(Illustration: iStock/Mykyta Dolmatov)
Since at least the Clinton administration, the edtech sector has often been hailed as a catalyst for fundamentally transforming the global education system, with the market ballooning to over $320 billion in revenue as of 2023. Yet with global annual education spending exceeding $6 trillion, edtech’s economic contribution still seems orders of magnitude smaller.
The majority of overall education spending falls into traditional cost categories. In the US, over 95% of the K-12 education budget goes to compensation, operations, and services, with only around 2% going to technology. This is significantly lower than the US corporate technology spending average of 8.2% and a far cry from the digital industry’s 22%. Yet two-thirds of educational software licenses purchased in the US remain unused. Ed-Tech in education is often neither new nor trusted.
That doesn’t mean the industry will always remain in a state of excitement and hype. For example, Ed-Tech is currently at its peak in popularity as a Google keyword, far surpassing climate tech and rivaling medical tech. Yet the market cap of private healthcare is estimated at $5 trillion, making up 60% of the $8 trillion market size. Meanwhile, the market cap of the global education market lags far behind, at only about 5% of the total $6 trillion spend.
After a wave of excitement caused by the pandemic, private edtech investment fell 50 percent to $25 billion in 2022. There are twice as many edtech deals as climate tech, but on average they attract only one-eighth of the funding. This highlights a fundamental problem: the edtech funding market seems ill-suited to support effective learning solutions.
Did you enjoy this article? Subscribe to read more just like it and the complete SSIR archives.
Learning the wrong lesson
Ed-Tech, which encompasses both school and workplace learning, presents a unique challenge in that the end user is far removed from the buyer, who is almost always a non-learner and often a non-teacher. This disconnect can delay recognition of quality products and allow subpar products to settle in long software review cycles. The notion of “product-market fit” in other technology sectors, which assumes that addressing user problems will drive demand, can be misleading; the best solution will not always prevail.
Added to this is the difficulty of measuring the effectiveness of edtech itself: it requires resource-intensive research projects that often cost six figures or more, and there are no agreed-upon, universal metrics. Even if edtech buyers want to source the best products available, it’s difficult to know which solutions are best-in-class. This makes it hard for investors to predict and guarantee adoption.
Ed-Tech is also characterized by its diversity. The market is fragmented into areas such as higher education, K-12, preschool, enterprise, and open learning, each with distinct subsegments and unique requirements. This diversity makes it difficult for investors to make direct comparisons. With more than 30 subsegments and a total addressable market (TAM) of $320 billion ($115 billion in the U.S.), the average size of each investment category in Ed-Tech is less than $4 billion. For investment funds that target 10-20 ventures, this size is limiting and prevents specialization.
The issue of the small overall addressable market represents an additional problem for the world of venture capital. According to Apple, there are over 80,000 iPhone education apps worldwide, and the number of EdTech companies in the US is estimated at over 10,000. Combining this with the market size, we conclude that the expected revenue of the average EdTech company is $10 million. This seems at odds with the established VC mindset of expecting a 10x return on investment and the notion of unicorn hunting. The EdTech industry has spawned around 30 such mythical creatures so far, but they remain more of a statistical curiosity than a viable investment thesis.
From an investor’s perspective, the properties of the edtech capital world are similar to those of the used car market, studied by George Akerlof in his 1970 paper outlining the “Lemons Problem.” That is, investments are proliferating, but investors have no reliable way to gauge the quality of the stock before buying it, and founders can’t reliably communicate it either. So investors end up making subpar, low-confidence investments; none are likely to be “peaches,” and most are likely to be “lemons.” This gradually drives the “peaches” out of the market. Edtech founders who have developed products that truly contribute to learning outcomes and have the potential for widespread adoption are priced out because the expected “lemon” term sheets are unattractive. The equilibrium outcome is that only “lemons” are funded, and companies with the potential to be “peaches” leave the market unfunded.
Edtech’s “bad problem” is also evident in financial data. According to Preqin data covering all VCs that invested in edtech at least once between 2008 and 2023, the average return on edtech venture funds is 17%, compared to an average of 36% for other technology VCs. Many education-focused VC funds have closed and few have exited, resulting in underperformance of edtech assets in portfolios.
End users are becoming increasingly aware of the problem of “bad products.” For example, the United Nations recently released a warning report showing that most edtech products are not evaluated, with fewer than one in eight UK companies undergoing rigorous testing or disclosing third-party certification. In the US, only one in ten edtech decisions are backed by peer-reviewed evidence, and much of the data comes from biased sources.
A recent survey by the Association of State Educational Technology Directors found that more than half of U.S. teachers believe they are not effectively using available educational technology, and fewer than one in 10 believe they need to use it more. This “lemons” problem reflects significant delays in the hoped-for education technology revolution, with untested tools obscuring the promise of “peaches.”
