Nonprofits vs. For Profits

Employees of nonprofits, who toil away at below market rate pay scales (a scandal), must get really tired of the “new donors” who are demanding that they act more like for profit businesses and treat them like they aren’t very smart.

I think that the trend towards venture philanthropy, social enterprise and market-based solutions is very positive and should be encouraged. I think that it is terribly exciting that the Silicon Valley tech elite and the New York centered, “masters of the universe” financial wizards have turned their attention to philanthropy. At the heart of the technology and financial revolutions that have taken place over the past few decades is a focus on innovation. Applying this same innovation to improving the state of the world is going to have a dramatic impact.

But before we get carried away and start assuming that Google knows more about global warming than the Environmental Defense Fund, that Bill Gates knows more about vaccines than the World Health Organization, or that the founder of an online auction company knows more about the poor of India than Mother Theresa, let’s make sure these new donors know that nonprofits function differently than for profit businesses for a reason:

Nonprofits are paid by one customer (the donor) and deliver products and services to another customer (the cause there are advancing). This makes things tremendously complicated. I advocated recently that nonprofits need to remember that “the customer is always right” (See The Agitator’s post on when this isn’t true, which I completely agree with). But what happens when one half of the customer base is demanding something that hurts the nonprofits ability to serve the other half? Nonprofits do not exist to serve donors; they exist to serve a cause. The new donors need to understand that nonprofits will almost always know more about what is best for the cause than the donor does. So cut them some slack and don’t tell them to change until you’ve really done your homework.

Administrative expenses are not evil. There is such a thing as waste in both for profit and nonprofit financial statements. But the administrative expense by itself is not going to tell you that. I would venture that The Four Seasons hotel has higher administrative expenses than Motel 6. Does that mean Motel 6 is a better hotel? Sometimes great businesses have to spend more money to produce their product or service than their lesser competitors do.

Market based solutions are great when they are appropriate, but they aren’t always appropriate. Innovations like carbon trading are great alternatives to scolding people to think more about the environment. But the nonprofit sector exists because there are things people want that for profit businesses don’t deliver.

Markets are great when society is fine with whatever outcome is generated. If markets decided that athletic shoes are going to cost $120, you might think that is too high, but few people will believe it is “wrong”. But if society is unwilling to accept a market outcome (for example, electricity prices so high that elderly people can’t afford to heat their homes and die as a result), than you must impose some sort of modification to the market system. You can’t ask the “free market” to pick the most efficient quantity and price if you are unwilling to accept the outcome.

Markets are great when all costs associated with a product or service is borne by the trading partners. But markets cease to function when third parties have to pay. Cigarette smoking is the classic example. Since we know that smoking creates costs that people other than the tobacco company or the smoker pay (for instance health care costs generated by second hand smoke), than we know that the “correct” price and quantity of cigarettes will be miscalculated by a free market.

Markets are great when all benefits associated with a product or service is enjoyed by the trading partners. But when third parties enjoy the outcome, markets also cease to function. For example, the more people around you are vaccinated against a disease, the less likely you will be to get it. Therefore, people who do not pay for a vaccination derive benefit from people who do. Under these conditions, the market is generating incorrect prices and quantities, since the cost of the product does not reflect the value being gained by third parties.

For profit business models aren’t perfect. Neither are nonprofits. I don’t think the solution to the world’s ills is for nonprofits to act more “business-like”, instead I see a future where the line between the for profit and nonprofit business model begins to break down. Where for profit business recognize that doing “social good” does not have to be at odds with profits. And where nonprofits recognize that doing “social good” does not mean ignoring the lessons of the business world.


  1. Paul Botts says:

    I regularly read and enjoy this blog, thanks for doing it. A few unconnected comments on the above in no particular order:

    — it reads in spots there like you are confusing basic market forces with the outcomes of markets such as the cigarettes example. Market forces are simple human nature, inherent to human interaction whether or not any money is involved. They certainly don’t “cease to function” just because one party is paying for a different party to get something. They function in that case _differently_ than in another sort of case but are certainly still present and functioning.

    — the only reasonably-rigorous examination of non-profit salaries that I’ve yet seen in the U.S. has not found that they are much lower than comparable for-profit ones, indeed quite the contrary:
    Surprised the hell out of me too. If anyone has any actual worthwhile data (not simply anecdotes) to say otherwise I’d love to see it.

