Pearson e textbook reader

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The digital education industry is delivering increased amounts of education content to classrooms every year. Pearson should make a credible entry into this market by providing free eReaders to …

The digital education industry is delivering increased amounts of education content to classrooms every year. Pearson should make a credible entry into this market by providing free eReaders to educational institutions and bundling the eReader with content subscriptions for digital textbooks. Pearson’s entry into the market will help them to retain bargaining power over other eReader providers by providing them with a real value option. By outsourcing the eReader manufacturing, Pearson can combine their design ideas and content with the manufacturing expertise of the outsourcer. Pearson can continue to focus on its core competency of creating unique educational content by partnering with a manufacturer to own the complete end-to-end classroom experience, making the vision of a paperless and interactive classroom a reality.

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  • 1. HAAS SCHOOL PEARSON ETEXTBOOK READER OF BUSINESS Ahmed Tantawy Brian Guernsey Josh Lauman Pranav Dharwadkar Tapan Kamdar
  • 2. Pearson Digital Textbook eReader Executive Summary eEducation industry comprises of digitization of textbook content and delivery of textbooks via digital media such as eBook readers. Industry size is in the range of $15 to $20 billion with a consumer base of 75 million school students1. Pearson is exploring entering the eEducation industry by either selling its own eBook reader with their content or by solely concentrating on selling content to existing eReaders. The eBook reader market is crowded with technology giants like Apple, Sony, Amazon, and Fujitsu featuring products that address current consumer demands. If Pearson concentrates on selling content only, then it will eventually lose all bargaining power over the eReader manufacturers who will own the distribution of content moving forward. Given this competitive landscape, Pearson should focus on penetrating a green ocean market for textbooks in the education industry by leveraging its core expertise. The digital education industry is delivering increased amounts of education content to classrooms every year. Pearson should make a credible entry into this market by providing free eReaders to educational institutions and bundling the eReader with content subscriptions for digital textbooks. Pearson’s entry into the market will help them to retain bargaining power over other eReader providers by providing them with a real value option. By outsourcing the eReader manufacturing, Pearson can combine their design ideas and content with the manufacturing expertise of the outsourcer. Pearson can continue to focus on its core competency of creating unique educational content by partnering with a manufacturer to own the complete end-to-end classroom experience, making the vision of a paperless and interactive classroom a reality. Market Overview With close to 75 million students enrolled in public and private schools, from kindergarten through high school, the market for digital textbooks boasts a large, diverse, and ever-changing population. With 50 million students2, public school systems have significant purchasing power. A state-wide policy shift promoting the adoption of digital text could constitute a significant portion of the $6.4 billion textbook market3. Given schools’ desire for cost savings and enhanced learning experiences, digital textbooks are an attractive option. Within digital textbooks, the potential exists to address both of these desires. In the K-12 market, several public school initiatives are driving a shift from traditional paper textbooks to digital textbooks. The California public school system is leading the way with its Digital Textbook Initiative, the most progressive public effort towards digital education in the country4. With an annual textbook market of $400 million, California represents the second largest state market in the United 1 Digest of Education Statistics, page 45, April 2010, http://nces.ed.gov/pubs2010/2010013.pdf 2 Digest of Education Statistics, page 45, April 2010, http://nces.ed.gov/pubs2010/2010013.pdf 3 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run- Down.html 4 Leading the Nation Into a Digital Textbook Future, June 2009, http://gov.ca.gov/index.php?/fact-sheet/12455/ 1
  • 3. Pearson Digital Textbook eReader States5. Consequently, any statewide policy shift towards digital content would dramatically increase the overall demand for digital textbooks. California’s effort is significant and being launched in phases. The first part of the program calls for high school science and mathematics textbooks to transition to digital textbooks, while the final phase calls for all textbooks to transition to digital textbooks. California is not the only state contemplating the use of digital media for textbooks. Texas, the largest annual textbook market at approximately $500 million, is conducting a request for proposal (RFP) for digital content providers6. Georgia recently passed legislature in the state senate allowing the definition of a textbook to be extended to digital formats, which could clear