Shifting to an impact-centered investment model
Investors have a clear influence on today’s edtech issues, but they also have the potential to spearhead change. Drawing on lessons learned from impact investing in other markets, here are four social innovations relevant to the world of edtech that could address the underlying “lemons” problem.
1. Incorporate impact intent into your investment process.
Investors looking to put capital into edtech should look for targets with the clear premise that, in the long run, their capital will generate a higher total return if the technology has a real impact on education. To that end, they should aim to formally establish the validity of potential investments during the due diligence process. While feasibility studies and RCTs are cost-prohibitive at the minimum viable product stage, edtech validity can be reasonably understood using less resource-intensive methods. For example, the US Department of Education provides a framework that categorizes edtech solutions into four levels. Level IV is awarded for “promise of evidence” and “foundational support,” while Level III requires “one correlational study with appropriate statistical control.” Certification is granted through the What Works Clearinghouse, a government-sponsored organization. Investors can enter such a framework with the assumption that the best edtech products will not have much trouble getting certified. If they have much trouble getting certified, they probably shouldn’t scale. One example of an edtech investor that successfully leverages such logic is Owl VC. The firm’s annual impact report details the rigor of measuring the effectiveness of its portfolio companies, revealing how many have a product research base, conduct quasi-experimental studies, or have full-time staff dedicated to outcomes.
2. Review the academic literature to understand possible broader implications.
Investors can complement the bottom-up logic of evidence levels by integrating a top-down synthesis of a broad range of academic research. The ERIC database alone stores over 28,000 studies on educational effectiveness, which investors can leverage as a resource to conduct more in-depth comparative analysis of future edtech tools with existing interventions. Understanding the academic consensus (triangulating papers and making assumptions when data are not available) allows for a comprehensive picture of expected effectiveness and addresses issues such as scalability, depth, and additionality of impact. Such careful efforts ensure that capital is allocated not only to solutions that work, but to solutions that outperform current alternatives. Frameworks such as impact-weighted accounts help translate academic insights into quantifiable predictions and provide benchmarks for future impact goals. An example of an investor leveraging such an approach in another industry is Sama Equity, a sustainability-focused private equity fund that uses academic research in its impact reports to quantify the environmental impact of its investments and set future goals for its portfolio companies.
3. Create the infrastructure for impact reporting at the portfolio level.
While growing startups may be hesitant to build out effectiveness measurement and reporting capabilities (and rightly so; startups shouldn’t check their own homework), portfolio investors may be in a good position to do just that. Not only do investors have an incentive to dispassionately evaluate the effectiveness of their investments for governance and steering purposes, but they also benefit from the intellectual synergy of deploying such impact infrastructure across their portfolios – measurement across 10 companies instead of 1. Investors can hire in-house staff to do this (indeed, many impact funds are starting to hire people dedicated to impact effectiveness) or they can leverage external solutions such as LearnPlatform. With investors at the forefront of effectiveness measurement, this will also accelerate the convergence of industry standards and create a more sophisticated understanding of education effectiveness in relation to commercial potential. In return, impact refinement will enable investors to better select future investment candidates, allocate resources more efficiently across their existing portfolios, and ultimately report impact to their own limited partners, expanding their access to future capital.
4. Align your hold periods with realistic scaling timelines.
Finally, it is important to reconcile the impatient logic that has plagued some EdTech venture investments. The typical VC paradigm of spending money to accelerate sales does not apply to most EdTech scenarios. Sales cycles to technology-skeptical schools and cost-conscious enterprises are significantly longer, and traction builds over multiple academic years rather than virally. Investors seeking EdTech targets should consider reframing their return expectations and moving from a “unicorn-hunting” mentality to one of “trimming the camels”: holding a company for seven years or more and helping it patiently build a customer base while fine-tuning its product. Given the small market size and fragmented landscape, EdTech businesses are unlikely to become unicorns anyway. But they can offer steady, recurring cash flows with a sticky customer base, making them a commercially attractive investment strategy if properly underwritten, especially in a recessionary and volatile market. By lengthening holding periods and adjusting scale goals, investors can create the space needed for end users to adopt and evaluate the product, reduce the unhealthy pressure brought on by “lemon” sellers, and bring the “peaches” back into the market.
The education technology revolution can still happen. After all, education is a $6 trillion spending sector worldwide, with software accounting for a very small share. Just as buying a used car is easier today than it was in the 1970s, the education industry can bounce back from its “faulty goods problem.” Since flawed financing markets are one of the root causes of its current underdevelopment, investor-initiated reforms could benefit all stakeholders, especially learners.
Support SSIR’s coverage of cross-cutting solutions to global challenges.
Help us spread innovative ideas. Donate now.
Read more stories by Jakub Labun.
