As the summer heat started to rage in most parts of China since early May, a different kind of heat was rising among the country’s edtech space. Zuoyebang—the edtech giant in China was one of the first to be hit by the heatwave.
The company’s growth hacking department sent out a sudden and urgent message to all its advertising partners, demanding them to pull all its advertisements offline and stop all sales calls and messages.
Its advertising partners were puzzled by the demands. These scheduled ads were designed months in advance and incurred considerable expenses for all parties. Zuoyebang’s explanation was simple yet cryptic, “There is a problem with the content of the ads; we need to pull them offline.”
The advertising partners soon realized the reason behind Zuoyebang’s sudden decision when authorities in Beijing announced massive fines of RMB 500,000 (USD 78,152) for four popular edtech companies on April 25, 2021. These companies are GSX Techedu, Xueersi, New Oriental, and Gaosi. They were fined for misleading advertisements, including price misrepresentation (e.g., “Original Price: RMB 799 RMB (USD 125), now only RMB 50 (USD 8)”. In reality, the products were never sold for 799 RMB.)
Summer is a very important period for edtech companies as students spend their time learning at home. The months of April and May are when the growth and sales departments of edtech companies work overtime to ensure their summer courses are completely sold out. In 2020, Zuoyebang’s target was to achieve significant growth to directly compete with Yuanfudao. In order to achieve these goals and launch learning centers across different cities, some of Zuoyebang’s employees did not return home for the entire summer.
In 2021, uncertainty over advertising rules caused many edtech companies to cancel their pre-summer sales campaigns.
Shattered IPO dreams, shattered livelihoods
The new regulations directly affected Zuoyebang’s IPO dreams. The Beijing-based company aimed to be listed in New York in 2021, hence it employed a new CFO and finished drafting its prospectus. This listing would have valued Zuoyebang at over USD 10 billion.
On May 26, 2021, Zuoyebang announced it was shelving its IPO plans indefinitely.
If we compare the edtech industry to a bullet train speeding onto the horizon, where investors and founders were confident of scaling at high speed and taking over the markets, the recent regulations turned off the engine on the bullet train suddenly, and the entire industry is grinding to a halt.
Nobody expected the massive fines to be a prelude.
On May 27, 2021, a number of teachers who were prepared to join Yuanfudao found that the company had disbanded its WeChat group for incoming teachers for fear of “misleading advertisements within the group.” They shortly received notices that there were insufficient incoming students for these new teachers and that their employment offers had been rescinded.
The teachers soon realized that Yuanfudao was not the only company to stop hiring new teachers; many teachers who held employment contracts with Zuoyebang, GSX Techedu, and Tencent Education also had their employment offers rescinded.
Many of these teachers were fresh graduates who had rejected other job offers and rented apartments near the offices on the assumption that they were going to start work shortly. When they lost their jobs, many had to deal with uncertainty over the coming months.
The HR departments of these edtech companies were similarly puzzled by the decision of their senior management. They were initially being rushed to get these teachers on board as soon as possible in anticipation of the summer sales. In a blink of an eye, they were asked to retract the employment offers to the same teachers.
Many insiders have commented, “We knew we were going to take a reputational hit, but what choice did we have? Retracting their job offers comes at a cost to us too; we had to pay a recruitment fee of RMB 2,000–5,000 (USD 313–782) to the recruiters who helped us manage the entire employment process.”
On June 1, 2021, the HR department of Yuanfudao received new instructions, “Let us get in touch with those teachers whom we retracted offers previously and find them some other roles in the company. They probably have rented apartments and took on obligations to come and work for us. Let us try to help them and give them a chance.”
Yuanfudao’s valuation currently stands at around USD 15 billion RMB 96 million), and it started a new fundraising round in this January, aiming for a valuation in excess of USD 20 billion (RMB 128 billion). After introducing the new regulations, Yuanfudao pulled the plug on the fundraising round in March.
According to an insider in Yuanfudao, the current mentality of everybody is to “endure” and to wait for clarifications as to the final policy direction.
Where it all started
The first whispers of enhanced supervision in the online education industry were first heard on March 5, 2021, during the Two Sessions of the plenary meetings in China. In the three months since then, there has been relief, anguish, and reflection in the edtech market, but the dominant feeling is “uncertainty.”
In the Two Sessions, many representatives suggested regulating education companies that were not registered as schools; some representatives even called to stop such unregulated education altogether.
