Pearson e textbook reader

HAAS SCHOOL

OF BUSINESS PEARSON ETEXTBOOK READER

Ahmed Tantawy

Brian Guernsey

Josh Lauman

Pranav Dharwadkar

Tapan Kamdar

Pearson Digital Textbook eReader

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Executive Summary

eEducation industry comprises of digitization of textbook content and delivery of textbooks via digital

media such as eBook readers. Industry size is in the range of $15 to $20 billion with a consumer base of

75 million school students1. Pearson is exploring entering the eEducation industry by either selling its

own eBook reader with their content or by solely concentrating on selling content to existing eReaders.

The eBook reader market is crowded with technology giants like Apple, Sony, Amazon, and Fujitsu

featuring products that address current consumer demands. If Pearson concentrates on selling content

only, then it will eventually lose all bargaining power over the eReader manufacturers who will own the

distribution of content moving forward. Given this competitive landscape, Pearson should focus on

penetrating a green ocean market for textbooks in the education industry by leveraging its core

expertise.

The digital education industry is delivering increased amounts of education content to classrooms every

year. Pearson should make a credible entry into this market by providing free eReaders to educational

institutions and bundling the eReader with content subscriptions for digital textbooks. Pearson’s entry

into the market will help them to retain bargaining power over other eReader providers by providing

them with a real value option. By outsourcing the eReader manufacturing, Pearson can combine their

design ideas and content with the manufacturing expertise of the outsourcer. Pearson can continue to

focus on its core competency of creating unique educational content by partnering with a manufacturer

to own the complete end-to-end classroom experience, making the vision of a paperless and interactive

classroom a reality.

Market Overview

With close to 75 million students enrolled in public and private schools, from kindergarten through high

school, the market for digital textbooks boasts a large, diverse, and ever-changing population. With 50

million students2, public school systems have significant purchasing power. A state-wide policy shift

promoting the adoption of digital text could constitute a significant portion of the $6.4 billion textbook

market3. Given schools’ desire for cost savings and enhanced learning experiences, digital textbooks are

an attractive option. Within digital textbooks, the potential exists to address both of these desires.

In the K-12 market, several public school initiatives are driving a shift from traditional paper textbooks to

digital textbooks. The California public school system is leading the way with its Digital Textbook

Initiative, the most progressive public effort towards digital education in the country4. With an annual

textbook market of $400 million, California represents the second largest state market in the United

1 Digest of Education Statistics, page 45, April 2010, http://nces.ed.gov/pubs2010/2010013.pdf

2 Digest of Education Statistics, page 45, April 2010, http://nces.ed.gov/pubs2010/2010013.pdf

3 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run-

Down.html 4 Leading the Nation Into a Digital Textbook Future, June 2009, http://gov.ca.gov/index.php?/fact-sheet/12455/


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States5. Consequently, any statewide policy shift towards digital content would dramatically increase

the overall demand for digital textbooks. California’s effort is significant and being launched in phases.

The first part of the program calls for high school science and mathematics textbooks to transition to

digital textbooks, while the final phase calls for all textbooks to transition to digital textbooks.

California is not the only state contemplating the use of digital media for textbooks. Texas, the largest

annual textbook market at approximately $500 million, is conducting a request for proposal (RFP) for

digital content providers6. Georgia recently passed legislature in the state senate allowing the definition

of a textbook to be extended to digital formats, which could clear the path for digital text usage in its

schools.

Cost savings and more comprehensive, tailored curriculum are the two factors driving this change.

Adopters of digital textbooks expect it to lower the cost of providing educational content. While actual

cost savings have not been proven, the expectation is that digital text will drive savings through

decreased frequency with which textbooks will need to be replaced. Textbooks which are damaged or

have a discrepancy in them will not need to be entirely replaced as has been required with physical print

textbooks. Since textbooks typically cost schools $75 per student in California, the elimination of these

costs will provide considerable cost avoidance, especially in states where the textbook lifespan is

significant, such as California with a textbook lifespan of 6 years (average K-12 lifespan is 2-3 years7).

Additionally, textbooks which require content updates will not require brand new editions to replace the

previous ones. Instead new editions are replaced by digital updates electronically distributed to

customers. Due to the per student cost of textbooks, digital text is expected to drastically reduce these

expenses based on license prices ranging from free to $25. California expects a saving of $2 million8

from its first phase of shift to digital textbooks for high school science and mathematics.