    — at one level I completely agree that the “non-profits should be run like a business” thing is nonsense. In another sense though I’ve come to the conclusion that it’s good advice:

  2. Holden says:

    We can agree that there are things nonprofits can learn from for-profit businesses, and there are ways in which they should definitely stay different; Bill Gates and co. have some good new ideas, but there are also plenty of ways in which the existing nonprofits know more.

    The only thing I want to point out is that “running like a business” really has nothing to do with skimping on administrative expenses. In fact, quite the opposite: whenever I am trying to convince someone that “Administrative expenses aren’t evil” (as you put it, and I completely agree), I start by saying “Would you want to run a business that way? Minimizing administrative expenses?” Honestly, the argument usually ends there because it’s so obvious. There is simply no good explanation for why people focus on administrative expenses, except that it’s a number that can be easily measured in a sector that has practically no other easily visible and comparable information.

  3. Paul, Thanks for reading my blog. Regarding market forces: When I used the term “cease to function”, I should have been more specific and said “cease to produce optimized outcomes”. Free markets are suppose to produce a price and quantity which is optimum. But in the examples I gave, they are producing outcomes that are sub-optimal because they fail to take into account all costs and benefits. If you stood on a scale with one foot on the ground, the scale would “function” but it would display an incorrect measurement of your weight. Something similar is happening when markets can not capture all cost/benefit information.

    Regarding nonprofit salaries: Interesting research, I’ll comment fully in a future post.

  4. Holden, I agree that the focus on administrative expense as some sort of all inclusive measurement is wrong headed. The problem is that for profits have easily measurable goals (profits), whereas nonprofits have goals which are, at least today, essentially unmeasurable. How much is it worth to save 100 children from AIDS in Africa? How much is it worth to provide a display of artwork to the public in a museum?

    Since we don’t yet know how to measure these outputs accurately, people turn to those things that can be measured. Unfortunately, accurately measuring the wrong thing is not as helpful as inaccurately measuring the right thing.

  5. Holden says:

    @Sean: How much is it worth to enjoy a delicious hot dog? What about a plasma TV? The value of these things is as hard, and as easy, to measure as the value of saving dying people. The value is what people are willing to pay.

    Translating good deeds into dollars is not hard, and it’s not the challenge of nonprofit evaluation. The challenge is figuring out what good deeds are actually taking place. If we could do that, donors would decide for themselves how much it’s worth to them. The problem now is that they don’t even know what they’re getting.

    Might seem like a trivial point, but it’s important to recognize that (a) assessing the unmeasurable is nothing new – for-profit companies have to do that too; (b) not all charity has to be translated into the same terms; you can offer a consumer different products and let them choose what to fund. The current level of clarity is below what’s acceptable, and “you can’t translate lives into dollars” shouldn’t be used as an excuse for that (not that that’s what you were trying to do – but others do).

    (And I think we agree on the administrative expenses thing: there are reasons people focus on it, but they are bad reasons. The focus makes no sense.)

  6. When you buy a “delicious hot dog” the value you place on it is entirely up to you. I don’t get any pleasure or pain from your choice. But the “value” of saving someone from dying can not be assigned by the “buyer” since there are large benefits accruing to people other than you.

    None of this is intended to suggest that we can’t measure the good that nonprofits achieve. But I think it is important to recognize that 1) free markets don’t achieve optimum outcomes when there are externalities (costs and benefits which accrue to people other than the buyer and seller) and 2) that measuring things like the value of a person’s life is difficult to measure with the accuracy that profits are measured with.

    As a hedge fund employee you know that price targets like $44.48 for a stock is dumb, because value can’t be measured with that kind of accuracy. But that doesn’t mean we can’t rank things of value. For instance we can say that Charity A does a better job at saving lives than Charity B does. And we can get insight into how much it costs to “save a life”, but that is just the cost, not the value.

    Remember that using the comparison to a hot dog would require you to believe that as the demand to save lives fell, the price of saving a life would also fall. Or if the number of dying people increased, that the price of saving a life would decrease.

    My point is not that for profit metrics and analysis cannot be applied to the nonprofit sector, just that the uniqueness of the nonprofit sector should not be ignored when importing skill sets from the for profit world.

  7. mbatley says:


    I don’t know if you meant to say it this way but you did really say two different things. You said, “How much is it worth to save 100 children from AIDS in Africa? How much is it worth to provide a display of artwork to the public in a museum?”