the path for digital text usage in its schools. Cost savings and more comprehensive, tailored curriculum are the two factors driving this change. Adopters of digital textbooks expect it to lower the cost of providing educational content. While actual cost savings have not been proven, the expectation is that digital text will drive savings through decreased frequency with which textbooks will need to be replaced. Textbooks which are damaged or have a discrepancy in them will not need to be entirely replaced as has been required with physical print textbooks. Since textbooks typically cost schools $75 per student in California, the elimination of these costs will provide considerable cost avoidance, especially in states where the textbook lifespan is significant, such as California with a textbook lifespan of 6 years (average K-12 lifespan is 2-3 years7). Additionally, textbooks which require content updates will not require brand new editions to replace the previous ones. Instead new editions are replaced by digital updates electronically distributed to customers. Due to the per student cost of textbooks, digital text is expected to drastically reduce these expenses based on license prices ranging from free to $25. California expects a saving of $2 million8 from its first phase of shift to digital textbooks for high school science and mathematics. The prospect of tailored class curriculum, which can be ordered and assembled by individual teachers, is viewed as another benefit of digital textbooks. With the ability to assemble a curriculum from different content providers, school teachers will be able to develop programs that can mix and match offerings from the same publisher, combine content from multiple publishers, and cull content from open source mediums like flex books. While the prospective benefits of digital textbooks are clear, the delivery of this content remains challenging. School districts do not have the necessary technology in place to enable the use of 5 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run- Down.html 6 Request for Offer: State Developed Open Source Textbooks, Feb 2010, http://search.tea.state.tx.us/search?q=digital+textbook+proposal&btnG=Search+TEA&entqr=0&sort=date%3AD% 3AL%3Ad1&output=xml_no_dtd&client=default_frontend&ud=1&oe=UTF-8&ie=UTF- 8&proxystylesheet=default_frontend&site=default_collection 7 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run- Down.html 8 Leading the Nation Into a Digital Textbook Future, June 2009, http://gov.ca.gov/index.php?/fact-sheet/12455/ 2
  • 4. Pearson Digital Textbook eReader eReaders. In 2004, Pearson converted 100% of California’s social studies material into digital textbooks, which can be viewed entirely online. The school districts, however, did not have the necessary computers and interactive whiteboards to leverage this technology and continued to use printed textbooks. One of the primary concerns surrounding the switch to digital textbooks is the initial investment required to obtain the necessary hardware for each student. In the same time, elementary schools are cautious to adopt an open platform eReader in fear of exposing children to other non- educational applications on the device without direct supervision. Beyond this obstacle lies a tremendous opportunity for content providers in the large, stable, multi-billion dollar textbook market. Private universities, with their larger budgets and reduced bureaucracy, are more likely to overcome the above mentioned initial hurdle and pilot digital textbook programs. Approximately 5 million students attend private university undergraduate or graduate programs, representing a substantial consumer segment. Furthermore, with significant textbook turnover in the university system, digital content could be viewed as a means for reducing student textbook costs. Princeton University is among a handful of schools that have piloted digital textbooks through the use of content accessed through Amazon Kindle eReaders. The motivation stated by Princeton and other schools participating in the pilot is to transition to a paperless learning environment, differing from that of the K-12 public schools, but nonetheless an important one. Seattle University, also experimenting with the Kindle, envisions the benefits of the device to be a blend between Princeton’s view and the public school system. Touting both reduced paper and the opportunity for students to save money on books, Seattle also sees an advantage for the students in terms of carrying all their material in a lightweight device instead of heavy textbooks. Porters Five Forces A Porter's five forces analysis of the digital publishing industry is done from the perspective of two key stakeholders in the digital publishing industry: digital content providers and eReader providers. 3