The prospect of tailored class curriculum, which can be ordered and assembled by individual teachers, is

viewed as another benefit of digital textbooks. With the ability to assemble a curriculum from different

content providers, school teachers will be able to develop programs that can mix and match offerings

from the same publisher, combine content from multiple publishers, and cull content from open source

mediums like flex books.

While the prospective benefits of digital textbooks are clear, the delivery of this content remains

challenging. School districts do not have the necessary technology in place to enable the use of

5 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run-

Down.html 6 Request for Offer: State Developed Open Source Textbooks, Feb 2010,

http://search.tea.state.tx.us/search?q=digital+textbook+proposal&btnG=Search+TEA&entqr=0&sort=date%3AD%

3AL%3Ad1&output=xml_no_dtd&client=default_frontend&ud=1&oe=UTF-8&ie=UTF-

8&proxystylesheet=default_frontend&site=default_collection 7 Digital Text Books Rundown, March 2009, http://www.convergemag.com/edtech/Digital-Textbook-Run-

Down.html 8 Leading the Nation Into a Digital Textbook Future, June 2009, http://gov.ca.gov/index.php?/fact-sheet/12455/


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eReaders. In 2004, Pearson converted 100% of California’s social studies material into digital textbooks,

which can be viewed entirely online. The school districts, however, did not have the necessary

computers and interactive whiteboards to leverage this technology and continued to use printed

textbooks. One of the primary concerns surrounding the switch to digital textbooks is the initial

investment required to obtain the necessary hardware for each student. In the same time, elementary

schools are cautious to adopt an open platform eReader in fear of exposing children to other non-

educational applications on the device without direct supervision. Beyond this obstacle lies a

tremendous opportunity for content providers in the large, stable, multi-billion dollar textbook market.

Private universities, with their larger budgets and reduced bureaucracy, are more likely to overcome the

above mentioned initial hurdle and pilot digital textbook programs. Approximately 5 million students

attend private university undergraduate or graduate programs, representing a substantial consumer

segment. Furthermore, with significant textbook turnover in the university system, digital content could

be viewed as a means for reducing student textbook costs. Princeton University is among a handful of

schools that have piloted digital textbooks through the use of content accessed through Amazon Kindle

eReaders. The motivation stated by Princeton and other schools participating in the pilot is to transition

to a paperless learning environment, differing from that of the K-12 public schools, but nonetheless an

important one. Seattle University, also experimenting with the Kindle, envisions the benefits of the

device to be a blend between Princeton’s view and the public school system. Touting both reduced

paper and the opportunity for students to save money on books, Seattle also sees an advantage for the

students in terms of carrying all their material in a lightweight device instead of heavy textbooks.

Porters Five Forces

A Porter's five forces analysis of the digital publishing industry is done from the perspective of two key

stakeholders in the digital publishing industry: digital content providers and eReader providers.


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Figure 1: Five Forces analysis

Suppliers

Digital content providers: Digital content providers include book publishing houses, newspapers,

textbook publishers, book-digitizers. Supplier power is relatively strong because the volume of content is

a strong differentiator for any eReader. If an eReader boasts of a large number of exclusive titles, it can

attract more users and lock them in. Content providers can charge a high premium for their content by

restricting the content to a single distribution medium, thus wielding additional supplier power.

Alternatively, content providers who want to maximize the number of readers consuming their content

have access to multiple distribution mediums.

Brand recognition is a big barrier to entry for suppliers of digital content. The availability of similar

content makes brand recognition a key differentiator making some content more popular over others.

Any company that has unique content can command a high supplier bargaining power.

Buyers

Consumers have a high amount of bargaining power simply because they have the choice of selecting

the method of content consumption. They often choose multiple methods such as computer, paperback

and eReaders. Brand recognition is a major barrier to entry for the eReader market. This brand

recognition is achieved not just in the eReader market, but rather carried over from other markets. Thus

Threat of Substitutes

•eContent Providers:

•Book publishing houses

•Google online book

•Blogs/Wikipedia

•eBook Readers

•Amazon Kindle, Apple iPAD

•Computer

•Textbooks

Threat of New Entrants

•eContent Providers

•Traditional content providers moving to digital content

•eBook Readers

•Fujitsu, Sony, Google, Netbooks

Customers Bargaining Power

•Schools/State Government: High.

