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How Rosetta Stone has prospered despite the Silicon Valley onslaught in language learning

Key Points
  • Founded in 1992, Rosetta Stone was known for language-learning software that sold in big yellow boxes of CD-roms.
  • To stay relevant and competitive the company transformed itself into a SaS subscription-based business and expanded into edtech.
  • Rosetta Stone made the pivot through several acquisitions, including Lexia Learning, an educational platform designed for schools.
  • Its literacy business grew 21% last year.
Students begin their Spanish language class on Rosetta Stone software during class at Madison Area Memorial High School. The school system was unable to find a language teacher for this school year. In order to keep students up to speed until a teacher is hired, they have utilized Rosetta Stone. (Photo by Michael G. Seamans/Portland Press Herald via Getty Images)
Michael G. Seamans | Portland Press Herald | Getty Images

In the language learning space, few companies have become as iconic as Rosetta Stone. Founded in 1992 by Allen Stoltzfus as Fairfield Language Technologies, Rosetta Stone was known for language learning software that sold in big yellow boxes of CD-roms. Today, those boxed CD-rom sets have gone the way of the floppy disk, but Rosetta Stone is still around.

What kept the company relevant was a drastic change in strategy. Language learning has become a busy space with lots of competition from online upstarts such as Duolingo, Babbel and Linguatronics. Some of these competitors even offer their services for free.

To compete and stay relevant against this onslaught of start-up rivals backed by well-heeled investors like Kleiner Perkins, the company got rid of the boxed CD-rom sets and became a subscription-based business, joining the ever-growing number of companies offering software-as-a-service. Another, perhaps even more significant shift was expanding into schools with a K-12 educational platform.

John Hass, who became Rosetta Stone's chief executive in 2015, after a series of leadership changes, watched the market change very quickly when he took over the reins.

"When I joined the business as a director in late 2014, we were still primarily language learning through boxes of CDs. The company sold 750,000 boxes in 2014. I watched a company that had been pursuing a strategy of decreasing prices and I watched that strategy stop working," he said.

What became clear was that customers are moving to mobile apps and subscription services. Over the past three years, mobile usage among Rosetta Stone customers has exploded going from being less than 10% to 85% of usage today, Hass said.

"Providing a seamless learning experience across desktop and mobile devices became the clear path forward when we saw that most of our learners were using a mobile device for at least part of their learning," he said.

Another big shift for the company has been expanding into edtech and the K-12 literacy education space. Rosetta Stone made the pivot through several acquisitions, including Lexia Learning, an educational platform designed for schools, which the company bought in 2013. Steve Frankel, an analyst at Dougherty & Co., described Lexia as "the red-headed stepchild" of the company.

Providing a seamless learning experience across desktop and mobile devices became the clear path forward when we saw that most of our learners were using a mobile device for at least part of their learning.
John Hass
CEO, Rosetta Stone

"It hadn't gotten enough attention, but once Hass came in and saw the value that was there, the company slashed costs in the language business to invest in Lexia, and that is now the company's crown jewel."

Today Rosetta Stone's consumer language learning business makes up about a third of total revenue while its "literacy" business — selling Lexia's educational platform to schools — makes up another third. Its enterprise and education business, which sells a series of web-based subscriptions of language learning solutions to schools and businesses, makes up the remainder.

Rosetta Stone

Total revenue totaled $173.6 million in 2018, down 6% from the year before, but revenue in the literacy business grew 21% while bookings grew by 23%. Declining revenue in the consumer language business was mainly due to the change in the business model from large upfront payments to subscription offerings. For 2019 Rosetta Stone says it expects consolidated revenue growth of 10%, to approximately $191 million.

Investors have reacted favorably to the strategic shift. Over the past five years, Rosetta Stone stock has soared from $10 a share to $26. In the past one-year and three-year periods, the company stock has outperformed its peer group by a wide margin, posting returns of 80% (1 year) and 50% (3-year). So far in 2019, its shares are up about 40%.

Fast-growing market with lots of competitors

Education, and specifically education technology, has become an enormous area of interest for start-ups and investors. Silicon Valley seems to have set its sights on transforming the educational sector. Last year U.S. edtech companies raised $1.45 billion, up from $1.2 billion in 2017, according to EdSurge, an education news organization funded by several venture capital firms.

Start-ups in the language learning arena such as Duolingo, which is financed by Kleiner Perkins, Union Square Ventures and others, have huge potential to change the way we learn. They aim to shift students from books or software that updates maybe once a year to apps that are part gaming — and part behavioral psychology.

Today's mobile apps can "hear" and correct pronunciation in real-time, "see" and identify everyday items around the student. Babbel, for instance, uses speech recognition tools to test 'users' pronunciation. Online apps can also customize lessons. Duolingo uses gamification to keep users motivated and adapts lessons and tailors exercises to different learning styles.