    But then you went on to say, “Since we don’t yet know how to measure these outputs accurately, people turn to those things that can be measured.”

    How much something is worth is based on an individual’s subjective belief of its worth. In fact every donor decides that worth by the amount they give. But on the other point you can measure how much your outputs “cost.” Outputs are made up of resources consumed by people and their activities as they work through identified processes. We capture that info for non-profits all the time as a course of our work. Based on measuring those outputs management can make strategic decisions to better alignment those people/activities and processes to execute their mission.

    Also, you didn’t say this but it is a theme…admin cost as a function of any org is neither good nor bad because you have to spend it. The question is whether or not you are spending it most strategically where it can accelerate the organization most effectively.

  8. Holden says:


    “Remember that using the comparison to a hot dog would require you to believe that as the demand to save lives fell, the price of saving a life would also fall. Or if the number of dying people increased, that the price of saving a life would decrease.”

    Both things stated here are true, and in the same way that they’re true of hot dogs.

    If demand to save lives fell, the price of saving a life (in terms of the price at which the market clears – not in terms of the cost) would fall. If the number of people dying rose, then the price of saving a life would generally fall, because whatever was causing the other people to die would be a problem you could solve for possibly less money than the other problems that cause people to die. Just as with any other product, the price would stay the same or fall.

    That does not mean that either of these events would be a good thing, any more than the economy collapsing is good because it means things are cheaper. None of these events would change the “intrinsic” value of saving a life, any more than changes in demand and supply of hot dogs change the “intrinsic” value of a hot dog. But the dynamics of the price at which the market clears are the same.

    The more I think about whether we are actually arguing about anything, the more I think the basic disconnect is that you are starting with a comparison between donors and investors, and I’m starting with a comparison between donors and customers. Both break down, though, and we both end up saying that the nonprofit sector faces unique challenges. But there may still be a difference.

    I don’t agree with your analogy between donors and investors for a variety of reasons. First among them is the notion that a for-profit company’s value – its attractiveness to an investor – is quantifiable, or even the least bit measurable. As you state in your most recent comment, it isn’t. Investing is fiendishly difficult and there is practically nothing about it that is really purely quantifiable – there are estimates, but any formula that is truly reliable is pretty much ipso facto useless (it will be priced in). Sure, businesses can publish their profits, but that really doesn’t make investing easier.

    Unlike investing, donating involves exchanging money for things that aren’t money. Unlike investing, it is UNNECESSARY (not just challenging) to put everything you can buy in the same terms. And unlike investing, you need not be better at it than other people to get what you want. This is why I think of it more like consuming.

    But there is an important difference with consuming, too. When you buy a hot dog, you eat it and you immediately know what you got (certainly with no more than a 24-hour lag). Figuring out how much you like a hot dog is easy (not quantifiable, but easy), and so therefore is figuring out how much you’ll pay for it. When you purchase a better world, there is no guarantee that you will ever find out what you got. That’s why the effort at transparency and education has to be so much greater.

    Show the donor what they’re getting, and they’ll know what to pay (as the post above mine argues). But showing them what they’re getting involves figuring out what they’re getting, and that is a challenge that is truly unique, though it involves many of the same obstacles to certainty that investing does.

    Here’s where the difference comes. If you start by comparing donating to investing, you end up thinking that all charitable works would ideally be translated to the same terms (just as investors try to put everything in terms of return). This is impossible, but you end up doing the best you can.

    By contrast, if you start off by thinking of donating as consuming, you never feel the need to put different things in the same terms. Saving a life is saving a life; giving a dying child a wish is giving a dying child a wish; each person can decide for themselves what each is worth to them.

    This is an essential difference between the GiveWell approach and the approach we’ve seen in some places of trying to put ALL causes in the same terms. Our approach is to pit organizations against each other when their goals are philosophically similar, and beyond that to do our comparisons through discussion, intuition, and personal choice rather than numerical estimates.

  9. This is a refreshing and wonderful analysis. In his paper Good to Great and the Social Sectors: Why Business Thinking Is Not the Answer, Jim Collins says, “We must reject the idea — well-intentioned, but dead wrong — that the primary path to greatness in the social sectors is to become ‘more like a business.’ Most businesses — like most of anything else in life — fall somewhere between mediocre and good. Few are great.”

  10. Thanks Celeste. Jim Collins’ book was one of the suggestions in our philanthropy book recommendations post.