•Consumers: Moderate. In some ways consumers are limited to what the school/state chooses. But consumers can potentially influence that choice through petitions, parent funding, etc

Suppliers Bargaining Power

•eContent Providers: High

•Volume of content is the key differentiator amongst different ebook readers.

•eBook Readers: Strong Bargaining power

•Multi-purpose devices have market penetration and network effect

Competitive Rivalry


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for a new entrant, building this brand recognition might be very arduous unless the new entrant has a

strong pre-existing brand in other markets.

Schools, Universities, and Governments have significant bargaining power simply because they

constitute a large portion of the market and have the power to make rules. The eReader that those

three constituents mandate will typically be the reader that the students use for other non-school

content as well. These institutions negotiate multi-year contracts and command significant bargaining

power because of the locked-in user base that they provide.

New Entrants

eReader Manufacturers: The barriers to entry for eReaders are high because of the brand recognition

required for success. The market already includes brand-name players such as Amazon, Sony, Google

Android, Apple iPad, Samsung, and Fujitsu. Any new entrant would have to build a strong brand in order

to capture the market.

Digital Content Providers: The barriers to entry for digital content providers are very low. Digital

content providers include blogs, newspapers, and open source flex books. Thus digital content

providers may have difficulty commanding premium prices unless they have really unique content. But it

is possible for content providers to create barriers to entry. For example, when a digital textbook is

approved for a particular course curriculum, this selection serves as a significant barrier to entry. But for

new course offerings, the barriers to entry are low as there is a large selection of digital content

available that teachers can choose from.

Brand recognition serves as a barrier to entry for content providers. If a content provider has a strong

brand in the printed textbook market, then the brand name carries over to the digital textbook market.

Thus publishers who have built strong brand recognition in the printed textbook market can be

expected to enter the digital textbook market as well.

Competitors

Competition is really strong in both the eReader market and the digital content market. In the eReader

market, competitors include Amazon, Sony, and Apple, and all possess significant brand name

recognition. In the digital content market, the biggest competitors are Google, Amazon and Barnes &

Noble, who all have strong relationships with the top publishing houses. Pearson must rely on sourcing

its own content in order to thrive in this competitive environment. At the same time, Pearson can

improve its chances of success by focusing on its core competence in the education market. However,

the same cannot be said for the non-education market due to the relationships Pearson's competitors

have with publishing houses.

Substitutes

Consumers of digital content typically view the content using a computer due to ease of viewing the

content on a larger screen and its’ multi-functional capabilities. Thus computers are a popular substitute


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for eReaders. Additionally, many consumers will still prefer printed books due to cost of eReaders or

switching costs.

McKinsey Value Chain

Pearson can either compete with the incumbents in the eReader market (Apple, Amazon, Barnes &

Noble, Sony, etc) or create a niche market exclusively for education. The existing eReader solutions

address a number of needs for the general consumer, but do not address the specific needs of the

education industry – automated testing and evaluation, interactive content and learning, and homework

capabilities, consequently lowering the cost of education for the cash strapped local school districts and

governments.

We evaluated two solutions using the McKinsey Value Chain as follows:

1. Providing digital content for each platform as per their requirements and pricing:

Figure 2: MVC eReader Content only

2. Build a specialized eReader education platform with digital textbooks and contents which address

the specific needs of the education industry: Pearson should leverage its strengths in selling

content and education specific add-on services to the K-12 and university segments.

Technology Product Design ManufacturingMarketing & Distribution

Service

•Technology

provided by 3rd

party

• No R&D

investments

• Leverage best

of breed

solutions in

market to offer

applicable

features

• Support

multiple platform

formats for

books

• Limited by h/w

functionality of

platform to

leverage features

• No negotiations

with Wifi/3G

providers

• Reply on

eReader DRM

• No H/W manuf.

Required

•Compete with

existing market

place (red ocean)

• Content needs

to be published

in multiple

formats for

different

eReaders

• Channels• Online Book Stores

e.g. Amazon, Apple

Store, B&N

• Through native

Application purchase

• Complimentary to

textbook purchase

• Prices governed

by Channel

owner

• Format

distribution

restricted as per

h/w platform

• No H/W service

• No 3G/Cell

network service

problems

• Cannot control

end-end

experience


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Figure 3: MVC eTextbook + Content

Game Theory

Once a consumer has decided to purchase an eReader their purchase choice will depend upon both the

eReader itself and the amount of content available for the device. Consumers choose their eReader

prior to choosing their content; however the amount of content that an eReader has available

influences the customer’s initial eReader choice. With this in mind most content distributors are making

proprietary eReaders that only recognize content purchased from their stores. This forces customers to

purchase content from their sites thereby creating switching costs. Thus, the battle that is emerging in

the eReader industry is not between publishers but between content distributors. However, Pearson,

though not directly involved, has a vested interest in the outcome of this battle and should actively work

to ensure a favorable outcome for itself.

