Charter Schools and Private Profits

The emergence of educational management organizations to run charters raises questions about the pursuit of profits and the quality of education by DAVID N. PLANK, DAVID ARSEN AND GARY SYKES

One of the most significant developments associated with the introduction of charter schools is the rapid emergence of educational management organizations.

Unlike the schools with which they contract, which are legally prohibited from seeking profits, EMOs usually are for-profit firms that seek to earn profits from their provision of administrative and educational services to schools. Rapid expansion in the number of charter schools has opened the door to the public school system for these firms, and they have been quick to enter.

A critical question is whether this development is good or bad for students. Our research in Michigan raises concerns, while pointing to the importance of the rules that govern the emerging market for schooling. The rules embodied in charter school legislation determine whether expanding private participation in the public school system will help or harm children.

Different rules create different incentives, and different incentives produce different outcomes. A carefully designed policy framework can ensure that the market for schooling works efficiently and effectively to improve the educational opportunities available for all children.

Debate Over Profits
In an interview we conducted not long ago, the principal of a charter school made a surprising statement. "I hate charter schools," she declared. "They are not doing a better job, and they will ruin public education." She was especially troubled by the thought that charter school operators might profit from their management of schools.

"You can’t make profits if you’re committed to educating kids," she said, because there is never enough money to meet all of the challenges that children bring to school. In her view, profits can be obtained only by depriving children of services and opportunities that would help them to succeed in school. This is wrong, she said.

The views of this principal may be unusual among charter school administrators, but they are widespread among educators in the traditional public school system. Professionally committed to pursuing ambitious goals with an ethic of public service not personal gain, it is natural for public school educators to view profits as suspect. After all, the money that is returned to adult investors as profit is money that could otherwise be spent on the education of children.

In response to these qualms, the advocates of private-sector participation in the education system make three arguments. First, they say, many important activities in the educational system always have been the preserve of private firms, including textbook production and most standardized testing. Private sector participation has been increasing in recent years. Why should profits be acceptable in some parts of the educational system and not in others?

Second, they contend the pursuit of profits serves our society well in many ways, as anyone who has a 401(k) retirement plan or shares in a mutual fund will recognize. We rely on profits to finance our retirement. We rely on for-profit firms to provide most of the goods and services we consume, including food, housing and health care. Why should we exclude for-profit firms from providing educational services as well?

Finally, the advocates of private-sector participation in education note that the public sector has failed to provide a satisfactory standard of education for large numbers of children, especially poor and minority children in urban school districts. Some claim that resources are being wasted on a grand scale. If private firms, motivated by profit, can enhance organizational efficiency and do a better job of educating these children, why not let them try?

The Rise of EMOs
Charter schools are public schools, financed by taxpayers and accountable to agencies of state or local government. Like other public schools, they are non-profit organizations. Any surplus revenues they generate must be used to advance their educational purposes.

Increasingly, however, charter schools are managed under contract by for-profit educational management organizations. EMOs provide a variety of services to charter schools. Some offer a relatively limited array of management and financial services to their schools. Others offer whole-school packages to charter school operators.

Under these contracts, the EMO exercises full administrative control over the school. The principal and teachers are EMO employees, and decisions about curriculum and instructional practice are made by the EMO. Some EMOs, including Edison and Advantage, have implemented whole-school packages in traditional public schools as well as in charter schools.

One of the early lessons from charter school reform is that starting a school from scratch without the support of a public school district is very difficult. Opening and maintaining a building, hiring and paying a staff, developing and implementing a curriculum and ensuring compliance with state regulations and reporting requirements takes more work than many charter school operators ever imagined. Many EMOs have emerged to provide charter schools with the administrative support that traditional public schools ordinarily receive from the central office. They are, in other words, private-sector school districts.

There are two questions we need to answer as we seek to evaluate the role of EMOs in the public school system. First, can EMOs produce student educational outcomes that are equivalent or superior to traditional public schools while generating profit rates sufficient to attract private investors? Second, can EMOs generate profits from increased efficiency and improved performance--and not at the expense of students who remain in traditional public schools?

Even if privately managed schools satisfy both of these efficiency conditions, thoughtful people may disagree as to whether they advance or undermine other values that are important in the public school system.

