Computing Applications Technology strategy and management

Are the Costs of ‘Free’ Too High in Online Education?

Considering the economic implications as educational institutions expand online learning initiatives.
  1. Introduction
  2. Positive and Negative Network Effects
  3. Paying the Costs of Free
  4. Conclusion
  5. References
  6. Author
  7. Footnotes
  8. Figures
2012 MIT symposium on The Future of Education
In fall 2012, MIT hosted a symposium examining the influence of technology on new teaching and learning methods in higher education.

Over the past year, there has been a flurry of activity by private entities as well as renowned universities to offer “free” and massive open online courses (MOOCs). The Internet, along with software learning-enhancement tools as well as techniques such as crowdsourcing for grading, are creating a revolution in education. Technology now makes it possible to reach many more students at minimal costs compared to on-campus education. These “distance learning” efforts began years ago, but have gained special prominence recently. There is the success of Khan Academy (http://www.khanacademy.org), which offers for free nearly 4,000 10-minute lectures on a variety of subjects. Other free online education efforts involving universities include Coursera (http://www.coursera.org), a for-profit company formed in 2011 by two Stanford professors. This initiative now has more than 30 partners, including Princeton, Brown, Columbia, Duke, Stanford, the University of Pennsylvania, and Johns Hopkins. As of November 2012, Coursera offered 200 courses and had 1.9 million users. It is supported by $33 million in venture capital while the partners pay their own operating costs. The management team has yet to announce how it plans to make money and eventually repay investors.6

We can expect that free MOOCs will continue to grow and educate millions of students, often in effective and creative ways.

At the Massachusetts Institute of Technology, where I have been teaching since 1986, we have been one of the leaders in free and open online learning. We started with Open Courseware in 2002 (http://ocw.mit.edu), which has been supported by the Hewlett and Mellon Foundations, as well as MIT funds, with an annual budget of over $3 million. It offers a variety of courses, syllabi, and other educational materials, with more than a dozen other universities now as partners. Although the program will soon run out of funding, MIT followed up with MITx and then edX in 2012, a $60 million joint venture with Harvard.a The University of Texas, Berkeley, Wellesley College, and others have also joined (http://www.edx.org).

We can expect that free MOOCs will continue to grow and educate millions of students, often in effective and creative ways. Although dropout rates are about 90%, they may still force universities and colleges to control their costs better and lessen the steep rise in tuition rates that has become an obstacle for many families. So free and open online education should be good for everyone, right? Maybe, but maybe not.

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Positive and Negative Network Effects

Initially, “free” and “open” as in Linux and Apache open-source software or Wikipedia as a user-generated encyclopedia came with the assumption that users would participate and contribute to the accumulating knowledge or technology base in a way that was cost-effective and of high quality. As long as there is peer pressure to be a contributor as well as a user, we might even be able to observe positive platform-like “network effects”—the more contributors, the more valuable the knowledge source becomes, which encourages more users and more contributors, ad infinitum.

I worry, however, based on the history of free products and services available on the Internet and their impact on the software products business as well as on the music, video, book publishing, and newspaper and magazine businesses. We have learned that there can also be “negative” network effects. In education, this would occur if increasing numbers of universities and colleges joined the free online education movement and set a new threshold price for the industry—zero—which becomes commonly accepted and difficult to undo. Of course, it is impossible to foresee the future. But we can think about different scenarios, and not all of them are good.

Economists and management researchers see prices as important signals of value. Prices may signal other things, such as status and cost. But if we agree they have something to do with value, then “free” sends a signal to the world that what you are offering costs little and may not be worth paying for. If more or less comparable products and services are easily available and some are free, users should gravitate toward the free. When universities offer free courses or inexpensive extension school classes as part of their non-profit mission, it is laudable. It is even feasible economically if foundations contribute money to such efforts, which they did for MIT’s Open Courseware (at least initially, and they did not contribute as much as MIT administrators had hoped). Wealthy universities and colleges can subsidize their free or low-fee efforts from other revenue sources—students who pay tuition, donors who add to the endowment, or companies, governments, and foundations that fund research and education.

