Can Chegg Shift its Business Away From Online Textbook Rentals?

by Ian Woller

Ian Woller
Ian Woller
Apr 3, 2014 at 11:20AM
The Business

After two months of studying abroad in Pamplona, Spain, I've noticed I have more spending money than in a typical Washington, D.C. semester (I study full-time at George Washington University). Besides the difference in housing costs, the only other cost differential that comes to mind are textbooks. Not needing to buy the overpriced tomes means several hundred dollars per semester in my wallet.

Over the past three decades, the cost of college textbooks has risen more than 800%, faster than the cost of health care, housing, and inflation. With tuition and housing costs rising and a lack of high-paying jobs, paying for textbooks has become a serious issue.

In 2005, three students from Iowa State University sought to build a business and help students everywhere by founding Chegg (NYSE:CHGG). The name comes from a hybrid of "chicken" and "egg," alluding to the post-graduation dilemma in which students cannot find a job without experience, but cannot gain experience without a job. By 2007, the company had begun to rent textbooks to college students, saving students from buying full-price books that they'd only use for one semester.

Today, Chegg continues to provide rental services to students at a competitive price. Currently, the cost of the brand new 9th edition Campbell Biology textbook is $104.48 on (NASDAQ:AMZN). At Chegg, students can rent a brand-new version of the same edition textbook for the five months for $25.99, a 75% discount. Chegg still allows students to highlight and underline pages in their textbooks, as long as no pages are missing when upon return.

Chegg IPO flops out of the gate

On paper, Chegg's business model looks strong. Any student who wants to spend less money for a similar product can use Chegg, while the company can recycle books every semester to new customers. However, the company has run into its share of financial problems. After its IPO of $12.50 a share on Nov. 13, 2013, Chegg stock tumbled 22.6% to $9.68. Since then, it has fallen even farther to around $7, where it hovers today. With a number of questions left to be answered on the company's profitability, investors should be hesitant. However, if the company is able to differentiate itself from competition in the information technology sector, there will be better days to come.

Chegg must find a way to differentiate from market giants

Since Chegg began renting textbooks in 2007, Amazon and Barnes & Noble (NYSE:BKS) have followed suit. Chegg's prices generally remain lower (the same biology textbook can be rented on Amazon for $38.57), but customers might be more inclined to rent from the names they know. Without the cash reserves or brand reputation to compete with these giants, Chegg began to look into online solutions for students. The company began to design a subscription service that would allow students to ask questions about problems in specific textbooks, provide answers to their peers, and find tutors who can explain concepts and mathematical problems. The goal is to provide students with options outside of the classroom, to learn and ask for help along the way.

Even with the implementation of this subscription service, Chegg has continued to struggle. In early February, Chegg stock fell 22% after the company's earnings call for the fourth quarter of 2013. Investors were discouraged after the announcement of an increase in GAAP losses for the second consecutive year. With current assets last reported at $124.31 million, and a net loss of $55.9 million from 2013 expected to increase year to year, it is clear that Chegg needs to decrease its margin, mostly hindered by the textbook rental service.

Change in foundation = change in direction

While Chegg's drive to provide students with cheaper textbook options is admirable, it is time for a change. Encouragement comes from chairman and CEO Dan Rosensweig, who mentioned in the most recent earnings call that the company is entering a stage of "evolution from textbook renter to connected learning platform, allowing us to better connect students with the services and skills they need for academic and career success."

It seems as if Chegg has steered away from its core principle of low-cost print textbook rentals, and will look to provide more online solutions for students. For investors, this should be encouraging. While the company has not entirely given up on its foundation, the margin of print textbooks is not high enough to consistently turn a profit. So how does Chegg move forward?

Options for the future

In 2006, Salman Khan, a graduate of MIT and Harvard Business School, founded a non-profit website with the goal to provide a "free world class education for anyone, anywhere." He called it Khan Academy. The website contains instructional videos covering hundreds of topics that students can access completely free of charge.

I believe Chegg can learn a lot from the model that Mr. Khan has implemented. While its current online service includes a network for students to ask questions, there is no type of visual aid such as the instructional videos from Khan Academy. It is one thing to read an explanation on a computer screen, but to see and hear someone walk you through a problem or concept step by step is a more efficient way of learning.

In the future, Chegg can benefit by removing their subscription fee for online solutions. Instead, the company can generate revenue through advertisements before videos, and continue to rent textbooks emphasizing e-textbook options versus low-margin print ones. While this change may take some time, I will definitely be watching to see what steps the company takes in the next calendar year.