  • 5. Pearson Digital Textbook eReader Threat of Substitutes Threat of New Entrants •eContent Providers: •eContent Providers •Book publishing houses •Traditional content providers moving to •Google online book digital content •Blogs/Wikipedia •eBook Readers •eBook Readers •Fujitsu, Sony, Google, Netbooks •Amazon Kindle, Apple iPAD •Computer •Textbooks Competitive Rivalry Customers Bargaining Power Suppliers Bargaining Power •Schools/State Government: High. •eContent Providers: High •Consumers: Moderate. In some ways •Volume of content is the key differentiator consumers are limited to what the amongst different ebook readers. school/state chooses. But consumers can •eBook Readers: Strong Bargaining power potentially influence that choice through •Multi-purpose devices have market petitions, parent funding, etc penetration and network effect Figure 1: Five Forces analysis Suppliers Digital content providers: Digital content providers include book publishing houses, newspapers, textbook publishers, book-digitizers. Supplier power is relatively strong because the volume of content is a strong differentiator for any eReader. If an eReader boasts of a large number of exclusive titles, it can attract more users and lock them in. Content providers can charge a high premium for their content by restricting the content to a single distribution medium, thus wielding additional supplier power. Alternatively, content providers who want to maximize the number of readers consuming their content have access to multiple distribution mediums. Brand recognition is a big barrier to entry for suppliers of digital content. The availability of similar content makes brand recognition a key differentiator making some content more popular over others. Any company that has unique content can command a high supplier bargaining power. Buyers Consumers have a high amount of bargaining power simply because they have the choice of selecting the method of content consumption. They often choose multiple methods such as computer, paperback and eReaders. Brand recognition is a major barrier to entry for the eReader market. This brand recognition is achieved not just in the eReader market, but rather carried over from other markets. Thus 4
  • 6. Pearson Digital Textbook eReader for a new entrant, building this brand recognition might be very arduous unless the new entrant has a strong pre-existing brand in other markets. Schools, Universities, and Governments have significant bargaining power simply because they constitute a large portion of the market and have the power to make rules. The eReader that those three constituents mandate will typically be the reader that the students use for other non-school content as well. These institutions negotiate multi-year contracts and command significant bargaining power because of the locked-in user base that they provide. New Entrants eReader Manufacturers: The barriers to entry for eReaders are high because of the brand recognition required for success. The market already includes brand-name players such as Amazon, Sony, Google Android, Apple iPad, Samsung, and Fujitsu. Any new entrant would have to build a strong brand in order to capture the market. Digital Content Providers: The barriers to entry for digital content providers are very low. Digital content providers include blogs, newspapers, and open source flex books. Thus digital content providers may have difficulty commanding premium prices unless they have really unique content. But it is possible for content providers to create barriers to entry. For example, when a digital textbook is approved for a particular course curriculum, this selection serves as a significant barrier to entry. But for new course offerings, the barriers to entry are low as there is a large selection of digital content available that teachers can choose from. Brand recognition serves as a barrier to entry for content providers. If a content provider has a strong brand in the printed textbook market, then the brand name carries over to the digital textbook market. Thus publishers who have built strong brand recognition in the printed textbook market can be expected to enter the digital textbook market as well. Competitors Competition is really strong in both the eReader market and the digital content market. In the eReader market, competitors include Amazon, Sony, and Apple, and all possess significant brand name recognition. In the digital content market, the biggest competitors are Google, Amazon and Barnes & Noble, who all have strong relationships with the top publishing houses. Pearson must rely on sourcing its own content in order to thrive in this competitive environment. At the same time, Pearson can improve its chances of success by focusing on its core competence in the education market. However, the same cannot be said for the non-education market due to the relationships Pearson's competitors have with publishing houses. Substitutes Consumers of digital content typically view the content using a computer due to ease of viewing the content on a larger screen and its’ multi-functional capabilities. Thus computers are a popular substitute 5