Language-learning app Duolingo took out billboard ads in Silicon Valley to recruit tech workers to its hometown of Pittsburgh, part of a trend among start-ups setting up shop in cities across the US that offer a better quality of life than the expensive Bay Area.  
Source: Duolingo

There is much room to grow. According to Holon IQ, a data and research firm focused on education, the $6 trillion global education market, which is expected to reach $8 trillion by 2025, is grossly under digitized, with less than 3% of global education spending on technology. Spending on digital technology worldwide was around $152 billion in 2018 and is expected to reach $342 billion by 2025.

Today's mobile apps can "hear" and correct pronunciation in real-time, "see" and identify everyday items around the student. Babbel, for instance, uses speech recognition tools to test 'users' pronunciation. Online apps can also customize lessons. Duolingo uses gamification to keep users motivated and adapts lessons and tailors exercises to different learning styles.

Constantly adapting the business model

Today's subscription and mobile app model allows Rosetta Stone to be more interactive, Hass says. When the company sold boxes of CDs, it had no idea how or if they were being used. With the online subscription model, companies can now see how it is being used, customize, and make adjustments accordingly.

Last year, the company introduced "seek and speak," a feature that uses object recognition technology so users can, for instance, point the camera on their phone or tablet at a piece of fruit; the app can identify the fruit in the target language and engage users in a conversation about it.

"We can push out new technology and changes to consumers and allow them to benefit as they evolve," Hass said.

In addition to adding new, interactive features on its language learning app, Rosetta Stone has also rolled out a variety of subscription plans to attract a broader audience. This is a departure from the one-size-fits-all approach of the single upfront purchase Rosetta Stone used in the past.

"A big opportunity remains in helping people learn that we are a mobile company with a great almost 5-star-rated app. Many people still think of us as only offering CDs," said Hass.

In the first quarter, Rosetta Stone's consumer language business had 516,000 subscribers, an increase of 32% from a year ago and 6% from the previous quarter. But while the number of subscribers is increasing, the subscription periods are declining. The average initial term is now 13.7 months, down from 15.6 months a year ago. In other words, customers are becoming more short-term.

That's become a common challenge among apps where consumers are increasingly opting to buy month-to-month or a bundle of months. To overcome these shorter subscription periods, companies need to grow subscriber numbers, which Rosetta Stone has been doing.

Expanding in schools

Just as technology has transformed the consumer language learning market, it's also been transforming schools and the way teachers run their classrooms.

Kelly Calhoun Williams, an analyst at Gartner Group, says there's been an enormous investment in educational technology for K-12 in the US driven by several factors: the lower cost of devices and the ubiquity of everyone having their own devices.

"School districts and organizations are focusing on digitizing the classroom" now that the cost of providing devices for every student is no longer as prohibitive as before, she said.

Schools are spending billions on technology. Money that used to go to textbooks and paper-based learning materials are now going to technology, including subscription-based learning materials.

The market for K-12 educational software, platforms, and tools is expected to reach $1.83 billion by 2020, according to FutureSource Consulting, with data analytics and instructional tools expected to show strong growth. The market research firm projects a compound annual growth rate from 2014 to 2020 for all edtech to be 4.5%.

Rosetta Stone

"Rosetta Stone has a huge amount of name recognition and it's a very smart bet to go directly into the education market," said Calhoun Williams.

Hass said that the depth and quality of the research backing the Lexia platform stood out to him as well as the quality of the relationships the company has with partner schools. Rosetta Stone has invested in Lexia by building out a complete suite literacy products to serve children who are new learners or older learners who are struggling.

Another change has been to the sales model. Lexia was previously sold mostly through third parties. Over the last three years, the company has built a direct sales, implementation, and training team to deepen relationships with schools.

However, FutureSource anticipates year-over-year market value growth to slow to 3% in 2020 as penetration of these solutions rises. Like the consumer market, there is also a lot of competition and from some of the same competitors such as Duolingo, which has generated a lot of buzz about its free product.

Hass says that as Rosetta Stone is already in 17,000 schools, the company has a leg up because it's viewed as a trusted advisor. Approximately 14% of all U.S. public schools license at least one of the company's products. Those schools are in districts that account for 41% of all U.S. public schools, Nick Gaehde, who heads Rosetta 'Stone's literacy business, said during the company's fourth quarter conference call.

Growing the literacy business, Frankel said, is more a matter of expanding within the school districts they're already in – to grow from a couple of schools in the district to district-wide.

"They already have a proven track record in that district, growing from two to six schools in a district should be low hanging fruit. It's a challenge they can meet," he said.

The company expects 20% revenue growth from the literacy business in 2019, 8% revenue growth in consumer and relatively flat revenue from the enterprise and education business.

"We do believe that we have not yet fully tapped the potential of our brand. It's very well trusted in the language learning market and iconic, but relative to the size of the market it has a very small market share. It's a challenge to us to do a better job of leveraging the brand we've been given to be shepherds of," Hass said.