Some online ventures will probably pursue a middle road and charge for certificates. There will then be more pressure to give course credit for classes completed online. But most non-profit educational institutions have high costs and limited resources, and the quality of potentially free contributions from users will be difficult to administer. Someone ultimately has to pay for what the online programs give away. Given that there are real costs and quality issues, what are some potential downsides of a free or low-fee college education, especially now that nearly all the elite U.S. institutions have jumped onto the bandwagon?

One real possibility is that universities and colleges that are not so elite will be unable to survive in the new environment. For-profit universities, whose degrees and promises of employment are already being questioned and investigated by the U.S. Congress, will probably be the first institutions to disappear.2 That may be a positive consequence for society. I also am not too worried about the survival of MIT, the Ivy League, or comparable schools of very high quality and global reputations, though their ability to charge tuition rates that reflect actual costs may well be threatened, sooner rather than later. I am mostly concerned about second- and third-tier universities and colleges, and community colleges, many of which play critical roles for education and economic development in their local regions and communities.

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Paying the Costs of Free

In other industries, we have seen that the real costs of free are absorbed by other parts of the market, with positive as well as negative effects. On the negative side in education, “free” in the long run may actually reduce variety and opportunities for learning as well as lessen our stocks of knowledge. For example, usage of Wikipedia is up, but contributions have been declining steadily over the past several years.4 Meanwhile, encyclopedia companies, including the venerable Encyclopedia Britannica, have closed or found it increasingly difficult to sell their traditional products.5 Will the world be better off if most encyclopedia companies shut their doors and most people only use Wikipedia? Maybe, but maybe not. We have already seen a major decline in the variety and health of book publishers as well as newspapers and magazines. We lost Newsweek in 2012 to bankruptcy and since 2009 have almost lost The New York Times more than once except for massive cash infusions by Mexican investor Carlos Slim.1 Many other newspapers and magazines have failed or had to be bailed out by local and foreign investors with a variety of agendas, and may no longer be the bastions of free speech and press they once were. Web content has replaced a lot of for-fee content, but is the quality and objectivity the same? Again, maybe not.

Free products and services appear over the Internet because the marginal cost of reproducing and delivering a digital good is essentially zero. The marginal cost of adding users to an online class of thousands of students is also close to zero, especially with grading done by computers or free crowdsourcing. But these calculations ignore the expenses associated with research, development, marketing, sales, infrastructure overhead, quality control, and administration. So, yes, digital goods and services such as software products, newspapers, magazines, books, music, video, and even college classes may have close to zero marginal costs and “gross margins” of up to 99%. But if revenues collapse—whether they are software product sales, newspaper subscriptions, or college tuition—then at least some institutions will have another calculation to make: 99% of zero = zero.

Companies that survive the on-slaught of competition from free alternatives generally have business models and economies of scale and scope that enable them to take advantage of what we call “multi-sided markets.” Their products are really “free, but not free.” They subsidize one side of the market to gain users and make money from other parts (see “The Evolution of Platform Thinking,” Communications, Jan. 2010). For example, Netscape in the 1990s gave away browsers to educational or trial users for free, but sold hundreds of millions of dollars worth of servers and development tools to companies that wanted to set up websites, intranets, and extranets. Then later it sold advertising through its website to companies that wanted to reach users of its browser. Nonetheless, Netscape eventually lost the browser wars after Microsoft started bundling its Internet Explorer browser for free with Windows.3 (Microsoft still gives away Internet Explorer while Windows continues to generate nearly $20 billion in revenue each year.) Adobe gives away the Acrobat Reader, but every year sells billions of dollars’ worth of other products, such as servers and editing tools. Open source software like Linux is free but the leading distributor, Red Hat, sells more than a billion dollars’ worth of professional services each year (and also pays itself for a lot of Linux development). Google gives away the Android operating system and the Chrome browser for smartphones and tablets, and much other software functionality delivered over its website. But Google is not in the business of selling software products; it primarily sells advertising to companies who want to reach the billions of users of its search tools and other free products and services.

What are some potential downsides of a free or low-fee education, especially now that nearly all the elite U.S. institutions have jumped onto the bandwagon?