The ideal situation for Pearson is for there to be multiple eReader content distributors with equal

market share. In this situation Pearson would have power within the distribution channel and could

allow multiple content distributors to compete for the privilege of earning their business. The worst

situation for Pearson would be for one very dominant content distributor to emerge and have significant

distribution channel power. In this scenario, the situation would be reversed and Pearson would be

competing for the privilege of using the content distributor. With this in mind, Pearson should work to

encourage a market that accommodates multiple content distributors. However, analyzing the market

from the perspective of the content distributors will show that the current situation encourages a

dominant strategy that opposes Pearson’s.

If we look at how the digital music industry emerged and use it as a proxy, we will see that the dominant

strategy for content distributors is to control as much of the distribution channel as possible by

Technology Product Design ManufacturingMarketing & Distribution

Service

• Constant

investments in

R&D to improve

platform

• Introduce new

features for a

new market, not

competing with

existing eReaders

• License content

from other

providers to

provide more

value to platform

• Drive innovative

product features

through h/w

support

• Wireless/3G

connectivity to

eStore for

delivery

•Differentiation

with add-on

services like tests

homework and

note sharing

services

•Partner with

H/W partner to

build solution

•Custom

regulations on

imports

• High FC

investment

• Build DRM /

Subscription

tech. into H/W

•Forecasting on

Volume

projections

• Give away

device for free,

with content

purchase

contracts

• Universities,

Schools

• Provide

exclusive content

• Lower content

pricing

• Online Book

Stores

• Reliable H/ W

• Reliable 3G

service

• Reliable eStore

• Own end-end

experience


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developing their own eReaders and making creative use of digital rights management (DRM). In the

digital music industry Apple developed a digital music player, the iPod, along with its content

distribution platform, iTunes. By using stringent DRM, Apple was able to restrict digital music purchased

on iTunes so that it could only be played on the iPod. Thus, the iPod was the digital music player with

the unique capability of being able to play digital music downloaded from iTunes. The iPod had the

ability to play digital music from other sources, but by maintaining control over its content distribution

platform, iTunes, Apple ensured that the iPod worked most easily with iTunes. This creative use of DRM

also allowed Apple to create significant switching costs for customers. If a customer wanted to switch to

a different digital music player all of the music that he purchased using iTunes would be unplayable.

This approach of controlling the distribution of digital music all the way from the record labels to the

end user device has allowed Apple to achieve approximately 70% digital music market share9.

Having seen Apple’s success in a similar digital market, content distributors have adopted a similar

strategy and developed their own eReaders. Amazon has developed the Kindle, Barnes and Noble has

developed the Nook, and Apple has developed the iPad. They are attempting to control the distribution

of eBooks from the publishers all the way to the end user device. While no one competitor has emerged

as a market leader, it is in Pearson’s interests to ensure that it stays that way. Or better yet to dominate

the educational digital textbook market by being the dominant content distributor.

If Pearson anticipates that a particular content distributor and its eReader will come to dominate the

market, then they should take steps towards disallowing it. Pearson could accomplish this by electing to

develop their proprietary eReader for textbooks. Pearson’s own proprietary eReader would serve as the

end user device for an additional internal distribution channel. This additional distribution channel

could serve as a credible threat that Pearson could use in negotiations with other content distributors.

Strategic Recommendations

Sell content only v/s Sell reader + customized content

Based on our analysis of the five forces and Pearson’s competitive advantage, we have ascertained that

its core competency is in developing educational content. Additionally, Pearson is a leader in the

educational content for K-12 school material with a market share of 37%10. Such competencies lend

itself to the strategic approach of focusing on digital content rather than on developing the hardware

itself. This approach will reduce the risk of hardware manufacturing and associated overhead from

managing the supply chain. In addition, by bundling the eReader as a part of a content and delivery

package, Pearson can obtain access to educational institutions and build a network effect for its

platform adoption. In this case, Pearson can capture additional educational market share and set the

standard for the delivery platform, especially as it is already the leader in the current traditional books

market. Pearson needs to make sure that it is ready with the software platform to be able to provide

the full experience to its customers.

