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How the “Netflix for Textbooks” wants to be the “LinkedIn of Education”

Initial Reaction

When I first heard the news that Chegg was going public I was a bit confused. What are the long-term prospects of a textbook rental service in a world soon to be without textbooks? In least in their expensive, heavy, paper form.

Chegg are primarily known for doing one thing very well, textbook rentals for college students. I’ve used their service before, it was great, and it’s hard to miss all those orange boxes everywhere the first week of school. But that was a few years ago, around the time the 1st iPad was launched. I assumed that by now students would at least have a choice between digital and paper, and if given the choice, why would anyone choose the latter? That would be problematic for Chegg.

The Textbook Industry

It turns out that demand for textbooks is both consistent and inelastic — two of the main ingredients for a lack in innovation. And with the industry being structured as a textbook oligopoly (pun intended), it takes a long time for what’s always been done to no longer be done. There is also little incentive to innovate when you can charge hundreds of dollars per book.

The consistently high cost of textbooks is quite a phenomenon when you think about it — at least from a business standpoint. So I decided to look into this.

Broadly speaking, a product can be expensive for one of the following reasons:

1. Luxury. For this to work, it is implied that the target demographic can afford it.

My findings: they cannot.

2. Exclusivity. For textbooks, I’ll interpret this as access to content that is unique.

My findings: we have this now

3. Production Cost. Keeping in mind that the curriculum is fairly stagnant — there are only so many scientific breakthroughs each year.

My hypothesis: the “cost plus” approach is probably the reason textbooks are so expensive. Also, publishers aren’t exactly known for their killer margins. But in that case, one must question the process leading up to such high production costs, and why it’s passed along to the students.

Other people’s findings can be found here, or for a more detailed analysis, here.

Chegg Found Product-Market Fit, Until it Didn’t

Chegg is the undisputed market leader when it comes to textbook rentals. Their brand is synonymies with the act of renting textbooks — so much that they are often called the “Netflix for textbooks.” Netflix is now doing very well, but lets not forget that it had to face a similar content digitalization challenge of its own. The difference is that when movies evolved from DVDs to online streaming, the content did not change — just the way you accessed it. After all, the movie business wasn’t exactly screaming for disruption.

In Chegg’s case, the future is a bit more ambiguous. The imminent disruption of the textbook industry is long overdue. Partly because Apple choose to make the iPhone before the iPad, but now that an iPad Mini is priced at the high-end textbook range, the industry will change.

This will be a fundamental shift in Chegg’s business model, their core competency revolves around maintaining a massive inventory of soon to be outdated textbooks, renting them, and liquidating the inventory at a fraction of the cost. When digital textbooks become the norm, Chegg’s core competency will no longer be relevant. The problem being solved (access to textbooks), — when digitalized, is all the sudden fulfilled with far more capable players: Apple & Amazon. They enjoy fighting over this stuff. And its exactly the territory the company finds itself in when the need to “rent” books in the first place is removed.

Chegg knows this, which is why it’s reinventing itself.

The “Netflix for Textbooks” wants to be the “LinkedIn of Education”

With an IPO on the horizon, Chegg started branding itself as more than just a textbook rental service, and as “the leading student connected learning platform.” Dan Rosensweig, Chegg’s CEO (who famously got Zuckerberg to agree to a $1 billion Facebook acquisition by Yahoo, only for the deal to break down due to Yahoo bureaucracy), gave an in-depth interview on Forbes about Chegg’s long-term vision and diversified revenue streams. Most of it centers around their mission to help students by putting students first, and building a learning platform that will be relevant in the next “10, 20, 30, 100 years.”

Throughout the interview Dan Rosensweig clearly articulates how Chegg’s vision far exceeds that of a textbook rental company, and how the company is uniquely suited to be the leading platform for students. The following are a few excerpts from the Forbes interview.

On Chegg’s value proposition:

At Chegg, we are building a student graph centered around you, as a student. So, if we know where you went to the high school, where you applied to college, when you got in, what you are studying, then we can bring you scholarships, help you plan your classes, recommend all your required materials and provide them cheaper than anyone else in any format (print, not print, digital, rental, new, used), connect you with students, professors and schools, provide study help and much more.