  • 7. Pearson Digital Textbook eReader for eReaders. Additionally, many consumers will still prefer printed books due to cost of eReaders or switching costs. McKinsey Value Chain Pearson can either compete with the incumbents in the eReader market (Apple, Amazon, Barnes & Noble, Sony, etc) or create a niche market exclusively for education. The existing eReader solutions address a number of needs for the general consumer, but do not address the specific needs of the education industry – automated testing and evaluation, interactive content and learning, and homework capabilities, consequently lowering the cost of education for the cash strapped local school districts and governments. We evaluated two solutions using the McKinsey Value Chain as follows: 1. Providing digital content for each platform as per their requirements and pricing: Marketing & Technology Product Design Manufacturing Service Distribution •Technology • Support • No H/W manuf. • Channels • No H/W service provided by 3rd multiple platform Required • Online Book Stores • No 3G/Cell e.g. Amazon, Apple party formats for •Compete with Store, B&N network service • No R&D books existing market • Through native problems investments • Limited by h/w place (red ocean) Application purchase • Cannot control • Complimentary to • Leverage best functionality of • Content needs textbook purchase end-end of breed platform to to be published • Prices governed experience solutions in leverage features in multiple by Channel market to offer • No negotiations formats for owner applicable with Wifi/3G different • Format features providers eReaders distribution • Reply on restricted as per eReader DRM h/w platform Figure 2: MVC eReader Content only 2. Build a specialized eReader education platform with digital textbooks and contents which address the specific needs of the education industry: Pearson should leverage its strengths in selling content and education specific add-on services to the K-12 and university segments. 6
  • 8. Pearson Digital Textbook eReader Marketing & Technology Product Design Manufacturing Service Distribution • Constant • Drive innovative •Partner with • Give away • Reliable H/ W investments in product features H/W partner to device for free, • Reliable 3G R&D to improve through h/w build solution with content service platform support •Custom purchase • Reliable eStore • Introduce new • Wireless/3G regulations on contracts • Own end-end features for a connectivity to imports • Universities, experience new market, not eStore for • High FC Schools competing with delivery investment • Provide existing eReaders •Differentiation • Build DRM / exclusive content • License content with add-on Subscription • Lower content from other services like tests tech. into H/W pricing providers to homework and •Forecasting on • Online Book provide more note sharing Volume Stores value to platform services projections Figure 3: MVC eTextbook + Content Game Theory Once a consumer has decided to purchase an eReader their purchase choice will depend upon both the eReader itself and the amount of content available for the device. Consumers choose their eReader prior to choosing their content; however the amount of content that an eReader has available influences the customer’s initial eReader choice. With this in mind most content distributors are making proprietary eReaders that only recognize content purchased from their stores. This forces customers to purchase content from their sites thereby creating switching costs. Thus, the battle that is emerging in the eReader industry is not between publishers but between content distributors. However, Pearson, though not directly involved, has a vested interest in the outcome of this battle and should actively work to ensure a favorable outcome for itself. The ideal situation for Pearson is for there to be multiple eReader content distributors with equal market share. In this situation Pearson would have power within the distribution channel and could allow multiple content distributors to compete for the privilege of earning their business. The worst situation for Pearson would be for one very dominant content distributor to emerge and have significant distribution channel power. In this scenario, the situation would be reversed and Pearson would be competing for the privilege of using the content distributor. With this in mind, Pearson should work to encourage a market that accommodates multiple content distributors. However, analyzing the market from the perspective of the content distributors will show that the current situation encourages a dominant strategy that opposes Pearson’s. If we look at how the digital music industry emerged and use it as a proxy, we will see that the dominant strategy for content distributors is to control as much of the distribution channel as possible by 7
  • 9. Pearson Digital Textbook eReader developing their own eReaders and making creative use of digital rights management (DRM). In the digital music industry Apple developed a digital music player, the iPod, along with its content distribution platform, iTunes. By using stringent DRM, Apple was able to restrict digital music purchased on iTunes so that it could only be played on the iPod. Thus, the iPod was the digital music player with the unique capability of being able to play digital music downloaded from iTunes. The iPod had the ability to play digital music from other sources, but by maintaining control over its content distribution platform, iTunes, Apple ensured that the iPod worked most easily with iTunes. This creative use of DRM also allowed Apple to create significant switching costs for customers. If a customer wanted to switch to a different digital music player all of the music that he purchased using iTunes would be unplayable. This approach of controlling the distribution of digital music all the way from the record labels to the end user device has allowed Apple to achieve approximately 70% digital music market share9. Having seen Apple’s success in a similar digital market, content