HMHC is the largest provider of basal and supplemental K-12 education content in the United States by market share, and a provider of educational content, technology, and services worldwide. HMHC reaches over 50 million students in 150 countries through either institutional or consumer channels, and believes that nearly every K-12 student in the United States will use its content at some point during their school career. HMHC operates in the huge US education sector, providing it with a large addressable market. It dominates the sizeable niche of K-12 education – indeed management claimed they had 52% share in their core’ adoption’ markets in 2014. HMHC is currently transforming its business from print to digital, and acquired EdTech from Scholastic Corporation for $575m last year to fuel this transition.
The current structure of the market allows HMHC to retain great pricing power. On the supply side the market is oligopolistic, with only three large players: HMHC, Pearson & McGraw-Hill. All three combined have over 90% of the K-12 market, and have historically been very rational on pricing. The K-12 sector represents a small portion of both Pearson and McGraw-Hill’s revenues, and while they are also shifting to a digital model, they are distracted by fighting on several other fronts as well. On the demand side the market is highly fragmented, and in order to compete for contracts publishers usually need to have direct relationships with decision makers at both state and local level, requiring the scale in terms of sales force and infrastructure that only the big three have. Decisions in the Education sector are not taken lightly, giving incumbents strong pricing power even though they are dealing with the Government.
In addition, the high cost of creating / updating content, publishing at scale and maintaining a large sales force to hold these relationships means that there have historically been very high barriers to entry into the industry. Teachers don’t like switching textbooks or changing their lesson plans, and authorities are unlikely to dislodge an incumbent with a strong brand in favor of a new competitor without a track record or the right relationships.
The transformation of HMHC’s business from print to digital will have a dramatic effect on the business and in turn the way in which it is viewed by the market. The impact of the shift to digital is being felt in every industry, and despite a slower pace this holds true for education. HMHC has positioned itself very well for this transition, most notably by investing heavily in developing a digital platform.
As the product mix shifts from print to digital there should be a significant reduction in COGS as digital content doesn’t require printing or transportation, improving gross margin considerably. Software as a Service (“SaaS”) companies provide a clear blueprint for what margins may look like in the future, as they also create content which is pushed out to customers on a proprietary online platform without incurring the costs of manufacturing or distribution. It may take more than 10 years for printed textbooks to disappear, but even a very gradual shift will dramatically improve margins.
A digital product will in theory be better for both children and educators. Content can be delivered intuitively, adaptively and in a targeted manner, allowing teachers to take a more supervisory role while algorithms continuously adjust the teaching materials for each individual’s needs.
In the future, test marking can be easily automated, and a single teacher should be able to take on a greater number of pupils, leading to efficiencies in state education budgets. This is unlikely to happen even in the medium term for various reasons, but as software gets better and better the content and technology providers should in theory be able to capture some of the value of these efficiencies. HMHC’s growing online resource marketplace will allow schools and consumers to flexibly order a variety of products from both HMHC and others (where HMHC may take a cut), creating an ecosystem advantage similar to that enjoyed by SaaS companies like Salesforce and Workday. With textbooks individual districts/schools often make do with old editions of books rather than buy new sets. However, in theory with a digital subscription they would need to renew their access to content immediately on expiry, increasing the predictability of HMHC’s cash flows. (718 words)