Edtech has always captured the minds of investors and founders alike in China. With a population of 1.4 billion people, an emerging middle class, and a historical emphasis on education, leveraging technology to make education more accessible to the public has been a sound business model in China. Some of the leading players that have successfully capitalized on the edtech trend include Yuanfudao and Zuoyebang.
Yuanfudao’s most recent fundraising kicked off this January, with a target to raise USD 1 billion. Thanks to a proven business model, strong traction, and growing revenue, investors flocked to its fundraising like bees to honey. Even existing investors like Boyu Capital and DCP Capital had to fight for more allocation on the capital table. Investors revealed that Yuanfudao was not keen to talk to new investors because it did not have the time to go through the due diligence process with them; a quick chat over coffee was all it could entertain.
The growing edtech market
The global COVID-19 pandemic in 2020 was a boon for edtech, where venture capitalist funds deployed RMB 50 billion (USD 7.8 billion) collectively in the sector. This does not include funds raised on the secondary market or deployment by corporate venture capitalists. ByteDance alone invested RMB 4 billion (USD 625 million) in edtech in 2020.
Chen Xiangdong, CEO of GSX Techedu, shared in an interview that in 2020, 80% of the capital deployment in edtech flowed to China. This was previously unimaginable in the history of capital deployment.
The inflow of capital buoyed the valuation of edtech companies. Since 2018, Yuanfudao’s valuation has increased 5x from USD 3 billion to USD 15.5 billion (RMB 19 billion to RMB 99 billion). Zuoyebang’s valuation has also multiplied over the same period.
The investment thesis is clear—China has 180 million students and a 23.2% online penetration rate for the K-12 education market. After the huge boost over 2020, there are now only 40–50 million students actively engaged in online education. This suggests that the industry still has room for exponential growth—which might lead to a “winner-takes-all” scenario if players can dominate the edtech space.
In a global edtech frenzy, valuation is not the only thing soaring—the pressure on edtech companies to hit their metrics has increased as well.
Edtech companies frequently scrutinize their user conversion rates, forcing these conversion rates to increase in line with their valuation. This results in growth hackers designing campaigns to convert user signups by introducing affordable trials to hook users into signing up for subscription packages.
On Douyin, the Chinese version of TikTok, users frequently see advertisements featuring parents arguing over which edtech product to subscribe to for their children or colleagues discussing which edtech products offer special discounts.
Other marketing techniques include engaging actresses acting as senior teachers with many years of experience in marketing videos and providing unrealistic promises of improved grades over a short time. These techniques ultimately resulted in the authorities stepping in and banning advertisement misrepresentation to protect students and reduce their academic burden, painting a gloomy picture for the sector’s future.
In May, GSX Techedu hosted an internal meeting where Chen shared that his company had to focus on education and not growth metrics.
The pursuit of growth and revenue metrics reflects an underlying trend where investment flowing into edtech has far outstripped the revenue generated by edtech in China.
In 2020, the average cost of producing a three-month lecture-style module for an edtech platform was around RMB 4,000 (USD 625). Each student would have to renew their subscription for two or more quarters for the edtech company to break even. Many students sign up via discount codes or trial packages, resulting in a minimum user churn rate of around 30%, making the business model unsustainable from a unit economics basis.
Edtech companies have tried to overcome this hurdle by focusing on growth rates. To achieve higher growth rates, edtech companies raised successive funding rounds to create in more advertisements across multiple channels and convert new users into paying customers.
With the change in authorities’ attitudes regarding edtech advertisements, investors’ confidence in edtech has also evaporated.
The long shadow of edtech regulations
After the Two Sessions in March 2021, Yuanfudao stopped its fundraising round. Many industry watchers commented that the valuation of edtech companies fell when news of enhanced regulations for the edtech sector was released. One of Yuanfudao’s existing investors commented that if these enhanced regulations were a false scare, then Yuanfudao’s share price had the potential to multiply over the upcoming years. Still, if the enhanced regulations were as they described, then the share price of Yuanfudao could only go down from here.