How They Profit
In a TV commercial from a few years back, an elderly stockbroker explains his firm’s philosophy to a prospective client: "We make money the old-fashioned way; we earn it." How do EMOs earn their money? Three ways, primarily


  • Reducing labor costs.


    The most obvious way to generate profit in education is to reduce labor costs, either through cuts in employment or compensation. Salaries and benefits for staff represent as much as 85 to 90 percent of non-capital spending in the educational system. Reducing the number of teachers or administrators, or paying them less, can free lots of money for other uses, including profits.

    Public school educators know this. In recent years many public school districts have turned to private-sector contractors to provide food, transportation and other services previously offered in-house. Districts facing budgetary difficulties routinely seek to reduce labor costs by cutting back the number of teachers, offering retirement incentives to highly paid veterans or shifting administrators back to classrooms.

    Educational management organizations have tried to reduce their labor costs in charter schools in a variety of ways. Teachers in Michigan charter schools are commonly younger and less experienced than teachers in neighboring public schools. Beginning salaries are generally competitive, but seniority brings smaller rewards. Teachers’ benefits are generally far less costly because EMOs do not have to participate in the state’s retirement system. Class sizes are sometimes significantly larger. Support services can be either contracted out to low-wage firms or provided on a limited basis by parent volunteers.

    It is not yet clear whether reducing labor costs is a strategy that promises long-term profitability for EMOs. If charter schools consistently pay teachers less than they could earn in nearby public schools, then their EMOs will have to provide some compensating advantage (stock options?) to make charter school employment attractive or else develop instructional strategies that make effective use of less qualified and less experienced staff. Teachers, parents and students strongly prefer smaller classes, so the potential for significantly increasing class sizes is limited.

    Reducing labor costs without compromising the educational services that children receive is likely to prove difficult. On the one hand, teachers may resist charter schools’ expectations that they work harder for less money. For example, the professional staff in one Michigan charter school has recently voted to affiliate with the Michigan Education Association. Still, it may be hard to demonstrate educational success while relying on young and inexperienced teachers in large classes.


  • Using economies of scale.


    Another way for EMOs to generate profits would be to take advantage of economies of scale.

    Scale economies rely on the possibility of lowering per-pupil costs by spreading them over larger numbers of students. For example, a national firm offering a standardized curriculum for hundreds or even thousands of schools may significantly reduce the per-pupil cost of curriculum development and instructional materials in the schools they manage.

    Similarly, it may be possible to standardize financial and other administrative services for large numbers of schools, reducing the per-pupil cost of providing these services. When economies of scale are present, firms can profit by increasing the number of students they serve.

    It is not yet clear whether significant economies of scale are available in the public school system, but there are reasons to believe that the potential for savings is limited. Parents and students expect every classroom to be supervised by a teacher, so firms that increase the number of students in their schools must also increase the number of teachers.

    Teachers’ salaries represent at least two-thirds of all educational expenditures, so economies of scale must be found in the remaining third of the educational dollar. Little doubt exists that per-pupil expenditures on administration, support services, instructional materials and operations and maintenance could be reduced in large-scale organizations, but it remains to be proven that the savings would be large enough to generate significant profits for EMOs.


  • Providing fewer services.


    Perhaps the most direct way to make money in the public school system is to provide fewer services to students and their parents or to make parents pay for the services their children receive. Most charter schools in Michigan do not provide transportation or school lunch programs for their students. Interscholastic athletics, band and orchestra programs and other extracurricular activities traditionally available in public schools are seldom offered in charter schools.

    Public school educators are familiar with these strategies. Facing budget pressures, many school districts have tried to cut back on extracurricular activities or have imposed participation fees. However, these efforts arouse fierce opposition from parents and students in charter schools and traditional public schools alike. This at least calls into question whether simply reducing services is a strategy that will lead to long-term profitability for EMOs.

    The most potent variant of this strategy is to specialize in the education of less costly students. Since they can design their schools to serve niche markets, charter schools can avoid providing services that traditional public schools must offer.

