The Transformation of EDMC

[This is the second part of our Higher Ed Watch series looking at what's gone wrong at the for-profit college giant Education Management Corporation. To read the first post, click here.]

When Todd S. Nelson joined Education Management Corporation as its chief executive officer in January 2007, he said he was attracted to the company because of both its “reputation for quality and doing things the right way” and its enormous potential for growth. Education Management is “in a position to become the preeminent global higher education company,” he told reporters on a conference call announcing his hiring.

To the journalists on the call, this may have sounded like an idle boast. After all, EDMC, with its then-enrollment of 82,000 students, didn’t appear to be any match for Nelson’s former employer, the Apollo Group, which owns the University of Phoenix. As The Chronicle of Higher Education noted at the time, “Apollo is nearly four times the size of Education Management in terms of enrollment (and nearly twice as large by revenue).”

But in the five years since Goldman Sachs and two other private equity firms acquired EDMC for $3.4 billion, and put Nelson at the helm, the company has experienced phenomenal growth, particularly in the exclusively online programs it offers. As we wrote on Tuesday, EDMC’s enrollment doubled from 2007 to 2011 to about 160,000, making it the second largest for-profit higher education company in the country. At the same time, its annual revenue has nearly tripled to a whopping $2.8 billion (nearly 90 percent of which came from the federal student aid programs).

The methods EDMC’s leaders used to achieve this massive expansion, however, have taken an enormous toll on the reputation that the company’s founders worked so carefully to build over nearly four decades. While EDMC was long considered to be one of the best for-profit higher education companies in the business, it is now the target of a multibillion dollar lawsuit brought by the U.S. Department of Justice and half a dozen states, accusing it of defrauding the federal government by defying a federal law that prohibits colleges from compensating recruiters based on their success in enrolling students. Meanwhile, attorneys general in four states – Florida, Kentucky, Massachusetts, and New York – are investigating the company, as is the Department of Education’s Inspector General.

In other words, under the leadership of Todd Nelson and Goldman Sachs, the days when Education Management had a “reputation for quality and doing things the right way” appear to be long in the past.

The Good Old Days

The story of EDMC begins at the start of the 1970s when financier Robert Knutson joined forces with the fledgling Education Management Corporation (which had been incorporated in Pennsylvania in 1962) to purchase the company’s first school -- the Art Institute of Pittsburgh. In an interview with the Wall Street Corporate Reporter in 2002, Knutson, who became the company’s president and chief executive officer in 1971, recalled that the school at the time had “600 students, 80 faculty members and staff, and revenue of less than $2 million a year.”

From the start, Knutson said, the company’s “philosophy” was to “do everything we can to ensure that students are successful, and our education process is oriented to the needs of our students.” For the next 25 years, Knutson tried to live up to this mission by taking a very deliberate approach to the company’s growth. During this time, EDMC added only eight additional art schools. Instead, Knutson focused his efforts on “investing in facilities and equipment, upgrading and adding faculty and student services, new academic programs and establishing a national marketing presence,” the company’s website states.

In the early 1990s, Knutson took a stand that persuaded even some of the for-profit college industry’s harshest critics that EDMC was one of the better companies in the sector. He broke ranks with the Career College Association (CCA) over the bare-knuckled campaign it was waging against Congressional efforts to crack down on unscrupulous schools that were enrolling students right off the welfare lines. “He found their strategy to be too defensive,” Richard Jerue, a then-EDMC lobbyist, told The Chronicle of Higher Education several years after the company exited CCA. “The association was not able to take criticism constructively.” [EDMC eventually rejoined CCA after the association's leadership changed.]

The Transformation Begins

The first signs of change at EDMC came in 1996, when Knutson took the company public and promised Wall Street that he would add at least two new schools per year. But even then he kept the company focused on its strengths – the arts, with some culinary programs thrown into the mix.

The company’s real transformation started in 1999 when Knutson brought in former Maine Governor John R. McKernan, Jr. to be Education Management’s vice president. At the time of McKernan’s arrival, EDMC had just 19 art schools serving 24,000 students, the Chronicle recently recounted.

Whether at the behest of Wall Street or in preparation for selling the company, McKernan, who became EDMC’s chief executive officer in 2003, went on a shopping spree, buying up other for-profit college companies that provided training in fields far removed from its core competencies. These included Argosy Education Group, which had 14 campuses offering degrees in education, psychology, business and health care; South University, which had four campuses that specialized in health-related fields, such as nursing;  and American Education Centers (later renamed Brown Mackie College), which had 18 schools that provided training in business, computing, criminal justice, and the health-related fields. By 2006, when EDMC was sold, it had more than 70 schools serving between 70,000 and 80,000 students.

It was also during this time of substantial growth that  EDMC started bending the rules, the Justice Department's lawsuit says. According to DOJ, beginning in July 2003, the company started providing incentive payments to recruiters based solely on their success in enrolling students, in violation of federal law. EDMC denies these allegations.

But even at this point, Knutson, who remained EDMC's board chairman, tried to keep the company’s focus on the students it was serving. He took pride, for example, in keeping class sizes small so students would have individualized attention, and he withstood pressure from investors to expand the schools’ online offerings.  “Our students like the fact that they have the choice to take some courses online, but prefer to do the majority of their learning in the physical school facility,” he told the Wall Street Corporate Reporter.

When Goldman Sachs and its private equity partners purchased EDMC in 2006, only about 4,000 of the company’s students were enrolled in its online programs exclusively. Five years later, that number has increased more than tenfold, and there have been serious allegations that the company has pumped up these numbers by aggressively recruiting unqualified students.

Soon after the buyout, Robert McDowell, an 18-year veteran of EDMC, resigned from his position as the company’s chief financial officer. As he told Bloomberg Businessweek last year, he and other company officials had for years “resisted calls from Wall Street analysts to pursue growth opportunities that could undermine academic quality,” the magazine article states.

But with Goldman's purchase of EDMC, he knew those days were over. “I was worried that the quality of the experience for employees and students was going to deteriorate,” he stated.

As it turns out, his concerns were well founded.

Next week, we will continue our Higher Ed Watch series looking at how Goldman’ s purchase of EDMC fundamentally changed the company.