At the end of this March, Tencent-backed online education platform Yuanfudao nabbed a staggering $1bn Series G round at a valuation of $7.8bn. The largest ever fundraising deal in China's edtech sector, it was also a rare deal in the midst of the coronavirus (Covid-19) crisis, shedding light on investors’ renewed interest in online education as the whole startup scene in the country saw a massive slowdown in VC activity.
Chinese online education startups raised a total of RMB 11.56bn ($1.65bn) last year, dropping by 31.4% from a year earlier. After going through a stagnant 2019, players in this sector are now witnessing how Covid-19 has turned out to be an unprecedented opportunity for fundraising and user acquisition.
According to a report by business information provider China Venture, Chinese startups raised a total of RMB 1.28bn in February, down by 63.07% from a year earlier, but the VC funding flowing into the online education sector alone increased by 275%.
Meanwhile, nearly 200m kids have turned to them for study-from-home. Online education accounted for only about 7% of the whole education sector before this crisis and is expected to see a sharp increase in its share. CSC Financial predicts Covid-19 will increase the penetration rate of online education from 20% to 100% in major cities.
“The traffic helped [online education platforms] save about RMB 100bn in advertising cost,” said Zhu Yun, Vice President of New Oriental Online and CEO of Oriental Broadcast.
Forced to go online
The preschool education platform Ivy Dad gained 310,000 new users without spending a penny on marketing, and its daily active users (DAUs) doubled in number before the Chinese New Year. During the crisis, its revenue from premium courses on the platform quadrupled from the same period of last year, exceeding RMB 25m. Profit also increased by RMB 8m.
The free traffic is especially valuable given the fact that the high cost of customer acquisition is the main obstacle on edtech startups’ path towards profitability. According to Chen Xiangdong, CEO and Founder of the NYSE-listed online tutoring platform GSX Techdu, his company spent RMB 2,000–3,000 per student in user acquisition costs in 2019.
It is also a process of user education. After being forced to try online education amidst the outbreak, those who used to know little about it might be impressed by its convenience and efficiency and consequently be converted into paying users after the outbreak subsides.
“We have always been steadfast in our optimism on online education,” said Li Xiaojun, partner of IDG Capital, which participated in the latest round of Yuanfudao. “Because of the outbreak, more people began to try online education, which would further prompt the wide acceptance of it.”
Obstacles to overcome
Beyond users, the sector has also welcomed a large number of new entrants, making the market even more crowded. Besides the nearly 8,000 businesses newly established from January to March this year, other players are also trying to seize the opportunities brought by Covid-19.
Short video platforms Douyin, the Chinese version of TikTok, and Xigua, as well as the news aggregator Jinri Toutiao (all three are under ByteDance), announced this February that they would join hands with 50 domestic education institutions and invite quality teachers from across the whole country to offer free courses. Meanwhile, the outbreak has prompted more offline institutions to go online.
On the user side, parents, also stuck at home, could spend more time comparing their kids' courses and then abandon those of inferior quality. One problem raised in parents' complaints is that they have to install so many apps for their kids and switch between them for different courses. They also voice worries about their kids’ worsening vision, caused by too much screen time.
Those who want to gain a foothold in the online education sector, face an imminent challenge. As school closures in China extend, how can they make students stick to their products after these kids have spent hours attending the online classes required by their schools?
Although the platforms don't have to spend money on advertising, other costs of teachers, servers, and bandwidth could still be a heavy burden on those without a deep pocket.
Additionally, many edtech companies had not been well prepared to handle the traffic spikes. As ten times more DAUs rushed to their platforms, congestion, slowness and even server crashing occurred. Although the infrastructure worked well, they might not have had enough staff to serve those newly-acquired users. Such problems have incurred negative reviews from students and their parents, creating another obstacle to converting the recent traffic into paying users in the long run.
Lessons from Yuanfudao
Investors saw these challenges very clearly. Despite renewed attention to online education, they have changed their strategy and valued profitability prospects over rapid growth. “Our first choices are those that are able to make a profit in the next 12-18 months by improving operation efficiency and cutting down on costs,” said Li Wei, partner of Shunwei Capital.
Right now, the massive traffic that has been attracted to online education platforms by free courses doesn't generate revenue. It's not surprising to see that some platforms saw spikes only in user number but not revenue. According to Li, the key lies in conversion and it won't be an easy task.
Conversion rate, the most important metric in the business of online education, also partly explains why the seven-year-old Yuanfudao secured that massive $1bn deal. Co-founder Shuai Ke is very confident about this. Although not disclosing specific figures, he said “we overwhelmingly beat our rivals in terms of conversion rate.” It has been reported that Yuanfudao's average renewal rate could hit 80%, much higher than those of its peers both online and offline.
Another quality that has impressed Yuanfudao’s investors is its efforts to keep fine-tuning business models. Founded in 2012, Yuanfudao started as a tool to help K-12 students search for and solve exam questions. As early as 2015, the startup, the first of its kind, began to provide one-on-one tutoring through livestreaming.
But the real turning point occurred in 2016 when the startup shifted its model from C2C to B2C. While offering a platform that linked teachers and students and charged a cut from teachers' revenue, Yuanfudao found it was hard to ensure the quality of every teacher on its platform. “The teaching content is out of our control. It’s meaningless to be just a platform,” recalled Shuai.
So Yuanfudao began to recruit full-time teachers and run like a self-operated online school. In order to scale up, it made another change by cutting most of its one-on-one classes which required heavy investment in Human Resources and by focusing on large class size.
“Its focus on product innovation and the importance attached to service improvement is what we valued,” said IDG Capital's Li of the VC's investment in Yuanfudao.