On Chegg’s business model:

So if you look at Chegg today, or if you look at LinkedIn today, there are three forms of monetization, and three distinct audiences you are getting money from. So in our case, we get money from our students via transactions, we get money from institutions when they want to recruit students cheaper than was historically possible, and we get money from brand partners who know that we have the students exactly when they choose brands.

So, is Chegg not just a textbook rental company anymore? To answer this question we must add some perspective.

Chegg the Startup vs. Chegg the Public Company

This is Chegg, the startup:

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Popular with the college crowd, clear differentiated value add, the famous investor (who is turning out to be quite a good one*), the brand investors (Kleiner Perkins, Insight Venture Partners, and a host of other top VCs and Angels), and revenue. In facts, lots of revenue — $213 million according to their Form S-1 filing. A respectable sum for a startup, but perspective is everything.

*Ashton Kutcher is undoubtedly a smart guy regardless of the roles he is known for as an actor. Combine that with how access to deal flow wins over proprietary information (thank you Nivi, Naval, and AngelList), with venture capitalists’ urge to invest alongside celebrities, and all the sudden Ashton Kutcher has access to the very best deals.

This is Chegg, the public company:

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To Wall Street, “$CHGG,” as it will soon be called on Twitter, is a company that has never made a profit. While Chegg’s revenue has increased year over year, so did their net loss, reaching $49 million in 2012. On an adjusted (Non-GAAP) basis, the company is actually profitable, and it did produce positive cash flow from operating activities. For startups cash flow is key, otherwise you end up on a show that everybody but startups wants to be on.

Chegg is a startup that one-day may be ready to go public

Chegg claims that 20% of their revenue is generated from “digital sources.” Thus, it’s safe to assume that 80% of their revenue comes from “non-digital sources” — or that textbook rental service they are running but are not focusing on.

This begs the question: what will happen when textbooks are fully digitalized?

All About Perspective

Chegg started out as a startup that did a remarkable job solving a very important problem — providing college students with a lower cost alternative to buying high priced textbooks. By solving I mean making less severe. It’s unfortunate that they found a product-market fit in an industry that would so quickly be disrupted from the outside through technological innovation (iPad and mobile computing — not the eBook industry itself).

The fact that so much of their business depends on textbook rentals and so little of their broader aspirations are proven is a cause for concern. Nevertheless, Chegg is perfectly positioned to make their education platform vision a reality.

From an investor’s perspective, Chegg will actually get the benefit of the doubt. A long-term perspective on Wall Street is about 3 years out. In fact, public companies are only required to disclose that they might go out of business if it’s in the foreseeable future — usually at least within 12 months (not a going concern). A long-term perspective on Sand Hill Road, however, is closer to the time frame required to grow an emerging growth company — a 10+ year view.

Today, Chegg has nearly mastered the textbook rental space (profitability is coming as they scale), and is well positioned to be the leading education platform of the future. This position in their life cycle is more representative of a later stage startup than that of an IPO candidate. After all, the public markets are not very forgiving if you are not quite ready.

Why Chegg is Going Public

Chegg is going public for two reasons. The first is to have the necessary resources to achieve their long-term vision of being an education platform. To do that, they desperately need to expand outside of their core textbook rental business model, and they have been doing just that with a series of acquisitions. To maintain that growth rate, they simply must go public to have at their disposal the resources that come with being a public company, particularly with M&A transactions.

The second reason Chegg is going public is because they can. They are taking advantage of the recent JOBS Act, which among other things, easies the restrictions private companies must go through in an IPO. This is how they were able to quietly start the process as early as June, and why investors will have to make do with less detailed disclosures then they would have liked. I prefer to look at the glass half full — the lucky Ernest & Young associates slaving away on their excel sheets this summer will have slightly less excel sheets to document ;)

Final Thoughts

Chegg has an ambitious vision that if properly executed will pay dividends (pun intended). To do that they will need more capital, and have just about exhausted the private markets. It is difficult to predict the future of digital textbooks, let alone the broader education space. But as a public company, Chegg is far more likely to play a role in an industry that is desperate for innovation.

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