    It costs considerably less to educate elementary students than secondary students because elementary students don’t require the specialized courses, facilities and equipment that are generally available in high schools. Students with severe handicaps or special needs can cost far more to educate than students without disabilities. Students who do not speak English at home may cost more to educate than students who are native English speakers. Schools that find ways to limit the enrollment of students who are expensive to educate can significantly reduce their costs and may succeed in generating profits for their EMOs.

    Under Michigan’s school finance system the state provides the same subsidy for every student in a local school district. If students from that district choose to attend a charter school, their subsidies follow them to their new school. The state subsidy is greater than the average per-pupil cost of educating elementary students, but less than the average per-pupil cost of educating high school students.

    This represents a powerful incentive for schools to specialize in the education of elementary students, and this is just what most Michigan charter schools do. Many schools focus on early elementary education. Only a few offer programs for secondary students, and many of these are low-cost alternative or vocational programs targeted to specific groups of students.

    By specializing in the education of low-cost students, charter schools are able to reduce the average cost of educating the students in their schools. The margin between the subsidy provided by the state and the average cost of education is available for other uses, including profits for EMOs.

    When charter schools reduce the average cost of educating students in their schools, however, they raise the average cost of educating students in nearby public schools, which must continue to offer high-cost programs, including secondary education and special education services. If low-cost students leave to take advantage of opportunities elsewhere, then the subsidy provided by the state will begin to fall short of the average cost of educating students in the traditional public school system.

    In this case, the profits of charter school operators are obtained at the direct expense of neighboring public schools. This will not lead to general improvements in the education system, but instead to fierce competition to enroll the most desirable (that is, the least expensive) students.

  • Elusive Profits
    It’s hard to generate profits in the world of K-12 public education, as many management companies now are learning.

    Despite widespread investor interest in the basic education industry, profits are proving elusive for most EMOs. The share price of Edison Schools has fallen by nearly a third in the weeks since the company first offered shares to the public. Other companies are experiencing similar difficulties.

    It’s even harder to make money "the old fashioned way." As generations of public school reformers have discovered, efficiency gains and scale economies are hard to come by in education. Reducing labor costs is likely to have negative effects on student learning, and cutbacks in the services that schools provide are vehemently opposed by parents and students. Under these circumstances, the incentive to seek profits by recruiting low-cost students is strong.

    Whose Rules?
    This is the bottom-line question: Is the pursuit of profits in the public school system good for kids?

    Our answer is straightforward: "It depends on the rules that govern the market for schooling."

    There is no reason to suppose that the pursuit of profits necessarily damages the educational opportunities available to children. If private-sector firms can provide better educational services at lower cost than their public sector counterparts, they should earn a profit for doing so.

    At the same time, it is clearly bad public policy to allow charter schools to deny children the services they need or to specialize in the education of less costly students. This is the easy way to profit in the public school system, and Michigan’s school finance policies promise substantial rewards to EMOs that take advantage of the opportunity.

    This is neither illegal nor immoral. Firms are simply following the rules. Seeking profits by specializing in the education of low-cost students will not and cannot lead to general improvements in the public school system, however.

    Whether charter schools enhance educational opportunities for all children or widen the gaps between winners and losers in the education system ultimately depends on the rules that are developed to govern the emerging market for schooling. It depends, as well, on the leadership of educators who are committed to expanding educational opportunities for all children. If we get the rules right, we can harness the power of markets to advance the core purposes of public education.

    Opening Doorways
    Charter schools mean different things to different people. President Clinton takes this view: "Charter schools are living proof of what parents and teachers can do to reinvigorate public education." To others, they offer a potent strategy for breaking down the public school monopoly and creating a competitive market for schooling.

    Among other things, charter schools open the door to private-sector firms seeking profits from the educational services they provide. This is not necessarily a bad thing, but state policymakers must ensure that the profits of educational management organizations are made the old-fashioned way and not simply by taking advantage of flaws in policy to exploit schools and children for the benefit of adults.

    David Plank is a professor of educational administration at Michigan State University, 419 Erickson Hall, East Lansing, MI 48824. E-mail: dnplank@msu.edu. David Arsen is an associate professor of political economy in James Madison College at Michigan State University. Gary Sykes is a professor of educational administration and teacher education at Michigan State University. This article is based on their 1999 report "School Choice Policies in Michigan: The Rules Matter."