9 iPod Market Share, After Dawn Blog, September 2009,

http://www.afterdawn.com/news/article.cfm/2009/09/09/ipod_market_share_at_73_8_percent_225_million_ipo

ds_sold_more_games_for_touch_than_psp_nds_apple 10

Pearson PLC, Annual report and accounts, 2009.


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Pearson needs to consider how to take a blue ocean strategy and create such a market rather than

taking a red ocean strategy and competing in a market where incumbents are fighting for market share.

If it delays this introduction, then the current popular eReaders, such as iPad or Kindle, will likely

become the industry standard, robbing Pearson of the ability to shape the market per it needs. If

Pearson is able to control the overall user experience for both software and hardware, it can lock in the

schools for long term and strengthen its presence in the educational content industry.

Sell all types of content or eTextbooks only on Pearson eReader

The electronic content market is already crowded with Google, Amazon, Apple, Sony, each pitching

exclusive access to a huge volume of content. Competition in the textbook eReader segment of the

market is concentrated around new players who are pitching their technology solution, but have no

backing from the content producers. Pearson can leverage its established brand in the education

industry and use its expertise and content to sell content specifically for schools, universities, and

colleges. By shifting to a subscription based model rather than current paper-textbook sale model it

employs today, Pearson will build a repeated and closer engagement with its customers. By enabling

customers to customize their products to address the specific needs, Pearson can grow its market share

and the overall pie of the market. By bundling in access to business informational content through

Financial Times and consumer content through Penguin, it can address consumer's content needs

beyond educational content.

Partnering vs. Building in house

Business Model: As we consider Pearson’s position in the digital textbook market and contemplate a

market entry strategy for a dedicated educational eReader, the main question we face is: Would

Pearson build its own eReader as a hardware platform for its content or would it partner with a 3rd

party

hardware manufacturer and focus on the content?

1. Build its own eReader in house: Pearson has traditionally been a content provider and does not have

a core competency in building hardware platforms. In order to build hardware in house, Pearson

would have to acquire a company with core competencies in manufacturing. The post acquisition

integration of two very different companies could be difficult as well as expensive. The huge upfront

cost of acquisition could prove to be a huge barrier to entry into the market and would give away

Pearson’s intent to entry to its competitors. In addition, if Pearson’s foray into the digital textbook

initiative failed, its hardware division acquisition would be viewed as an expensive failure by the

Board and it could lose its bargaining power with the incumbent eReaders forever.

2. Partner with a 3rd

party hardware manufacturer to develop its own branded eReader: Pearson can

use its relationships with the schools to provide both the eReader and the educational content. By

providing the hardware for free, it can foster easier adoption as well as control the overall

experience for the students. It can provide value by standardizing the platform across all schools

with a software interface that is optimized for its own hardware. Such platform will be optimized

for educational content with controlled access to non-educational applications as gaming,

entertainment. However, such an approach introduces the risk of managing the partnership with a

hardware manufacturer.

Based on these considerations, we recommend partnering with a hardware manufacturer like Foxconn.


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Distribution model: Physical v/s Digital

Multiple players involved in the production and distribution of a physical textbook are as follows:

1. Authors: Royalties from publishing houses vary on book type (textbook, professional, fictional, etc).

In the textbook industry, royalties are based off the “price received”, a percentage of the publisher’s

receipts from a bookseller which is much lower than the actual sale price11. The royalties range

between 10-15% of price received for local sales. Factoring in international sales, which have higher

cost of shipping and distribution, the actual payments that an author receives are in between 5 and

7.5% of price received.

2. Editors: They work closely with authors to review the books and have direct contracts with the

author based on page numbers. At times, the editors act as the author’s agent and negotiate with

the publishers, in exchange for a management fee.

3. Publishers: They are involved with the printing, distribution and marketing of the book. In the

textbook market, Publishers rely on long term contracts with wholesale distributors or institutions,

in addition to their online sales to individual customers12.

4. Wholesale distributors and Retailers: Wholesalers distribute books to retail chains, schools, and

universities. Wholesale distributors play a major role in the textbook industry as most school

districts and universities have a variety of book needs that span across multiple publishers. Online

retailers like Amazon rely on a direct sales channel with the publishers for their inventory of books.

The newer model of digital textbooks changes the players involved and their roles. To validate the new

model of digital textbooks, we need to make sure the main contributors (authors) would not resist the

new model.