I worry especially because my research going back several years found that about two-thirds of the public software product companies existing in 1998 disappeared by 2006.b Part of the explanation is the Internet boom, which allowed some fledgling companies to go public, followed by a wave of failures as well as acquisitions led by stronger companies such as Oracle, IBM, Microsoft, Cisco, EMC, SAP, and Adobe. But another reason why many failed or struggled was the increasing prevalence of free or cheap alternatives that were “good enough” and available over the Web. Most software product companies can never reach a scale big enough to sustain their businesses simply by selling advertising, like Google does. They need to sell services or monetize another side of the market related to the free products (for example, give away the reader but charge for servers, tools, and services). For companies that would like to sell products, “free” as in Google’s software or Microsoft’s bundles can be very destructive, and sometimes fatal, to their business models.

The industries I follow closely are still struggling to recover from the impact of free. The New York Times made a mistake when it offered its content for free over the Internet, and is now trying to backtrack and adopt a hybrid model and charge for some usage. This hybrid model is what The Wall Street Journal has successfully utilized. Hulu.com, the TV distribution joint venture formed in 2007 and led by NBC, Fox, and Disney-ABC, once gave away all its content for free, with advertising. It has evolved as well to a hybrid model, adding a monthly subscription service with premium content, much like Netflix. The music industry was nearly destroyed by free (and often illegal—remember Napster?) sharing until Steve Jobs found a way to price and distribute songs with Apple’s iTunes service. Music is no longer free, for the most part, and the industry and its creators, the artists and publishers, have survived. Book publishers are still figuring out how to compete with free Web content and new entrants into publishing such as Amazon.

Universities may gain some benefits to their reputations and attract more students and employees or create more scholars by giving away some knowledge for free. But free such as we have seen in software as well as digital music, book publishing, newspapers, magazines, and video, when it works economically, really needs to be more like “free, but not free,” a term we first used with reference to the Netscape browser. The survivors have found indirect ways of covering their costs and generating a surplus.

Do we have more variety and a better world when only a few players survive in an industry? The expansion of free massive open online courses now being offered by elite universities (whose reputations are already high, without free Web courses) creates the risk that lesser institutions will suffer the fate of many software product companies as well as other producers of digital goods and services. Will two-thirds of the education industry disappear? Maybe not, but maybe! It is hard to believe that we will be better off as a society with only a few remaining mega-wealthy universities. Then there is the other issue of whether online education is truly a desirable substitute for in-class learning and face-to-face interaction. We often say at MIT that the personal networks and bonds our students form while at the university are probably the most valuable part of their education.

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Stanford, MIT, Harvard et al. have already opened a kind of Pandora’s box, and there may be no easy way to go back and charge students even a moderately high tuition rate for open online courses. Free learning via the Internet seems here to stay. It is probably most valuable in moderation and as a complement to traditional university education and degrees, not as a substitute. It also will probably force educational institutions to bring down the rising costs of education, as well as the rising prices of tuition. This seems positive but may lead to potentially negative effects and unintended consequences: Elite universities need to ensure the true costs of their MOOCs do not become too high for society as a whole by destroying the economic foundations of less-prominent educational institutions—or of themselves.

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UF1 Figure. In fall 2012, MIT hosted a symposium examining the influence of technology on new teaching and learning methods in higher education.

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    1. Adams, R. Carlos Slim boosts stake in New York Times again. The Wall Street Journal (Oct. 6, 2011).

    2. Crotty, J.M. For-profit colleges thrashed in congressional report. Forbes (Aug. 2, 2012).

    3. Cusumano, M. and Yoffie, D. Competing on Internet Time: Lessons from Netscape and Its Battle with Microsoft. Free Press, 1998.

    4. Dillow, C. Is Wikipedia in decline? Scientists search for answers in Wikipedia's numbers. Fast Company (Aug 3, 2009).

    5. Eaton, K. Microsoft shutters Encarta as Douglas Adams' encyclopedia model wins. Fast Company (Mar 31, 2009).

    6. Korn, K. More colleges team with for-profit educator. The Wall Street Journal (Sept. 19, 2012).

    a. P. Cohan, "Will edX put Harvard and MIT out of business?" Forbes, May 6, 2012. See also MIT News Office, "What is edX," May 2, 2012; http://web.mit.edu/newsoffice/2012/edx-faq-050212.html

    b. M. Cusumano. Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Unpredictable World (Oxford University Press, 2010), p. 94. Also see M. Cusumano, "The Changing Software Business: Moving from Products to Services," IEEE Computer 41, 1 (2008), 78–85.

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