In response to my recent column in the Financial Times, Reader Jeremy Gregg has been asking what makes a nonprofit “sustainable”. George Overholser of the Nonprofit Finance Fund (profiled in the FT story), has sent an email my way that breaks down the distinctions between earned income, donations, and what makes a nonprofit sustainable. I think his line of thinking is a wonderful example of drawing on business thinking without committing the sins of “philanthrocapitalism”.
Although a nonprofit is driven by a mission to help others, it is inescapably in the business of turning funders’ money into program execution.
If I buy a tutoring session [from a nonprofit] for my own kid, that’s called “earned revenue”. If I make a donation that results in a tutoring session for someone else’s kid, that’s “unearned”. But in both cases, the nonprofit firm does the same thing: it turns someone’s money into a useful tutoring session. And it ought to be that good tutoring begets a sustainable flow of loyal paying customers, earned or unearned.
For this reason, I think it’s often best for philanthropists to avoid a “support the organization” mindset, in favor of a mindset that says “buy program execution from the organization”. That way, the earned vs unearned distinction stops being (incorrectly) mapped into the sustainable vs unsustainable distinction.
All this plays directly into the question of sustainability, because an organization that sells a product (superior program execution) is inherently more stable than one that asks for generic support (“we need your help… again!”). Likewise, funders that “purchase” program execution will come back for more (if they think they got a good deal) whereas funders that “support” an organization may begin to ask why the organization can’t seem to get past its difficulties.
All this to say, so-called “unearned” philanthropic revenues can be a fine source of sustainability.
[Not to be confusing, but all of the above excludes what I think of as Builder type funding relationships (as opposed to “Buyer”). Builders are the ones who provide one-time equity-like growth capital. Builders are decidedly not the source of an organization’s financial sustainability. Rather, they help pay the bills while an organization learns to attract Buyer types. Our SEGUE methodology is designed to attract Builder capital.]
When George writes about “Builders vs. Buyers”, he’s making a distinction between “investors” in the nonprofit and “customers” who buy from the nonprofit. This concept was discussed in the FT column and you can read George’s excellent paper on the concept titled “Building is not Buying”.
You have to be careful here because this same logic has been used to poor ends in the past. A Buyer or project-only funder mentality has been linked to the “low-overhead” game where funders want to ensure they are buying the “product” by arbitrarily limiting overhead expenditures.
It’s fine to be a Buyer and not a Builder, but Buyers have to pay the full cost and that includes overhead that goes to turning on the lights, raising more money, and investing in developing and retaining a high staff. Overhead is not part of the equity-like, growth capital the Builder provides. It’s the fixed, organizational costs and in a for-profit world, those costs are included in the price of the product.
Funders and government agencies have dictated arbitrary amounts of overhead (10 or 12%) for so many years now that nonprofits sometimes don’t know how to talk about what it would really cost to “buy” their services, including the appropriate overhead.
Of course you and George Overholser know this, but I think you have to be careful that you don’t throw around Buyer and “project support” without that caveat.
Sometimes I have to decide whether to write for readers who are new, or those that are long time readers. I think anyone who has read my blog for awhile should understand where George is coming from, but you’re right that his line of thinking can be used towards bad ends.
I am much more interested in approaching philanthropy as a Builder. I’ll spend some time explaining the Builder vs Buyer concept in the future.
But in short, I agree with your point completely.
I, too, have spent years combating overhead-bashers.
Interestingly enough, though, the builder/buyer concept is meant to help combat the problem. Reason being: when a nonprofit presents itself as selling something (a unit of output or a unit of outcome), then the buyer of that something is less prone to focus on inputs, or to second guess how the nonprofit is managed.
To extend the example – we don’t think about overheads when we consider the price of a tutoring session from Kaplan, whereas a nonprofit that “needs your support” is often viewed as a conduit that takes money from the rich and gives it to the poor… in which case the overhead rate can become a tempting proxy for efficiency. Much better for the nonprofit to reposition the conversation towards units of output or (better yet) units of outcome.
