NOVA–END OF THE TRACKS? / Nova’s business model based on faulty premise

English conversation school chain operator Nova Corp. has filed for court protection from creditors after running into financial trouble under its president, Nozomu Sahashi, who has since been sacked by other board members.

This is the final installment of a three-part series of articles taking an in-depth look at Nova’s collapse.

The dramatic collapse of Nova Corp., the nation’s largest English-language school chain, has provoked mixed feelings among government officials, in part because it followed a decision by the Economy, Trade and Industry Ministry in June to punish the firm only several months ago.

“I’d heard Nova’s financial situation wasn’t good, but I never expected it would fail just 4-1/2 months after the administrative punishment [imposed by the ministry],” a senior ministry official said.

On Oct. 26, the day Nova filed for court protection, Economy, Trade and Industry Minister Akira Amari said: “Nova had a registration system that other English schools decided against introducing. But it had a fatal flaw.”

The system in question involved requiring students to purchase lesson points when they signed contracts of up to three years, which allowed them to take classes based on the number of points they bought. The more points a student bought in one go, the lower the cost per unit.

But revisions to the Specified Commercial Transactions Law in 1999 introduced changes that would later contribute to Nova’s undoing.

Prior to the changes, language schools were not covered by the law, meaning that some schools were not obliged to accept cancellations after lessons had started, except for in special circumstances such as illness or a job transfer, while some other schools had introduced expensive breakup fees for students cancelling contracts.

Revision of the law allowed customers of aesthetic clinics and language schools to cancel contracts after lessons had started for any reason. Some senior executives at other language companies thought the changes would hurt Nova most, because it had been using lesson fees paid in advance to open more branches.

But Nova’s then President Nozomu Sahashi, 56, reportedly said at a meeting of a deliberative council of the then International Trade and Industry Ministry that was held before the revision, “Our management is as solid as a rock, no matter how the system changes.” The senior executives of other schools looked at each other in complete confusion.

One of associations in the industry that language schools belong to had by then already voluntarily refrained from taking tuition fees in advance for contracts longer than a year. However, Nova continued the long-term contracts even after the revision.

Sahashi was determined to continue the system because of the company’s method of adjusting accounts at the time of a midterm cancellation. For example, even if a student paid tuition in advance on the understanding classes would cost 2,300 yen, Nova would calculate tuition as 5,000 yen per class for those lessons already taken if a contract was cancelled midterm, thus minimizing refunds.

Following the 1999 change, the ministry issued an instruction that worked out in Nova’s favor as it allowed high unit costs to be applied at the time of cancelation in cases when there was “a rational reason.”

Some students complained the refunds were too small, but Nova dismissed such claims by stating that the ministry had accepted its method.

However, things turned sour for Nova when the Supreme Court ruled Nova’s settlement method was illegal on April 3.

Sahashi argued in a statement submitted to the court: “If students started buying large numbers of points for the lower prices and could just cancel them whenever they wanted, our company would go bankrupt.” But the court ignored his pleas.

After the Economy, Trade and Ministry imposed a six-month ban on Nova soliciting for long-term contracts in June, there was a big jump in the number of students asking for their contracts to be cancelled.

“The court ruling and the ministry order led students who had given up on canceling, and who weren’t attending lessons, to take action,” one Nova employee said. “It was like waking up a sleeping dog.”

From April to June, the company had to refund 1.6 billion yen–more than the company had set aside for refunds for the entire year. Nova executives quickly realized they had little cash on hand.

Now, about 300,000 students, who paid a total of about 40 billion yen in advance have been left out of pocket. When a company goes into liquidation, outstanding taxes and worker’s salaries are prioritized over refunds, so it is likely that students will get nothing back.

Sahashi had hoped to establish 1,700 branches around Japan–about twice what it achieved at its peak. But the capital for enlargement came from advanced payments from students.

Nova was structured on the faulty premise that there would be an endlessly increasing supply of students. This assumption was based on shakier foundations than the ministry realized.