Effective Economic Decision-Making by Nonprofit Organizations

Dennis R. Young, Editor

Published by the National Center on Nonprofit Enterprise and The

Foundation Center, 2004, 228 pp. US $34.95


President & CEO, YMCA of Greater Toronto

Many voluntary sector organizations including charities and not-for-profit organizations and their leaders have been admonished by private and public sector partners to become more business-like in their approach to management and decision-making. In fact, the use of business principles in the nonprofit sector has helped many organizations to ensure financial sustainability and success.

The YMCA of Greater Toronto is a case in point. In the 1970s, the organization was in dire straits. After 120 years, the YMCA was close to bankruptcy with revenue insufficient to cover costs and facilities and equipment aging and irrelevant to current community needs. The board of directors, teamed with a visionary CEO, decided that the paradigm needed to shift. Management and board had been focused on covering direct costs only and ignoring overhead and re-investment needs. “Not-for-profit” actually had come to mean “for loss.”

The new paradigm included pricing strategies to ensure full cost recovery (direct and indirect) as well as fund re-investment in equipment and facilities so that they were “as new and relevant” to community needs. The YMCA began to “think like a business and act like a charity.” In fact, this business orientation included providing an educational experience for three CEOs in a row through the Harvard Business School’s Advanced Management Program.

This orientation has paid off. In 25 years, the YMCA of Greater Toronto has recovered from virtual insolvency to become the largest YMCA in North America and the fourth largest charity in Canada (excluding hospitals and universities).

Despite this evidence that the adoption of sound business principles and strategy can and does strengthen not-for-profit organizations, I was most impressed with Effective Economic Decision-Making by Nonprofit Organizations because it cautioned against the wholesale acceptance of private sector values by the voluntary sector. The issue is far more complicated than simply applying what works best for business. The book takes a balanced approach:

We start with the basic notion that nonprofit organizations are businesses in the sense that they must compete in various marketplaces and must make financial ends meet. Unlike government, they do not have the power to tax, and they can go bankrupt. But they are more complex than businesses of similar magnitudes because they have multiple ways in which to support themselves— through charitable means, through government support, through investments, and through the sales of goods and services in the marketplace.

And nonprofits differ from commercial businesses in another way that is of primary importance: they are judged by how well they accomplish their charitable or public service missions, not how well they perform financially…That said, nonprofits can make their special economic choices using many of the same principles of economic analysis as businesses do…However, nonprofits are unused to applying such ideas, and they must be wary not to simply adopt the answers that businesses have reached.

I found this approach refreshing and appreciated the acknowledgement of the complexity of the field and the need to cautiously draw from business experience while ensuring that not-for-profit leaders are first and foremost driven by their missions.

After an introduction by the editor, the book is divided into three main parts that explore issues related to effective economic decision making by nonprofit organizations:

core operating decisions, including pricing, compensation, and outsourcing;

resource development, including fundraising costs and investment and expenditure strategies; and

new directions, including nonprofit commercial ventures, institutional collaboration, and Internet commerce and fundraising.

The book concludes with an article by the editor on the seven insights of effective nonprofit economic decision-making.

In the introduction to the book, Dennis Young makes the point that scarcity—the fact that the resources (volunteers, staff, funding) that nonprofits use to carry out their missions are becoming increasingly scarce and hence more valuable—is making it more important than ever to manage these resources effectively. In response to the issue of resource scarcity, nonprofit organizations can compete more effectively for their shares of the economic pie and/or become better at using existing resources more efficiently.

Throughout the course of the book, the various authors explore the contrasting applications of business principles in the nonprofit and for-profit sector. These principles include labour donations, opportunity cost, comparative advantage, transaction costs, economies of scale, specialization, analysis at the margin, crowding out/crowding in, organizational efficiency vs. social efficiency, total return, cost-benefit analysis, present value, gains from trade, return on investment, and product differentiation. It is fascinating to understand how these basic business principles are both relevant to and different for nonprofits.

Sharon Oster, Mel Gray, and Charles Weinberg assert that pricing is the most fundamental of economic decisions. They contrast for-profits, which price their products and services to exclude those who cannot pay enough for the firm to make a profit, with nonprofits, which want to be inclusive so that as many people as possible can benefit from their services. Similarly, while for-profit organizations use pricing as a means of generating revenue, nonprofits face a more complex decision in which they may price low and incur a loss because the service is fundamental to their mission, or they may price high in order to generate profits that can be used to subsidize other programs that are vital to the mission. Nonprofits may also set a price simply to regulate behaviour. For example, charging a fee for a counseling service may result in greater adherence by clients. Finally, for-profit organizations often engage in price discrimination among different classes of customers in order to maximize profits. Nonprofits may use the same strategy to generate more revenue from those who can afford to pay, thereby allowing greater access by less advantaged participants.

Anne Preston points out the similarities and differences between nonprofits and for-profits in her chapter on compensation. For instance, nonprofits must first decide whether to pay employees or to rely on volunteers. This is seldom an option for the for-profit manager. Both for-profit and not-for-profit organizations frequently use market wage to determine appropriate compensation levels for employees. However, not-for-profit organizations can depart from offering market wage through non-monetary benefits that may attract and retain employees. Preston also discusses incentive pay. This is a common practice in for-profit organizations but must be approached differently in nonprofits. Preston suggests that performance incentives be kept within narrow bounds and that these incentives should be collective rather than individual in order to correlate more closely with organizational mission.