Textbook margins are higher than normal books, especially in higher education. Textbook prices have

recently increased by 5-7% annually13. This is mainly attributed to the broken market structure, where

purchase decisions are made by educational institutions without regard to prices, which are negotiated

separately. In this model, the majority of the revenues are split between the publisher and wholesalers.

The physical textbook distribution model as compared to the digital model is as follows:

1. Physical distribution model

11

Advances & Royalties, Chris Holifield, 2002, http://www.writersservices.com/res/ri_adv_royalties.htm 12

Books in the United States, Industry profile, Datamonitor ref. code: 0072-0781 July 2009 13

College Textbooks: Enhanced Offerings Appear to Drive Recent Price Increases, U.S. Government Accountability

Office, July 2005, http://www.gao.gov/docsearch/abstract.php?rptno=GAO-05-806


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2. Digital distribution model

With the new distribution model, the authors earn more net royalty; Pearson eliminates the middle man

(wholesale distributors) and captures most of the pie; and the educational institutions get added

benefits and a better student learning experience, making it a win-win for all players.

Digital Textbook eReader: Feature and Content Strategy

Author

•5-10% royalties of price received

•Full book requires a lengthy writing process

•Royalties payments based on copies sold.

Editor

•Work closely with authors

•Payment based on pages reviewed

•Manage contracts for authors

Publisher

•Source books from multiple authors

•Handle distribution and marketing

•Good margins in textbook (~20%)

•Long term contracts with educational institutions

Wholesaler

•Deals with large retailers and institutions

•Long term contracts with educational institutions

•Source books from multiple publishers

•Good margins

Educational Institution

•Final consumer

•5yr book buying cycle

•Annual rising cost of books

•Use multiple books to accommodate curriculum

Author

• Multiple updates v/s full book writing cycle

• Periodic update of chapters as subject matter changes

•Royalties based on subscription model and chapters used

• Increased royalties due to increased chapter volume sales v/s complete book sales

• Revenues based more on volume sales of chapters, not entire textbooks

Editor

•Work closely with authors

•Payment based on digital content reviewed

•Simpler structure due to flexibility of content saleability

Publisher

•Source books and chapters from mulitple authors

•Distribution is digitial = minimal cost

•Different margins structure with subscription model

•More envolved with educational institutions for complete solution system

Educational Institution

•Buy materials when needed, not based on wear and tear

•Lower cost of books

•Source specifc chapters based on curriculum needs, update annualy

•Better overall experience with digital testing, content sharing, DRM management and homework system


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Pearson must invest R&D dollars into building an end-to-end solution which addresses the current

problems of schools and universities. Due to the high costs of replacing textbooks, schools are not in a

position to replace textbooks frequently or recommend multiple textbooks for the same class. Teachers

spend a large amount of time preparing and evaluating homework for students, but are not able to

improve the quality of student learning beyond the classroom.

Pearson owns numerous titles per subject in its portfolio. In addition, Pearson owns online resources

like the Financial times (FT.com) and Economic times, as well as the Penguin label for fiction books. By

allowing teachers to create a dynamic text pack which consists of individual chapters from various

textbooks, and online content, Pearson can create an annual custom teaching experience for each

classroom. Schools would have the flexibility to change their text pack every year to fit the specific

needs of the class.

By building interactive learning modules for each chapter, students would be able to better understand

the material taught in class and improve their test scores. Building homework modules combined with

automated testing would reduce the teachers time spent on evaluating homework, but at the same time

alert them to specific difficulties faced by individual students. School districts would be able to update

their content for classes every year, raise average test scores, and reduce teaching load on classroom

overhead, thereby raising the standard of education.

By building models with different levels of functionality (WiFi/3G access, testing/homework frameworks,

color screens, touch enabled screens, access to online content, etc), Pearson can evaluate content

contract willingness from school districts, and offer devices ranging in costs from $99 to $299. Our cost

estimates are based on iSuppli’s estimates of the iPad manufacturing costs, a 32GB iPad with 3G would

cost $287.15 with $59 in memory costs14. In return, Pearson would obtain multiple year contracts on

content for different classes. Availability of such features might even influence school districts to obtain

licenses on text packs for content which they previously never purchased from Pearson, thereby

increasing market share in the long run.

