The Spring 2005 issue of the Nonprofit Quarterly features an outstanding article by Clara Miller, President and CEO of the Nonprofit Finance Fund, that points out the insanity of many of the rules and practices that govern nonprofit finance. She doesn't just criticize--she also suggests a number of solutions--but she's particularly good when she's taking on the status quo, such as when she mocks donors who refuse to pay for overhead:
It’s a little like this. ...[Y]ou’re the owner of a restaurant. Your paying guest comes to pay the bill, offers a credit card, and prepares to sign the charge slip. But before signing, the guest says, “I’m going to restrict my payment to the chef’s salary. He’s great, and I just want to make sure I’m paying for the one thing that makes the real difference here. I don’t want any of this payment to go for light, or heat, or your accounting department, or other overhead. They’re just not that important. The chef is where you should be spending your money!”
The irony for the field as a whole is that a technique meant to control costs actually undermines efficiency and program quality. The inability of nonprofits to invest in more efficient management systems, higher skilled managers, training, and program development over time means that as promising programs grow, they are going to be hollowed out, resulting in burned out staff, under-maintained buildings, out of date services, and many other symptoms of inadequately funded "overhead."
She concludes with a concise set of admirable recommendations for change [empasis mine]:
Nonprofits need to make profits, just like their for-profit counterparts, or their enterprises falter. This alone would improve things. Behind nonprofits’ difficulty pricing their services to cover their costs is a wider struggle for resources. In government contracting, for example, for profits now price to cost plus profit, and generally enjoy better business terms. The for-profit and nonprofit government contracting rules should align with respect to pricing, profit margins, growth capital, overhead, and other well-known and accepted aspects of business operations.
The focus on overhead or fundraising cost rules of thumb for nonprofits is generally misplaced. It doesn’t get at the productivity of the organization with respect to mission, and ignores the nuances of a variety of business types and stages of development. Delta Airlines has a different cost structure from e-Bay’s; and the Boys & Girls Clubs’ is different from Compumentor’s. Let’s be intelligent about their financial needs.
More and more diverse scrutiny from government and other funders will create more transaction costs in an industry already carrying an overly high level. This will burden large and small alike, making small, innovative, and efficient organizations experience an infusion of cost just as growth is proceeding, and increasing the length of the already long climb to scale. Funders can go a long way toward lowering transaction costs for themselves and their grantees via small modifications to the way they do business, and by taking on the formidable task of tracking program and mission productivity—rather than questionable financial indicators—field-wide...
For all donors, unrestricted grants are the most positive financially and should be the rule and not the exception. This is because anything else, generally speaking, creates cost for the recipient. There may be exceptions, and giving unrestricted funding does not mean that funders cannot or should not be actively involved in communicating with the recipient about plans for the funds, budget, and program strategy. However, anything but unrestricted grants generally creates cost within the grantee’s operation.
With self-discipline and a little creativity, we can improve the business environment for our sector, creating a more intelligent, nuanced system of finance for "social enterprises," and nonprofit services. This will work better than the current approach, which substitutes well-meaning but counterproductive rules of thumb for sensible, informed financial practices. And it will allow us to power sustainability, management improvement, and innovation in the sector by leveraging appropriately some effective and time-tested rules of business.
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2 Responses
Ed:
Thank you for pointing out the article--I haven't read it but I have it deliciously bookmarked.
As we are wont to do, let me add some points from the "program officer" perspective. This is not a defense of current philanthropic practices, which I agree, could be more streamlined, more targeted, and more effective. And, btw, this is my personal opinion, not the viewpoint of my employer.
1. It's probably a better comparison to say that funders are investors rather than customers. Sure, as a customer, I shouldn't have to say that my bill goes straight to the chef, but as an investor, well, it's my job to make sure that the money goes to the right place. If you made an investment in a restaurant, and the owner went and bought a sports car and put a logo of the restaurant on the side, well, you would have to wonder what the investor was thinking.
Nonprofit customers (read clients, constituents, community members, etc.) are not always the ones that foot the bill. Thus a disconnect.
2. We don't know what the right metrics are for efficiency in nonprofits. Not every nonprofit should or needs to be compared against the same baselines, but there should be some metrics that are used. Unfortunately, in this void, the idea of overhead vs. program has reared its head to become a standard.
