Back in the early 1700s, in England, people were dirt poor and wanted to make themselves better off. So a market developed for selling dreams of becoming rich in America.

Gradually people started investing in totally fake schemes which promised to make your dream come true. One of the advertisements even said “Give us your money now and we will tell you why later”. Or words to that effect. I am not making this up.

The frenzy that followed is what led to the South Sea bubble in 1720. It is named after the South Sea company which promised huge returns on small investments.

Thousands invested and all came to grief when the company went broke in 1720 as it had to. After all, in reality, it was only selling dreams.

Then in mid-19th century America, there was what was called snake oil selling. It denoted the selling of something containing oil made from snakes. Its claims were wholly fake, like a cure for all mental and psychological problems. Eventually sellers of stocks in dubious ventures came to be known as snake oil salesmen.

This sort of thing even led to a joke in the 1980s about a clever Indian who was arrested for selling pure mountain air in bottles. As you can imagine, the bottles were empty.

There are literally thousands of examples of this sort of thing where a company has held out promises that it thought it could fulfil but couldn’t because of a simple reason: the promises were unrealistic to begin with. And demand had been overestimated just as it is now. Most promises were fraudulent but some of those early start-ups were genuine. Many of these companies had one thing in common: the promoters actually believed in whatever it was they were selling. It was classic self-deception and a wilful suspension of reality.

The market for dreams

This appears exactly true of edutech companies that are luring parents into parting with large sums of money to improve the lives of their children. The sellers and buyers are both willing participants in a market for dreams.

The big question, however, is how do you do your funding, costing and pricing when nothing more than intellect is involved? The product is of uneven quality and supplied against uneven specifications.

Thanks to the shortage of schools and the poor standards of teaching in them, India has been an early entrant into this market where the demand, for both quantity and quality, far outstrips supply. The coaching institutes that have proliferated since the 1980s are a response to this.

But these were constrained by space. So gradually their fees went up and they became like any American Ivy League college — commercial outfits unaffordable by most and dependent entirely on reputation.

The advent and subsequent explosion of the Internet has made room for competition from outfits that are not constrained by space. So here it’s a volume game at a lower price but branding via a premium charge. This is exactly the same as the single malt game.

Types of competition

What we now have in edutech is a variation on what economists call Bertrand competition: producers set the prices and buyers choose the quantities.

Earlier what we had was a variant of the Stackleberg type of competition. Here the dominant firm sets the price and others adjust their costs and prices.

There is a third and older model. This is the Cournot model where everyone is selling the same thing but they compete on how much they will produce.

The Indian edutech industry is a combination of the Bertrand and the Stackleberg models. The binding constraint is not space for students but teachers because both demand and the means of supply are unconstrained.

It is in these conditions that the firm has to raise capital and price its output. What this has led to is the promoter of the firm having absolutely no idea what his capital requirement will be.

So some firms have raised way too much capital; others have raised too little. And for both sets of firms pricing is a shot in the dark — but with an upward bias to compensate for initial demand projections that turn out to be not just wrong but also highly price elastic

It’s not surprising, therefore, that a shakeout is in progress. The industry will settle down in the coming 12-15 months. But the process is not going to be smooth because it will involve investor education as well. They need to be more circumspect about where to dump their dollars.

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