distributors have adopted a similar strategy and developed their own eReaders. Amazon has developed the Kindle, Barnes and Noble has developed the Nook, and Apple has developed the iPad. They are attempting to control the distribution of eBooks from the publishers all the way to the end user device. While no one competitor has emerged as a market leader, it is in Pearson’s interests to ensure that it stays that way. Or better yet to dominate the educational digital textbook market by being the dominant content distributor. If Pearson anticipates that a particular content distributor and its eReader will come to dominate the market, then they should take steps towards disallowing it. Pearson could accomplish this by electing to develop their proprietary eReader for textbooks. Pearson’s own proprietary eReader would serve as the end user device for an additional internal distribution channel. This additional distribution channel could serve as a credible threat that Pearson could use in negotiations with other content distributors. Strategic Recommendations Sell content only v/s Sell reader + customized content Based on our analysis of the five forces and Pearson’s competitive advantage, we have ascertained that its core competency is in developing educational content. Additionally, Pearson is a leader in the educational content for K-12 school material with a market share of 37%10. Such competencies lend itself to the strategic approach of focusing on digital content rather than on developing the hardware itself. This approach will reduce the risk of hardware manufacturing and associated overhead from managing the supply chain. In addition, by bundling the eReader as a part of a content and delivery package, Pearson can obtain access to educational institutions and build a network effect for its platform adoption. In this case, Pearson can capture additional educational market share and set the standard for the delivery platform, especially as it is already the leader in the current traditional books market. Pearson needs to make sure that it is ready with the software platform to be able to provide the full experience to its customers. 9 iPod Market Share, After Dawn Blog, September 2009, http://www.afterdawn.com/news/article.cfm/2009/09/09/ipod_market_share_at_73_8_percent_225_million_ipo ds_sold_more_games_for_touch_than_psp_nds_apple 10 Pearson PLC, Annual report and accounts, 2009. 8
  • 10. Pearson Digital Textbook eReader Pearson needs to consider how to take a blue ocean strategy and create such a market rather than taking a red ocean strategy and competing in a market where incumbents are fighting for market share. If it delays this introduction, then the current popular eReaders, such as iPad or Kindle, will likely become the industry standard, robbing Pearson of the ability to shape the market per it needs. If Pearson is able to control the overall user experience for both software and hardware, it can lock in the schools for long term and strengthen its presence in the educational content industry. Sell all types of content or eTextbooks only on Pearson eReader The electronic content market is already crowded with Google, Amazon, Apple, Sony, each pitching exclusive access to a huge volume of content. Competition in the textbook eReader segment of the market is concentrated around new players who are pitching their technology solution, but have no backing from the content producers. Pearson can leverage its established brand in the education industry and use its expertise and content to sell content specifically for schools, universities, and colleges. By shifting to a subscription based model rather than current paper-textbook sale model it employs today, Pearson will build a repeated and closer engagement with its customers. By enabling customers to customize their products to address the specific needs, Pearson can grow its market share and the overall pie of the market. By bundling in access to business informational content through Financial Times and consumer content through Penguin, it can address consumer's content needs beyond educational content. Partnering vs. Building in house Business Model: As we consider Pearson’s position in the digital textbook market and contemplate a market entry strategy for a dedicated educational eReader, the main question we face is: Would Pearson build its own eReader as a hardware platform for its content or would it partner with a 3rd party hardware manufacturer and focus on the content? 1. Build its own eReader in house: Pearson has traditionally been a content provider and does not have a core competency in building hardware platforms. In order to build hardware in house, Pearson would have to acquire a company with core competencies in manufacturing. The post acquisition integration of two very different companies could be difficult as well as expensive. The huge upfront cost of acquisition could prove to be a huge barrier to entry into the market and would give away Pearson’s intent to entry to its competitors. In addition, if Pearson’s foray into the digital textbook initiative failed, its hardware division acquisition would be viewed as an expensive failure by the Board and it could lose its bargaining power with the incumbent eReaders forever. 2. Partner with a 3rd party hardware manufacturer to develop its own branded eReader: Pearson can use its relationships with the schools to provide both the eReader and the educational content. By providing the hardware for free, it can foster easier adoption as well as control the overall experience for the students. It can provide value by standardizing the platform across all schools with a software interface that is optimized for its own hardware. Such platform will be optimized for educational content with controlled access to non-educational applications as gaming, entertainment. However, such an approach introduces the risk of managing the partnership with a hardware manufacturer. Based on these considerations, we recommend partnering with a hardware manufacturer like Foxconn. 9
