The seven key challenges for non-profit organisations
In this article John Wright, Yorkshire Culture’s Director of Policy and Strategy, identifies seven key challenges facing non-profit organisations in achieving sustainability. It challenges a number of assumptions commonly held by funders and support agencies. It is based on experiences of working directly with cultural non-profit organisations through the ERDF and Yorkshire Forward funded programme, ‘Modelling Sustainability for the Cultural Sector’ and a wealth of research, most notably through the US based ‘Non-Profit Finance Fund’.
In business, we are told that the customer is king; in the non-profit sector it is more like Jack, Queen and King — multiple stakeholders ranging from funders, to brokers to end users. The problem is that the end user or recipient often has very little say in what is being ‘purchased’ on their behalf. To most non-profit organisations the crucial relationship is that shared with the funder or broker, not the end user. If cultural non-profit organisations are to fully exploit their enterprise potential, relationships need to be rebalanced.
Satisfying the needs of the funders
In Clara Miller’s excellent article entitled ‘The looking-glass world of nonprofit money’ (Miller, 2005), she uses the analogy of a hotel. Guests arrive at the hotel in need of a room, but unable to pay the bill. Before they can be checked in, the hotel must find a third party willing to meet the cost. Fortunately, there are a number of third parties willing to pay for the rooms. However, each funder has its own idea about what the needs of the group are such as the quality and cost of the room, whether breakfast should be included, how long they can stay and even whether all the guests are eligible for support. After many hours of discussion with the funders, the hotel is finally able to assign a room to each of its guests. Finally at this stage the hotel must begin to address the needs of its guests directly.
This scenario, devised in the US, is equally applicable in the UK and most non-profit organisations would recognise the daily challenge of satisfying a range of funders to meet the needs of target groups. The majority of cultural non-profit organisations have received funding to deliver core services to priority groups such as young people or black and minority ethnic communities.
The industry of social policy intervention has grown and been sustained on a flood of public investment over the past 15 years. Starting with the lottery capital building boom from the mid nineties, through seven rounds of the Single Regeneration Budget, ERDF, ESF, Neighbourhood Renewal, numerous learning and skills initiatives, safer communities funding, community health, crime, cohesion and older people target schemes. Every aspect of the community has been addressed in one way or another and non-profit organisations have become expert at satisfying the needs of the funders.
The shift towards identifying and meeting the needs of customers directly requires a shift in mindset, along with a whole new language and approach to business. This transition rarely develops organically without entrepreneurially focused individuals. As with many skill sets, it can be developed, supported and encouraged but requires a medium to long-term commitment. Short-term interventions are unlikely to yield lasting results in changing organisational culture. Business support programmes need to adapt and develop to encompass this challenge.
Pricing and cost
The second challenge facing non-profit organisations is around pricing and cost. The reality for the vast majority of the cultural sector is that it is largely impossible to generate a profit on core business. Even within the commercial elements of the sector, income generated through box-office does not cover the costs of production and requires commercial sponsorship. Within the non-profit sector, this deficit has traditionally been met through revenue grants, and to a lesser extent through trading activities such as retailing, catering and asset rental.
Whereas commercial business would eventually abandon unprofitable areas of commerce, non-profit organisations must remain in these areas due to their mission and charitable status. Furthermore, their revenue support and eligibility for grants from the lottery and trusts and foundations is generally predicated on operating as a charity in an environment characterized by market failure. Market failure is characterized by environments where commercial business will not operate due to the difficulty of sustaining profitability. This is often due to the fact that the targeted customer base is unwilling or unable to meet the full cost of the product or service. This is particularly acute in health and social care charities where the most vulnerable groups are often the least affluent, but is also true for much of cultural sector.
Over the last decade, revenue funding both from local authorities and central government via the Department for Culture, Media and Sport (DCMS), has become conditional on working with targeted groups. This presents two problems for the sector. Firstly, these targeted groups, such as young people, ethnic minorities and disability groups, tend to experience high levels of social exclusion and below average levels of income. This means that not only do the costs of intervention rise, but also end users are not able to meet any of this additional cost.
Secondly, it means that cultural organisations can devote insufficient focus on the needs and demands of their traditional customer base. In other words, what would be considered a disastrous approach for business remains the standard operating environment for the non-profit organisations.
The problem is that it is all but impossible to generate a profit or operating surplus. Indeed, it is commonplace for organisations to make a loss on activities, providing in effect a subsidy to the funder. The increasing emphasis on full-cost recovery is certainly welcome and will lessen the pressure on organisations but knowledge of the cost recovery principles is not the same as securing them.
Organisations need support to develop both their management information systems to assess the true cost of delivery and also in developing their negotiation skills to try to secure more sustainable outcomes, often against a backdrop of reduced funding availability and funders more that ever wanting bigger bangs for their buck.
Unwilling funders
The third challenge exists where funders are not willing or able to fund on a full-cost recovery basis. Conventional business operates on an elemental supply and demand basis with companies competing for market share from consumers who are able to make a choice of suppliers. The operating environment for non-profit organisations is more complex, as they compete to secure both income for the activity and a subsidy to meet the losses incurred.
All too often funders will have different and sometimes conflicting goals and values. This is most evident in the debate between price and value. The funder will demand a certain level of value but will not pay the full price of these demands. This leaves organisations to decide whether to seek additional subsidy, turn down the money offered or provided under-funded services to clients leading to a reduction in quality.
