Observations on Friday's Reading First Hearing

Rather than provide an even playing field on which high-quality programs could compete based just on the merits for business with the states, these officials and contractors created an uneven playing field that favored certain products.

Chairman George Miller’s opening statement at the House Education and Labor Committee’s hearing on mismanagement of the $6 billion reminded this writer of his own experience as a k-12 investor. Circa 2000, he raised roughly $15 million to lead a small lending and equity investment activity. The Education Entrepreneurs Fund (EEF) focused on organizations selling comprehensive programs to improve public schools. The programs were developed over years of research and evaluation in hundreds of public schools.

EEF’s investment thesis was that Title I funds “fenced off “ in 1998 by Congress with the Comprehensive School Reform Demonstration Program (CSRDP) created a market for “research based” services. The law rebutted a presumption that small providers could not compete for revenue from federal funding streams dominated by major publishers. The fund invested in a range of school improvement providers including $3 million in Co-NECT (later purchased by Pearson) and $1 million to help launch the nonprofit Success for All Foundation. Every investment had its nail-biting moments, but the reason each succeeded was a federal law that gave our portfolio a defensible competitive advantage. CSRDP ended in 2006. The six years of federal protection allowed our providers to establish positions in the broader market created by NCLB.

The fundamental point here is that without CSRDP, EEF’s investment committee (which included David Kearns, John Ong and John Clendenin - former CEOs of Xerox, B.F. Goodrich and BellSouth) would never have considered the relative merits of a broad variety of school improvement providers. Few of the organizations in our portfolio would exist today to help schools meet NCLB’s demanding requirements. With CSRDP, Congress recognized the role of protection in stimulating a new industry.

Listening to the hearing also brought to mind innovators are chipping away at the textbook paradigm - a phrase contained in an advance copy of investment banking firm Berkery, Noyes’ annual report, Outlooks & Strategy.  Investor interest in school improvement innovators - offering a range of programs including student assessments, information systems and services aimed at improving student performance - is based on the same thesis as EEF’s.

No Child Left Behind’s various provisions require schools to purchase programs that are “research based,” use “scientifically based research” or, in the case of Reading First, use “scientifically based reading research.” Firms with such programs have a chance of winning k-12 market share because the dominant programs lack this attribute. Indeed, one reason NCLB incorporated the “research” requirement was the major publishers’ failure to innovate.

To the extent that school improvement providers can threaten publishers’ market positions - and particularly cut into their growth, the new firms would become attractive to Wall Street as initial public offerings, publishers seeking to regain their growth trajectories, banks financing management buyouts, and private equity groups interested in the potential for one or more of these options. But make no mistake, no matter how good their management or programs, not one of these firms has any hope of success competing absent enforcement of NCLB’s research requirement.

Testimony given at the hearing only reinforced Miller’s assertion. No investor can have much faith in the Department of Education’s capacity to regulate NCLB as a competitive market. It is infected by several kinds of corruption - the arrogant corruption of a true believer in phonics unable to separate his personal views from his legal obligations; the old-fashioned corruption of academic consultants who advised in favor of their own textbooks, programs or companies; the political corruption of senior government officials who countenanced this behavior, and the corruption of a Departmental culture that remains hostile to markets. The hearing suggests the school improvement industry has a political risk profile akin to investments in Russian oil and gas. Investors can find safer investments with better returns.

After listening to this hearing, no manager of an investment fund considering this emerging industry of innovators “chipping away at the textbook paradigm” could be eager to go ahead. If Congress expects innovators to change k-12 education, it must assure investors of federal market regulation that protects innovation. ••••