Financial Model

According to NCES, the number of students enrolled in school is anticipated to grow by 12% from 2008

to 201815. Since Pearson has a 37% share of textbooks purchased in the K-12 marketplace, we plan to

introduce the digital textbook eReader in grades 9-12 for public and private schools. In addition, private

universities also fit our target customer profile as the universities are interested in reducing costs, as

well as willing to experiment with cutting edge technologies. Appendix 1 shows our digital textbook

eReader market place growth projections in different segments from 2011-2014.

14

Mid Range iPad to generate maximum profits for Apple, February 10,2010,

http://www.isuppli.com/News/Pages/Mid-RangeiPadtoGenerateMaximumProfitsforApple,iSuppliEstimates.aspx 15

Digest of Education Statistics 2009, US Department of Education, http://nces.ed.gov/pubs2010/2010013.pdf


13

Figure 4: Books - Costs & Class level

The average number of books used per student per year is 10.4 (Figure 4), at an average cost of $60.80,

costing the school district $630 in books per student annually. Schools lose books to non-returns at

about 8% a year, and replace books with newer editions once in five years. Figure 5 shows Pearson’s

revenue from digital textbooks and cannibalization of sales of the physical textbooks at various price

levels. Even by pricing the textbooks at $10, and replacing $60 priced physical textbooks, the schools

stand to save millions of dollars.

Our assumption in calculating cannibalization equates the additional royalties paid to the authors to be

equivalent to the cost savings in printing and distributing textbooks. In an average case, cost savings

would be quite significant as compared to the additional royalties being paid out, thereby adding more

profits to Pearson’s bottom line.

Figure 5: School Savings with $10 text pack subscriptions instead of $60 textbooks

To calculate the profitability (Appendix 2) of giving away the digital textbook eReaders for free, and

charging an annual fee of $10 per text pack per student, we made the following assumptions:

1. Overall Pearson digital textbook eReader market share would grow at 1% overall after 2015

2. A reduction of 2% in cost of building the reader every year

3. An upfront R&D cost of $5 million, followed by an annual R&D cost of $3.5 million/year

4. Content distribution cost and administration cost of 5% of sales

5. Increased royalties paid to authors = Savings in cost by not printing physical copies

6. Marketing costs of 2% of sales

Class/yr Books/Class Books Cost/Book Annual Cost Costs Fraction

Grade K-8 8 1 8 55 $440 0.525

Grade 9-12 10 1 10 75 $750 0.219

Undergraduate 8 2 16 55 $880 0.219

Graduate 6 2 12 95 $1,140 0.037

Average 10.4 60.8 $630

Period 2011 2012 2013 2014

$10 54,529,537$ 178,701,123$ 405,885,640$ 729,349,873$

$15 81,794,305$ 268,051,685$ 608,828,461$ 1,094,024,809$

$20 109,059,073$ 357,402,246$ 811,771,281$ 1,458,699,745$

$55 22,193,521$ 50,537,836$ 92,464,099$ 131,649,943$

$60 24,211,114$ 55,132,184$ 100,869,926$ 143,618,119$

$75 30,263,893$ 68,915,230$ 126,087,407$ 179,522,649$

Digital $10 w/ Physical $60 30,318,422$ 123,568,939$ 305,015,715$ 585,731,754$

Current School costs 322,019,772$ 733,285,268$ 1,384,350,188$ 1,910,191,881$

School Savings 291,701,350$ 609,716,329$ 1,079,334,474$ 1,324,460,127$

Digital text book costs @ 37% Market Share

Cannibalization (Loss of Physical textbook revenue)


14

7. Pearson’s tax rate remains constant at 28%

8. Usage of a higher risk rate (WACC) at 10% as compared to Pearson’s existing rate of 8.9%

9. No external debt is issued

Figure 6: Pearson's Digital Textbook eReader NPV

Figure 6 shows Pearson’s NPV based on their potential share of the digital textbook eReader market

(based on current projections), under the assumption that the digital textbook eReader is given out for

free and the cost absorbed by Pearson, in exchange for a specific level of subscriptions of text packs for

a minimum period of five years per class. If Pearson is able to maintain its current share of textbooks in

the school districts where it offers their digital textbook eReaders, the NPV of their cash flow accounts

to $1.33 billion even by offering it’s most expensive eReader (costing Pearson $299) for free.

In addition, the savings in not printing physical textbooks will offset the increased author royalties by a

huge factor, thereby increasing Pearson’s profitability (variable cost of distributing a textbook is zero).