  • 11. Pearson Digital Textbook eReader Distribution model: Physical v/s Digital Multiple players involved in the production and distribution of a physical textbook are as follows: 1. Authors: Royalties from publishing houses vary on book type (textbook, professional, fictional, etc). In the textbook industry, royalties are based off the “price received”, a percentage of the publisher’s receipts from a bookseller which is much lower than the actual sale price11. The royalties range between 10-15% of price received for local sales. Factoring in international sales, which have higher cost of shipping and distribution, the actual payments that an author receives are in between 5 and 7.5% of price received. 2. Editors: They work closely with authors to review the books and have direct contracts with the author based on page numbers. At times, the editors act as the author’s agent and negotiate with the publishers, in exchange for a management fee. 3. Publishers: They are involved with the printing, distribution and marketing of the book. In the textbook market, Publishers rely on long term contracts with wholesale distributors or institutions, in addition to their online sales to individual customers12. 4. Wholesale distributors and Retailers: Wholesalers distribute books to retail chains, schools, and universities. Wholesale distributors play a major role in the textbook industry as most school districts and universities have a variety of book needs that span across multiple publishers. Online retailers like Amazon rely on a direct sales channel with the publishers for their inventory of books. The newer model of digital textbooks changes the players involved and their roles. To validate the new model of digital textbooks, we need to make sure the main contributors (authors) would not resist the new model. Textbook margins are higher than normal books, especially in higher education. Textbook prices have recently increased by 5-7% annually13. This is mainly attributed to the broken market structure, where purchase decisions are made by educational institutions without regard to prices, which are negotiated separately. In this model, the majority of the revenues are split between the publisher and wholesalers. The physical textbook distribution model as compared to the digital model is as follows: 1. Physical distribution model 11 Advances & Royalties, Chris Holifield, 2002, http://www.writersservices.com/res/ri_adv_royalties.htm 12 Books in the United States, Industry profile, Datamonitor ref. code: 0072-0781 July 2009 13 College Textbooks: Enhanced Offerings Appear to Drive Recent Price Increases, U.S. Government Accountability Office, July 2005, http://www.gao.gov/docsearch/abstract.php?rptno=GAO-05-806 10
  • 12. Pearson Digital Textbook eReader Educational Author Editor Publisher Wholesaler Institution •5-10% royalties •Work closely with •Source books •Deals with large •Final consumer of price received authors from multiple retailers and •5yr book buying •Full book requires •Payment based authors institutions cycle a lengthy writing on pages •Handle •Long term •Annual rising cost process reviewed distribution and contracts with of books •Royalties •Manage marketing educational •Use multiple payments based contracts for •Good margins in institutions books to on copies sold. authors textbook (~20%) •Source books accommodate •Long term from multiple curriculum contracts with publishers educational •Good margins institutions 2. Digital distribution model Educational Author Editor Publisher Institution • Multiple updates v/s •Work closely with •Source books and •Buy materials when full book writing cycle authors chapters from needed, not based on • Periodic update of •Payment based on mulitple authors wear and tear chapters as subject digital content •Distribution is digitial •Lower cost of books matter changes reviewed = minimal cost •Source specifc •Royalties based on •Simpler structure due •Different margins chapters based on subscription model to flexibility of structure with curriculum needs, and chapters used content saleability subscription model update annualy • Increased royalties •More envolved with •Better overall due to increased educational experience with chapter volume sales institutions for digital testing, v/s complete book complete solution content sharing, DRM sales system management and • Revenues based homework system more on volume sales of chapters, not entire textbooks With the new distribution model, the authors earn more net royalty; Pearson eliminates the middle man (wholesale distributors) and captures most of the pie; and the educational institutions get added benefits and a better student learning experience, making it a win-win for all players. Digital Textbook eReader: Feature and Content Strategy 11