Many industry players only knew that enhanced regulations were coming, but nobody knew in what form nor what shape these regulations would take. TAL Education (NYSE: TAL) issued new instructions to its partnerships team, requiring force majeure clauses to be inserted into all upcoming contracts with ByteDance and Tencent. If there was a change in the law or any unexpected events affecting the partnership between TAL and these partners, TAL could walk away without any responsibility.
A meeting document discussing education reforms was subsequently leaked in mid-March 2021. The document spoke about the “Two Reductions”: a) Reduction of a student’s academic burden from school; and b) Reduction of a student’s academic burden from education organizations outside of schools.
These new policy directions directly affected the online education scene in three ways. First, schools were recognized as the primary provider of education services where students were discouraged from partaking in academic and educational activities over the weekend. Second, the authorities would stop approving applications for companies keen on providing K-12 services outside of school. Third, strict restrictions on the advertising for both online and offline education services.
Many investors have commented that if there were restrictions on whether students can engage in academic activities over the weekend, the multi-billion-dollar total addressable market of edtech would shrink significantly.
In March 2021, an edtech alliance led by the Cyberspace Administration of China was established to promote industry standards and strengthen internal regulations in the edtech industry. On May 17, 2021, the education authorities from Shanxi Province announced that they would stop approving applications from private companies that wanted to provide K-12 education services.
Top edtech startups have relied heavily on growth hacking and advertising to achieve multiple growth rates over the past three years. On May 19, 2021, the State Education Commission issued a guidance note on advertising by edtech companies stating that growth hacking and advertising methods long employed by these edtech companies have all been restricted.
While the details of these restrictions may not be clear, the general direction has been set. Across the past few weeks, the Advertising Association of China has held multiple seminars to emphasize the restrictions laid out for K-12 edtech companies. These restrictions include no open promise of improvement, no actors masquerading as teachers, and no advertising language of “star teachers / clear improvement in grades.” These would all be treated as misrepresentations by the authorities.
How has the market responded?
Market players responded swiftly to these regulations. A growth hacker in TAL shared that after these restrictions were released, TAL started internal preparations to pull all online advertisements at a moment’s notice if needed. An industry insider shared that ByteDance Education had created an internal list of buzzwords that its advertisements should avoid. These buzzwords include “teacher,” “improvement,” and “results,” among others. It also plans to re-record various videos and pivot away from academic tutoring as part of its edtech offerings.
As various edtech companies were figuring out these new policy directions, new sanctions were being introduced by the authorities. In April and May 2021, the authorities in Beijing levied new fines amounting to RMB 7 million (USD 1 million) on GSX Techedu, Xueersi, New Oriental, Gaosi, Zuoyebang, and Yuanfudao over advertisement misrepresentations.
Investors have differing views over these sanctions. A Zuoyebang investor shared that if the advertising restrictions continued, it might not be that bad for Zuoyebang. In the edtech advertising war, the company with the deepest pockets will win the battle. If there were restrictions on advertising, more resources could be channeled towards improving its product to convert and attract new users.
According to data from QuestMobile, as of November 2020, Yuanfudao’s app had 20 million monthly active users, while Zuoyebang had 100 million monthly active users.
Zuoyebang has raised funds on a smaller scale compared to Yuanfudao. In 2020, China’s K-12 edtech space raised RMB 50 billion in total, half of that went to Yuanfudao, and a third of that went to Zuoyebang.
Yuanfudao’s investors also welcomed the new restrictions. If the advertising restrictions were maintained, Yuanfudao could adjust its growth targets to 30–40% instead of the current 100–200%. If Yuanfudao stops channeling cash to advertisements and maintains its student subscription renewal rates at the current 70% rate, Yuanfudao might be able to hit profitability earlier than expected.
The company which has suffered the most is GSX Techedu. At the start of the year, GSX Techedu was valued at USD 38 billion. Within four months, its share price has plunged by 90%. Any hope of rejuvenation was extinguished by May 2021.
On May 21, 2021, the Chinese authorities introduced new measures and policies to strictly regulate education companies that were not schools to further reduce students’ academic burden. Shortly after that, the CEO of GSX Techedu, Chen Xiangdong, announced in an internal meeting on May 27, 2021, that it was withdrawing from the pre-education space and would begin an internal retrenchment exercise soon.
Chen’s words in the meeting reflect the general consensus in the market right now: “The world of business is brutal, and the only priority is how to survive another day.”
While it is too early to tell how the authorities will regulate edtech players in China as policy details have not been released, the direction is clear—the great depression of edtech is here.
Players who can tide over the current crisis will have to play by the rules, and investors must realize that edtech in China may no longer achieve the growth rates they were previously used to.
This article originally appears in the LatePost, and was written by Chen Jin.