Over the past few months, the founder of Spark Education (Huohua Siwei), Luo Jian, has been engrossed with investor roadshows for Spark Education’s IPO in New York. Spark Education focuses on pre-education with a USD 1.5 billion valuation—an investor’s darling. In its last fundraising round in October 2020, investors raced to get allocation on the capital table. Tencent famously only conducted commercial due diligence and skipped legal and financial due diligence to ensure it stayed on the capital table.
A mere six months later, Luo Jian was finding it difficult to get investors to attend his roadshow. Many investors who have attended Luo Jian’s roadshow appreciated how he tried to explain why the new regulations would not affect Spark’s business model. Yet regulatory uncertainty casts a shadow over the industry, and investors do not have the appetite to take a position in such unpredictable times.
Luo Jian’s story is common among edtech founders. Another edtech founder who tried to raise RMB 200 million (USD 31 million) in January 2021 found so much interest from investors that he decided to increase the target amount to be raised. The fundraising round was scheduled to close in March 2021, with due diligence being carried out between January and February 2021. However, just before the round closed, the authorities released news of enhanced regulations for edtech companies. This had a chilling effect on investors’ confidence level, and many pulled out shortly after.
What does the future hold?
On April 25, 2021, when news of massive fines for edtech providers was released, many parents reached out to these edtech providers to understand what happened and whether the subscription packages would still be valid.
Most edtech companies have prepared responses for their employees to share with the parents. The key message was to reassure parents that the company will take these regulations seriously and make certain adjustments, but the courses will continue, and the subscription packages will remain valid.
On June 1, 2021, the laws on the protection of underaged minors were changed to restrict academic courses for pre-education children (aged six years old and below).
Many parents have reflected that they see the policy as intended to ensure that all children start elementary school on the same footing. Still, many have also lamented that, in reality, some children have advantages that others do not. As parents, they only want what is best for their children.
Some edtech founders remain optimistic; they shared that they would adapt their course offerings according to the new regulations to continue serving their students. However, depending on how the authorities implement the law, various startups might pull out of the pre-education market.
The uncertainty over the edtech industry is a real concern, yet market watchers can look to history for guidance on how this episode will play out.
In 2012, the Beijing authorities closed all the Mathematical Olympiad training centers in Beijing. TAL Education, which started out by providing Mathematical Olympiad training, was one of the many centers shut down. TAL Education only re-opened its doors when parents insisted that they needed their children to attend the training.
The need for education is deeply ingrained in China; as long as this mentality is around, the education industry will be around.
In 2018, the Education Ministry announced that it would no longer recognize International Mathematical Olympiad as supporting factors for school application. Despite the announcement from the Ministry, top universities and elite academies who run their own enrollment programs continue to place emphasis on Mathematical Olympiad scores. Training centers no longer send their students for International Mathematical Olympiad competitions, but they now hold “capacity diagnostic assessments” for students to prove their ability before seeking admission into top institutions.
Due to how fragmented the offline education market is, the regulation of offline training centers is challenging. Any location (including private residences) with a teacher and students can be defined as a training center.
Unlike the offline education market, the online education marketplace has consolidated over the past few years. By targeting the top edtech providers, the authorities can effectively govern the market. The digital footprint of disobeying regulations is also easily found on data servers, which leaves compliance as the only option available for edtech players.
Many edtech founders share a similar background—raised in an impoverished family but found success due to their education. They seek to change more lives by using technology and allowing education to touch the lives of even more people. China’s biggest edtech players all started by supporting mainstream education, and none sought to start a business selling courses online.
Over time, as the influx of venture capital forced these companies to chase growth and revenue metrics, they had to engage with marketing and growth campaigns—things they likely hadn’t intended to do at the start.
The authorities’ chilling effect raises a question for the future of edtech—on the education value chain, which parts should be overseen by governments to ensure impartiality, and which parts could be put into the hands of a free market to improve efficiency?
It’s a big question but ultimately the answer is: only time will tell.