Avner Ben-Ner writes about outsourcing as a third core function that is common to both nonprofit and for-profit organizations. He links outsourcing with the concept of opportunity costs – the value of a resource in its next best alternative use. It is vital for both nonprofit and for-profits to consider the best use of time by managers —whether it relates to delivering a non-core service or overseeing contractors who are outsourced to deliver the service. In the end, a nonprofit organization should never outsource functions that are core to its mission and should always keep in-house those functions that it can accomplish more efficiently than other businesses. The author also calls on nonprofits to analyze transaction costs to determine if it is more costly to contract to the marketplace or to manage the function through the internal processes of the organization.

Joe Cordes and Patrick Rooney argue that fundraising activity is often insufficiently scrutinized and, hence, frequently inefficient and wasteful. They first discuss the pros and cons of contracting out the fundraising function. While this activity is often core to a charity’s mission, economies of scale and specialization may make it more efficient for small organizations to hire fundraising firms. The authors state that “the very point of fundraising is to maximize net revenues.” While this is certainly true for some charities and nonprofits, there are many related benefits to fundraising that can be equally powerful and important. Fundraising raises the awareness of the mission and programs of a nonprofit organization more effectively than any communications strategy. It brings new friends and resources to the organization that go far beyond money. And for some organizations, the act of philanthropy—giving time, talent, and treasure—is itself an expression of the organization’s mission. This is certainly true for the YMCA, which seeks to help people reach their full potential in spirit, mind, and body. Cordes and Rooney explore the dilemma caused by the complexity of calculating fundraising costs and the increasing interest of donors and the public in efficiency and accountability in fundraising.

Marion Fremont-Smith focuses on investment and expenditures strategy. While some of the assumptions in the article are based on US regulations, the author explores a number of issues that are applicable to Canada. She points out that nonprofits need to focus on total return, including both the growth in capital and the dividend and interest income. She also notes that it is often difficult to determine whether risk preferences should reflect the donor, the beneficiaries of the not-for-profit’s services, the trustees who govern the organization, or the general public. The selection of the type of investment is also complicated both in terms of ethical considerations and in terms of choosing between investing in the direct delivery of service or in financial vehicles that return revenue to the organization over time. This shortterm/long-term choice can be very challenging for nonprofits.

Howard Tuckman explores the growing trend among nonprofits to engage in commercial ventures as a way of generating new resources and revenue. He cautions that nonprofit organizations need to assess the impact of commercial ventures on other revenue streams. While commercial activity can attract new partners and donors, it can drive others away. He also calls on nonprofits to know and focus on what they do best and not to attempt to compete in a commercial venture that is outside their core competencies.

Jim Austen (one of my professors at Harvard’s Advanced Management Program) contributes a chapter on institutional collaboration. Austen emphasizes the opportunities for both nonprofits and for-profit companies when they combine their strengths to achieve mutual goals. “Nonprofits can bring great credibility, consumer trust, and often specific programmatic knowledge and skills to a partnership. Businesses can bring their commercial acumen, market visibility, and significant financial resources to bear.” This can represent a solid business opportunity for the corporate partner and a chance for the nonprofit to access marketing and other more lucrative budgets rather than competing for scarce corporate philanthropy. The author points to the importance of creating win-win situations and properly assessing the risks, opportunities, and other costs of these relationships.

Finally, Dov Te’eni and Julie Kendall explore collaborative opportunities between for-profit corporations and nonprofits related to Internet commerce and fundraising. They point out the unique advantage of nonprofits in terms of public trust and the role that they can play in sorting the barrage of on-line information and making recommendations and referrals in connection with charitable causes in a way that for-profit enterprises cannot.

The book concludes with a summary chapter by editor Dennis Young in which he reviews seven insights of effective nonprofit economic decision-making. These are:

1. Mission is a primary concern, central to making all wise economic choices in nonprofit organizations.

2. As a practical matter, mission-related effects are often difficult to codify and quantify, but they should be made as precise as possible.

3. Qualitative as well as quantitative benefits and costs must be acknowledged.

4. The tensions between mission and market must be understood and appropriately managed.

5. Diversify to manage risk.

6. Nonprofit organizations are pushed and pulled in different directions by multiple, diverse stakeholders. The challenge is to retain a clear focus on mission and core competencies in light of these pushes and pulls.

7. Economic conditions change. Nonprofit economic decisions need constantly to be revisited.

Effective Economic Decision-Making by Nonprofit Organizations is a refreshing take on the age-old question of what lessons nonprofits can learn from the private sector. As Dennis Young states in his concluding comments:

Sometimes economic practices carry over from business to the nonprofit world in a fairly straightforward way…But nonprofits require a much more sophisticated set of guidelines for practice that take into account both their unique social missions, goals and constraints, and also the peculiar factors and conditions that affect the market venues in which they do their special work…Nonprofits will succeed by becoming competent economic enterprises but only if they also maintain their special character and identities and shape the rules of enterprise to fit them appropriately.


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