  • 13. Pearson Digital Textbook eReader Pearson must invest R&D dollars into building an end-to-end solution which addresses the current problems of schools and universities. Due to the high costs of replacing textbooks, schools are not in a position to replace textbooks frequently or recommend multiple textbooks for the same class. Teachers spend a large amount of time preparing and evaluating homework for students, but are not able to improve the quality of student learning beyond the classroom. Pearson owns numerous titles per subject in its portfolio. In addition, Pearson owns online resources like the Financial times (FT.com) and Economic times, as well as the Penguin label for fiction books. By allowing teachers to create a dynamic text pack which consists of individual chapters from various textbooks, and online content, Pearson can create an annual custom teaching experience for each classroom. Schools would have the flexibility to change their text pack every year to fit the specific needs of the class. By building interactive learning modules for each chapter, students would be able to better understand the material taught in class and improve their test scores. Building homework modules combined with automated testing would reduce the teachers time spent on evaluating homework, but at the same time alert them to specific difficulties faced by individual students. School districts would be able to update their content for classes every year, raise average test scores, and reduce teaching load on classroom overhead, thereby raising the standard of education. By building models with different levels of functionality (WiFi/3G access, testing/homework frameworks, color screens, touch enabled screens, access to online content, etc), Pearson can evaluate content contract willingness from school districts, and offer devices ranging in costs from $99 to $299. Our cost estimates are based on iSuppli’s estimates of the iPad manufacturing costs, a 32GB iPad with 3G would cost $287.15 with $59 in memory costs14. In return, Pearson would obtain multiple year contracts on content for different classes. Availability of such features might even influence school districts to obtain licenses on text packs for content which they previously never purchased from Pearson, thereby increasing market share in the long run. Financial Model According to NCES, the number of students enrolled in school is anticipated to grow by 12% from 2008 to 201815. Since Pearson has a 37% share of textbooks purchased in the K-12 marketplace, we plan to introduce the digital textbook eReader in grades 9-12 for public and private schools. In addition, private universities also fit our target customer profile as the universities are interested in reducing costs, as well as willing to experiment with cutting edge technologies. Appendix 1 shows our digital textbook eReader market place growth projections in different segments from 2011-2014. 14 Mid Range iPad to generate maximum profits for Apple, February 10,2010, http://www.isuppli.com/News/Pages/Mid-RangeiPadtoGenerateMaximumProfitsforApple,iSuppliEstimates.aspx 15 Digest of Education Statistics 2009, US Department of Education, http://nces.ed.gov/pubs2010/2010013.pdf 12
  • 14. Pearson Digital Textbook eReader Class/yr Books/Class Books Cost/Book Annual Cost Costs Fraction Grade K-8 8 1 8 55 $440 0.525 Grade 9-12 10 1 10 75 $750 0.219 Undergraduate 8 2 16 55 $880 0.219 Graduate 6 2 12 95 $1,140 0.037 Average 10.4 60.8 $630 Figure 4: Books - Costs & Class level The average number of books used per student per year is 10.4 (Figure 4), at an average cost of $60.80, costing the school district $630 in books per student annually. Schools lose books to non-returns at about 8% a year, and replace books with newer editions once in five years. Figure 5 shows Pearson’s revenue from digital textbooks and cannibalization of sales of the physical textbooks at various price levels. Even by pricing the textbooks at $10, and replacing $60 priced physical textbooks, the schools stand to save millions of dollars. Our assumption in calculating cannibalization equates the additional royalties paid to the authors to be equivalent to the cost savings in printing and distributing textbooks. In an average case, cost savings would be quite significant as compared to the additional royalties being paid out, thereby adding more profits to Pearson’s bottom line. Period 2011 2012 2013 2014 Digital text book costs @ 37% Market Share $10 $ 54,529,537 $ 178,701,123 $ 405,885,640 $ 729,349,873 $15 $ 81,794,305 $ 268,051,685 $ 608,828,461 $ 1,094,024,809 $20 $ 109,059,073 $ 357,402,246 $ 811,771,281 $ 1,458,699,745 Cannibalization (Loss of Physical textbook revenue) $55 $ 22,193,521 $ 50,537,836 $ 92,464,099 $ 131,649,943 $60 $ 24,211,114 $ 55,132,184 $ 100,869,926 $ 143,618,119 $75 $ 30,263,893 $ 68,915,230 $ 126,087,407 $ 179,522,649 Digital $10 w/ Physical $60 $ 30,318,422 $ 123,568,939 $ 305,015,715 $ 585,731,754 Current School costs $ 322,019,772 $ 733,285,268 $ 1,384,350,188 $ 1,910,191,881 School Savings $ 291,701,350 $ 609,716,329 $ 1,079,334,474 $ 1,324,460,127 Figure 5: School Savings with $10 text pack subscriptions instead of $60 textbooks To calculate the profitability (Appendix 2) of giving away the digital textbook eReaders for free, and charging an annual fee of $10 per text pack per student, we made the following assumptions: 1. Overall Pearson digital textbook eReader market share would grow at 1% overall after 2015 2. A reduction of 2% in cost of building the reader every year 3. An upfront R&D cost of $5 million, followed by an annual R&D cost of $3.5 million/year 4. Content distribution cost and administration cost of 5% of sales 5. Increased royalties paid to authors = Savings in cost by not printing physical copies 6. Marketing costs of 2% of sales 13