3. Nonprofits often do not have enough information related to their performance in the form of captured metrics over time. This is a complex issue--one that is not solely a resource or lack of resource problem. To use the restaurant analogy again, put simply, restaurant owners often uses the turnover rate of its tables to know whether or not at the end of the day whether it will make a profit. (That's actually one reason why a lot of cafes are turning off free Wifi--it reduces turnover of their customers.)
4. It will always cost money to get money. This is true for the for-profit as well as non-profit. It costs time and money to get a line of credit from a bank. Banks often asked for more detailed data than foundations do. I'm amazed at the number of times that an applicant has asked for an inordinately large sum for a grant without the requisite financial information to back up their ability to handle it well. Boggles the mind.
5. Program officers are often generalists. And the longer you're in the business, the more of a generalist you become. Sometimes this is a plus, other times it is a negative, especially in understanding how a nonprofit cash flow might work--cash flow would be very different for a charter school than for a community organizing campaign for instance.
6. The more a nonprofit can generate unrestricted funds, the better. I totally agree with this. It is the most valuable kind of dollars. There is a risk/reward with getting money from foundations just as there is a risk/reward for getting money from VCs. Often, I think that nonprofits don't fully recognize that there is "risk" side or that the funds do come with a number of requirements (which may distract the nonprofit from fulfilling its mission).
Someone--maybe you--could do a whole blog on this. Worth a real discussion.
Keep up the good work, Ed.
Thoughtful comments as always, Eugene--thanks. A few responses.
Foundations As Investors
I agree that foundations should be more like investors rather than customers, but actual investors' leverage over management's prerogatives is essentially limited to a vote of confidence/no confidence, and appropriately so. If I think Steve Ballmer's doing a poor job, I can sell my Microsoft stock, but I can't tell him how to do his job more effectively. If foundations truly want to act like investors, they need to disinvest from underperforming organizations, and they need to invest in high-performing ones--and then stop trying to act like managers by dictating how funds should be spent. I recognize that 1) many funders have the ability to act like early-stage investors rather than shareholders, and that they bring resources to the table above and beyond funds, and that 2) it can be difficult to determine which organizations are failing and which are succeeding. But that said, there's still a lot of room for improvement.
Who's the Customer?
This is a fundamental dilemma facing the nonprofit sector. In the commercial world, of course, "customer" connotes not only "the recipient of goods and services," but also (collectively, as a market), "the determinant of just what goods and services are needed and will be provided." Hence the beauty of the market cycle: Customers identify needs, enterprises rush to fill them, and those that convince customers they're doing the best job of meeting that need (usually, although certainly not always, the ones that are actually doing the best job of meeting that need), prosper.
But in the nonprofit sector, the recipients of goods and services are not "customers," they are "clients." And what a difference that makes. "Clients" do not determine what needs exist; they are simply perceived as "needy." They are disempowered and patronized, and ultimately take second place to the actual customers, the people who pay the bills.
Occasionally, we see leaders and organizations that buck this trend, but they're in the minority and always will be. The answer? Harness the market cycle wherever and whenever possible. I don't mean to say that nonprofits should simply ape businesses (I sense Michael Gilbert about to have a fit). But businesses don't have a monopoly on the market cycle. (They do have a monopoly on the ability to make a profit from it, an obscene absurdity that Clara Miller is right to refute.)
To digress for a moment, there's an interesting parallel on the business side of this discussion. A number of thinkers are rejecting the idea that maximizing shareholder value is the only function of a business. It's the most important function, but it must be balanced by the organization's responsibilities to other stakeholders: employees, surrounding communities, future generations. And it's management's duty to make the difficult decisions that must be made when these responsibilities conflict, as they ultimately will. Call this a social bottom line, if you like, although I don't. But businesses would do well if they became less...businesslike.
At the same time, nonprofits would to well to head in the opposite direction and meet them in the middle. And this this whole dysfunctional distinction between "for-profit" and "nonprofit" might simply be erased. We would simply have organizations meeting a range of market needs, responsive to but not governed by the profit motive, free to balance their multiple responsibilities as they see fit. And there would still be a great need for a vibrant philanthropic community, acting as early-stage investors in some cases, as shareholders in others, directing their capital where they believe it will do the most good. Yes, call me a Utopian.
So much more to say on the topics of metrics, data and infrastructure, Eugene, but it has been a very long week, and a Martini calls. Always good to cross paths, and I look forward to continuing the dialogue.