(The “buyer” approach is not the same as traditional program funding.)
By the way, a favorite debunking of the overhead mindset: did you know that a Rolls Royce carries less overhead than a Ford Saturn? (more advertising) Clearly, that does not make the Rolls a thriftier buy!
Sean, thanks for pointing us to George Overholser’s article on “building vs. buying.” George is to be commended for such creative, structural thinking in the service of nonprofit management. It’s really a fascinating idea.
Since George has been posting on this blog, I hope he’ll see this comment because I do have an initial question:
Does the ‘build vs. buy’ framework adequately address ongoing donor engagement? After all, what we want is an ongoing relationship with an expanding donor base, not builders who abandon what’s built (“My work here is done”) or buyers who feel like Kwik-E-Mart customers: “Thank you! And come again!”
(George, thanks also for the Rolls/Saturn observation. It’s great to have “sticky” examples and I expect I will use this one in the future.)
Thanks for the comment, Chris.
I guess my favorite variety of donor engagement comes in the form of what you might call customer loyalty. Indeed, the “builder’s” role is to help pay the bills while an organization learns how to attract these loyal “buyer type” funders and get them to come back time and time again, simply paying the nonprofit to do what it does so well.
You are quite right to point out, however, that the “builder” concept can tend to nudge particularly desirable funders towards “exit”. Much as with other types of capital campigns, particular care must be taken to avoid allowing a single large grant to prematurely end a valuable ongoing relationship.
Often a single funder can play an interim builder role, and then transition over to a long term buyer one. This is not unlike a for-profit company that provides an equity investment to help launch a new company that it then buys things from. The transition involves a shift from helping to “change what the organization does” to simply providing money that pays the organization “to do more of what it does so well”.
I should add that there is nothing that says the “buyer” experience can’t be one that has high touch, strong emotional content, or a lot of performance feedback. Indeed, “builder” capital is often all about investing towards creating a highly rewarding standard donor experience. (Without a rewarding experience to offer, it is often difficult for a nonprofit to build the loyal following it needs to sustian operations in a focused way. At the same time, unless it becomes more or less standard, the donor experience process can sometimes become a chronic source of mission drift and/or executional distraction.)
I understand what is being said here, but it still doesn’t make sense. If you are not 100% financed through earned income, then you perpetually take philanthropic dollars that could go somewhere else. The goal should always be to EXIT philanthropic support for good. The ONLY caveat is don’t sacrafice program effectiveness for financial sustainability until you have discovered the innovation that would enable you to maintain program quality and become financially sustainable. For example: why is an Higher Ed operating as a non-profit when it provides very attractive ROIs to its students???? I could go on, with the benefits of not having to kowtow to foundations and govt that a private financially sustainable organization affords.
John, the goal for a nonprofit is not financial sustainability, but furthering their mission. It may be that the most effective model for further their mission does not achieve financial sustainability via earned income exclusively. In this case, philanthropic dollars find a high social return on investment. Philanthropic dollars by the way are highly “sustainable”, the on a national level they have less volatility than GDP. If there is a model that maximizes mission advancement that does not require philanthropic dollars, great! But MOST social problems are not most effectively tackled via an earned income model.
Your comment agree with me, except you seem to assume that if a program is not sustainable on earned income, it is only due to them not finding the right “innovation”. I think there’s a lot of innovative ways that nonprofits can earn income, but I highly doubt that all social problems are fixable via earned income strategies.
Sean, as usual, you put it very well.
It would be great if earned revenue strategies could pay for everything that members of society would like to see happen. Of course, if that were so, then there would be no need for nonprofits (or for government)in the first place.
Problem is, even in a well-functioning for-profit economy, there are large swaths of market failure — in other words, large areas where members of society would like to see something happen, but business people can’t (and won’t ever) find a way to make it profitable without philanthropic or governmental outlays that go on “forever”.
Nonprofits are in the business of turning people’s money into program execution. In that sense, they are just like for-profits, except for a difference in tax status, and the fact that their paying customers mostly purchase goods and services for folks other than themselves.