  • 15. Pearson Digital Textbook eReader 7. Pearson’s tax rate remains constant at 28% 8. Usage of a higher risk rate (WACC) at 10% as compared to Pearson’s existing rate of 8.9% 9. No external debt is issued NPV (CF) Market Share Device Cost 37% 50% 75% $99 1.59B 1.44B 1.17B $199 1.48B 1.34B 1.06B $299 1.34B 1.23B 0.95B Figure 6: Pearson's Digital Textbook eReader NPV Figure 6 shows Pearson’s NPV based on their potential share of the digital textbook eReader market (based on current projections), under the assumption that the digital textbook eReader is given out for free and the cost absorbed by Pearson, in exchange for a specific level of subscriptions of text packs for a minimum period of five years per class. If Pearson is able to maintain its current share of textbooks in the school districts where it offers their digital textbook eReaders, the NPV of their cash flow accounts to $1.33 billion even by offering it’s most expensive eReader (costing Pearson $299) for free. In addition, the savings in not printing physical textbooks will offset the increased author royalties by a huge factor, thereby increasing Pearson’s profitability (variable cost of distributing a textbook is zero). With increased market share, Pearson bears the upfront onetime cost of providing free eReaders to its customers, but will realize the profits of contractual text pack subscription sales in future periods. In addition, by exploring variable pricing for text packs for different subjects for different segments, Pearson can grow their profits beyond our projections. Recommendations We recommend that Pearson partner with a hardware manufacturer to build a proprietary eReader for their digital textbooks. By taking this course of action Pearson will be able to ensure that they maintain at least two distribution mechanisms for its digital content. Additionally, Pearson should be able to combine its existing relationships and long term contracts within the education industry with its new end to end digital textbook solution to capture the vast majority of the value created. 14
  • 16. Appendix 1. Market Share Growth for 4 years 2008 2011 2012 2013 2014 Universities Public 13,972,000 Undergraduate 12,591,000 1.00% 2.50% 4.00% Graduate 1,381,000 1.00% 1.00% Private 5,131,000 Undergraduate 3,775,000 1.00% 2.00% 4.00% 5.00% Graduate 1,356,000 1.00% 1.00% Elementary / Secondary Pre-K - 8 39,179,000 Public 34,667,000 1.00% 2.00% 3.00% Private 4,512,000 1.00% 2.00% Grade 9 - 12 16,321,000 Public 14,955,000 3.00% 4.00% 6.00% 8.00% Private 1,366,000 3.00% 4.00% 5.00% 6.00% Mkt Size 527,380 1,200,920 2,197,205 3,128,370
  • 17. 2. Financial Model with $299 reader (given out for free), $10 annual subscription/student for a text pack per class 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Period 0 1 2 3 4 5 6 7 8 9 10 Units Sold 0 527,380 1,200,920 2,197,205 3,128,370 3,159,654 3,191,250 3,223,163 3,255,394 3,287,948 3,320,828 Unit Price $299 $293 $287 $281 $275 $269 $263 $257 $251 $245 $239 Reader Revenue $0 -$3,153,732 -$14,363,003 -$39,417,858 -$74,830,610 -$94,473,646 -$114,502,059 -$134,921,592 -$155,738,067 -$176,957,378 -$198,585,502 Content Revenue $30,318,422 $123,568,939 $305,015,715 $585,731,754 $591,589,071 $597,504,962 $603,480,011 $609,514,812 $615,609,960 $621,766,059 Revenue $0 $27,164,690 $109,205,936 $265,597,857 $510,901,143 $497,115,425 $483,002,903 $468,558,419 $453,776,745 $438,652,582 $423,180,557 R&D -$5,000,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 E-Reader Unit Costs -157,686,620 -201,388,460 -297,889,215 -278,418,335 -9,353,826 -9,447,365 -9,541,838 -9,637,257 -9,733,629 -9,830,965 -9,929,275 Labor/Distribution 0 -7,726,644 -17,235,604 -30,877,322 -43,027,601 -42,513,141 -41,984,088 -41,440,203 -40,881,242 -40,306,958 -39,717,100 Marketing 0 -3,090,658 -6,894,242 -12,350,929 -17,211,040 -17,005,256 -16,793,635 -16,576,081 -16,352,497 -16,122,783 -15,886,840 COGS $ (162,686,620) $ (215,705,762) $ (325,519,060) $ (325,146,586) $ (73,092,468) $ (72,465,761) $ (71,819,562) $ (71,153,541) $ (70,467,369) $ (69,760,707) $ (69,033,216) Depreciation 15,768,662 35,189,358 63,068,572 87,925,967 86,915,754 85,876,544 84,807,858 83,709,211 82,580,110 81,420,056 80,228,543 EBIT -146,917,958 -153,351,714 -153,244,552 28,377,239 524,724,429 510,526,208 495,991,200 481,114,089 465,889,486 450,311,930 434,375,884 EBIT*(1-tax) -105,780,930 -110,413,234 -110,336,078 20,431,612 377,801,589 367,578,870 357,113,664 346,402,144 335,440,430 324,224,590 312,750,637 CF $ (90,012,268) $ (75,223,876) $ (47,267,505) $ 108,357,579 $ 464,717,343 $ 453,455,414 $ 441,921,522 $ 430,111,355 $ 418,020,540 $ 405,644,646 $ 392,979,180 NPV $ 1,337,853,377