The most common response to the lack of operating profit, is for non-profit organisations to develop subsidy business to generate profits to subsidise core business. However, subsidy businesses from fundraising to retail incur their own costs and require investment and significant management time and expertise. The development of the subsidy businesses, often operating as social enterprises is another area requiring significant investment into business support.
Restricted income
The fourth challenge facing non-profit organisations is restricted income. Business requires cash-flow to survive and grow. Success is predicated on investment in people, equipment and systems. The role of directors and senior executives is to direct investment to bolster or secure market position. The trustees and managers of non-profits rarely have this freedom. It is the custom of most funders to restrict or ‘ring-fence’ funding to be spent on projects, often in delivering unprofitable services to targeted vulnerable groups.
For the funders, this allows them some measure of control over how funding is allocated and ensures that it goes directly to helping those most in need. However, the reality is that for nonprofits restricted income often carries high costs, which cannot easily be met from other sources.
Going back to Clara Miller’s hotel analogy, the funder decides that there are not enough hotel rooms to meet demand so decides to provide funding for more beds. However, in doing so it fails to recognize the additional costs incurred in providing hotel accommodation, such as heating, bedding and other furniture. If the non-profit organization is to accept the funding for the new beds, it needs to identify where it can raise the additional finance required to actually provide more accommodation.
A further problem of delivering restricted funding programmes is that organisations can be cash rich but have negative cash-flow. Unlike the private sector, managers operating in the non-profit environment cannot easily move funds around to meet cash-flow needs. It is therefore typical that organisations need to raise funds from several areas to meet the additional costs of delivery. Indeed when public or lottery funds go unspent it is often because non-profit organisations cannot afford to take the money, given the restrictions and the lack of funds to pay for all the necessities those restrictions rule out.
Handling surplus
The fifth challenge facing non-profit organisations is dealing with surpluses — despite everything that has been said about the difficulty of making a profit — well managed organisations will occasionally find ways to do so, particularly by reducing the cost of delivery.
Let us return to the hotel. Suppose it was discovered that a way of reducing operating costs was to make the building more energy efficient. The funders would not support it because it did not represent direct service delivery but the board decides to go ahead anyway to reduce costs and environmental impact and so decides to borrow capital on the basis that it can service the debt from the savings it makes on energy costs. In the commercial world this would be simply seen as good business, in the non-profit world it could be catastrophic.
As discussed earlier under the terms of restricted funding contracts, it is impossible to shift monies between restricted funds. Furthermore, it is often impossible to shift monies within restricted funds. Typically, budgets are agreed line by line and cost by cost and surpluses or profits must be refunded. So instead of being able to use the savings to service the debt on the investment in energy efficiency, the organisation would need to refund the under-spend on energy costs and of course the original capital investment costs are non-reimbursable — leaving the organisation to meet the costs of servicing the debt. Not all funders take such a draconian approach, but the feeling remains that surpluses are bad, signifying that organisations do not really need the money.
Investment problem
The sixth challenge is closely related to this and involves the difficulty of investing into non-profit organisations. Funders tend to ignore the standard business maxim that as the business grows, so the management costs increase. Businesses invest in infrastructure to increase efficiency as growth occurs. Non-profit organisations are rarely able to pursue the same approach, funders prepared to support investment into core costs are a very rare beast — and most not only refuse to support core but also seem to deny that these costs exist, or worse assume they can be reduced through economies of scale.
Costs of this nature might include training for staff to deliver new services, recruiting new staff, supporting managers to take on broader responsibilities, or fundraisers to meet higher targets. All these activities will increase the efficiency of the organisation and in the long term reduce costs, but in the short term, they place high cost burdens on non-profit organisations.
Most funders will not recognize these costs as they exist beyond the marginal cost of providing services. Sadly the end result of this is not that non-profit organisations will turn away the work as their dedication to the mission precludes this option, but that they continue to operate without the investment, undermining the quality of the services and ultimately leading to the organisation facing financial meltdown and the funders receiving poor value for their investment.
Overheads in service delivery
Our seventh and final challenge is related to the cost of overheads in service delivery. All too often overheads are viewed with suspicion by funders — indicating that too much money is being diverted from direct delivery. The irony is that most funders view the restriction of funding as a technique to control costs, in reality it undermines efficiency and programme quality. The inability of non-profits to invest for growth in their people, premises, marketing and managers means that eventually organisations and particularly managers burn themselves out.
Despite significant investment and all the right motives we have a system where we find it extremely
difficult to find and retain higher quality leadership in the sector, where self-sufficiency is almost impossible and sustainability very difficult in the short to medium term and where economies of scale are very difficult to achieve without sacrificing programme quality.
Alongside this, we have ambitions to increase commissioning of the third sector to deliver public services and, as we can see, more restricted funding will worsen the problem already facing the cultural sector and the third sector as a whole. Clearly there is no simple solution to this, but we must recognise the challenges and seek to address them. We must rebalance the relationships between the funders and the funded and focus on the true costs of service delivery.
Conclusion
With a constructive debate and some creative thinking, funders and support agencies can create a less dysfunctional environment for non-profit organisations to operate in, creating a more intelligent approach to funding, access to finance for social enterprise. It will allow is to work towards sustainability, support improved leadership and innovation and finally introduce some of the basic maxims of good business.
This article appeared in the Summer 2007 edition of, and was reproduced courtesy of, the Yorkshire & Humber Regional Review.