in fiscal 1993

Hurdles: Transferring its techniques to inner-city public schools where kids are handicapped by poverty and broken homes; selling the EAI concept to a variety of customers -- school boards, teachers' unions, parents, and children; providing a return to investors after four years of operating losses

THE FOUNDER

John T. Golle

Age: 47

Family: Married, with two children

Source of idea: After spending his entire career designing and selling custom educational programs, he was inspired by the negative experiences of his learning-disabled child to launch his own schools

Personal funds invested: $3 million in cash and

commitments

Equity held: 29%

Salary: $120,000 and incentives

Workweek: 60 hours

Education: B.S. in business administration from University of Minnesota

Other companies started: Golle & Holmes Cos., a designer of custom educational and training programs for Fortune 500 companies, started in 1970; its sales are now in the seven-figures


FINANCIALS

Education Alternatives Inc. Projected* Operating Statement

($ in thousands)
Fiscal Year (July 1 - June 30) 1991 1992 1993
TOTAL REVENUES
$2,687 $10,102 $22,602

(Including revenues from school

management, consulting, and

sales of proprietary products)

* * *

Direct expenses ($3,250) ($8,693) ($20,502)

GROSS PROFIT (LOSS) ($563) $1,409 $2,100

* * *

Selling, general, and ($531) ($871) ($970)
administrative expenses

Operating income (loss) ($1,094) $538 $1,130

* * *

*Projections are based on Inc. estimates.


(CONTINUED)WHAT THE EXPERTS SAY

OBSERVER

DENIS P. DOYLE

Senior research fellow at the Hudson Institute and coauthor of Winning the Brain Race

Golle is truly a pioneer, but he's got some tough sledding ahead. The public-school tradition is 150 years old, and there's a belief that the public sector should do it all. It's not just teachers and principals but school boards, parents, and business leaders who resist this kind of experimentation, largely because in public-education circles profit is a bad word.

Second, about 34 states have Blaine amendments, which restrict how public money can be spent. Very few jurisdictions could do what Miami has done with Golle.

Golle says he'll order pencils in bulk, but every school in the nation has that capacity now. Anyway, the percentage of the budget devoted to consumables is infinitesimal. Almost all the budget goes to hiring people, so the only way Golle will save money is to replace people with machines. His success will hinge on electronic technologies -- such as interactive computer disks -- to increase the rate and depth of learning, so kids will learn twice as fast at half the cost.

Last, Golle's promise of a 30% return on investment is probably something he can't deliver in the first couple of years. Once the thing gets off the ground, it will probably pay a handsome return. But given its huge capital base, returns would probably be more on the order of 7% to 9%, which still isn't bad.

CUSTOMER
ALBERT SHANKER
President of the American Federation of Teachers, in Washington, D.C.

Some school boards are made up of elected officials who want to be able to change things on almost a day-to-day basis so they can get reelected. At best, boards might contract out one or two schools, but any widespread use directly conflicts with their political needs.

Still, there's a lot of dissatisfaction with the whole method of operating schools through school boards. Perhaps the day will come when school boards are abolished and management companies bid on the right to manage schools for, say, 10 years. Instead of giving parents the choice of schools, as the president is proposing, we might give communities the right to choose which company will manage their schools.

As far as the teachers' union is concerned, as long as the collective-bargaining relationship is maintained and this company is willing to negotiate, I see no problems. It's a new employer to negotiate with, but if EAI develops a track record showing it's not hostile to unions, I think a lot of unions would welcome it.

CUSTOMER
DONALD INGWERSON
Superintendent of the Jefferson County Public School System, in Louisville, cited as one of the most progressive urban school systems

Here in Kentucky there's a law saying that every school will be governed by site-based management, meaning the district hands teachers and parents the right to decide how their schools will be run. This is just the kind of progressive school Golle's targeting; yet I suspect that the schools here won't hire him, simply because the teachers have their own ideas about what needs to be done, and they want to carry those ideas out themselves.

I'm worried also about the link between EAI's success as a business and its students' performance on standardized tests. Unless Golle gives some attention to this link-up, he'll find himself being driven by narrow-based measures because of what he has to deliver to the marketplace. He'll fall into the same trap public schools have traditionally fallen into, where measurements are based on what makes the school look good rather than on what works for the children.

Golle's educational program cannot stand by itself in a community. We may not think that setting up expectant-mother programs or providing gang information is part of our job, but to achieve excellence you must address these problems and be part of the solution. Golle is going to have to set up other programs -- costly programs -- to address a host of social ills. He may not be able to afford it.

FINANCIERS
PETER ULIN AND NICHOLAS HOLLAND
Managing directors of Ulin, Morton, Bradley & Welling, an investment bank for midsize companies, advisers to a start-up educational company in Boston

This is a company that has yet to show it can make a profit in any phase of its business. Moreover, most of the money it's raising in its IPO is going toward covering sins of the past, such as paying down debt, leaving little available for real development efforts. Yet it obviously has development needs. For example, EAI is counting quite heavily on revenues from proprietary products, while it has yet to develop a commercial offering.

And sure, teachers are dedicated, but there's a limit. Business cards and phones are nice, but if you ask teachers to do more in the classroom, you have to pay them more.

We are not impressed that Golle is going to save money by buying his pencils and erasers more cheaply. We are not impressed that he's going to make a profit by investing tuitions more wisely or by extracting concessions from the unions. This is not value-added stuff. Nor are they powerful rationales for turning over contracts to this company or for investors to expect that those things will yield big profits.

Last updated: Jul 1, 1991




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