With increased market share, Pearson bears the upfront onetime cost of providing free eReaders to its

customers, but will realize the profits of contractual text pack subscription sales in future periods. In

addition, by exploring variable pricing for text packs for different subjects for different segments,

Pearson can grow their profits beyond our projections.

Recommendations

We recommend that Pearson partner with a hardware manufacturer to build a proprietary eReader for

their digital textbooks. By taking this course of action Pearson will be able to ensure that they maintain

at least two distribution mechanisms for its digital content. Additionally, Pearson should be able to

combine its existing relationships and long term contracts within the education industry with its new

end to end digital textbook solution to capture the vast majority of the value created.

NPV (CF)

Device Cost 37% 50% 75%

$99 1.59B 1.44B 1.17B

$199 1.48B 1.34B 1.06B

$299 1.34B 1.23B 0.95B

Market Share

Appendix

1. Market Share Growth for 4 years

2008 2011 2012 2013 2014

Universities

Public 13,972,000

Undergraduate 12,591,000 1.00% 2.50% 4.00%

Graduate 1,381,000 1.00% 1.00%

Private 5,131,000

Undergraduate 3,775,000 1.00% 2.00% 4.00% 5.00%

Graduate 1,356,000 1.00% 1.00%

Elementary / Secondary

Pre-K - 8 39,179,000

Public 34,667,000 1.00% 2.00% 3.00%

Private 4,512,000 1.00% 2.00%

Grade 9 - 12 16,321,000

Public 14,955,000 3.00% 4.00% 6.00% 8.00%

Private 1,366,000 3.00% 4.00% 5.00% 6.00%

Mkt Size 527,380 1,200,920 2,197,205 3,128,370

2. Financial Model with $299 reader (given out for free), $10 annual subscription/student for a text pack per class

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Period 0 1 2 3 4 5 6 7 8 9 10

Units Sold 0 527,380 1,200,920 2,197,205 3,128,370 3,159,654 3,191,250 3,223,163 3,255,394 3,287,948 3,320,828

Unit Price $299 $293 $287 $281 $275 $269 $263 $257 $251 $245 $239

Reader Revenue $0 -$3,153,732 -$14,363,003 -$39,417,858 -$74,830,610 -$94,473,646 -$114,502,059 -$134,921,592 -$155,738,067 -$176,957,378 -$198,585,502

Content Revenue $30,318,422 $123,568,939 $305,015,715 $585,731,754 $591,589,071 $597,504,962 $603,480,011 $609,514,812 $615,609,960 $621,766,059

Revenue $0 $27,164,690 $109,205,936 $265,597,857 $510,901,143 $497,115,425 $483,002,903 $468,558,419 $453,776,745 $438,652,582 $423,180,557

R&D -$5,000,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000 -$3,500,000

E-Reader Unit Costs -157,686,620 -201,388,460 -297,889,215 -278,418,335 -9,353,826 -9,447,365 -9,541,838 -9,637,257 -9,733,629 -9,830,965 -9,929,275

Labor/Distribution 0 -7,726,644 -17,235,604 -30,877,322 -43,027,601 -42,513,141 -41,984,088 -41,440,203 -40,881,242 -40,306,958 -39,717,100

Marketing 0 -3,090,658 -6,894,242 -12,350,929 -17,211,040 -17,005,256 -16,793,635 -16,576,081 -16,352,497 -16,122,783 -15,886,840

COGS (162,686,620)$ (215,705,762)$ (325,519,060)$ (325,146,586)$ (73,092,468)$ (72,465,761)$ (71,819,562)$ (71,153,541)$ (70,467,369)$ (69,760,707)$ (69,033,216)$

Depreciation 15,768,662 35,189,358 63,068,572 87,925,967 86,915,754 85,876,544 84,807,858 83,709,211 82,580,110 81,420,056 80,228,543

EBIT -146,917,958 -153,351,714 -153,244,552 28,377,239 524,724,429 510,526,208 495,991,200 481,114,089 465,889,486 450,311,930 434,375,884

EBIT*(1-tax) -105,780,930 -110,413,234 -110,336,078 20,431,612 377,801,589 367,578,870 357,113,664 346,402,144 335,440,430 324,224,590 312,750,637

CF (90,012,268)$ (75,223,876)$ (47,267,505)$ 108,357,579$ 464,717,343$ 453,455,414$ 441,921,522$ 430,111,355$ 418,020,540$ 405,644,646$ 392,979,180$

NPV 1,337,853,377$

Pearson e textbook reader

Business

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