Nonprofits Are in a Unique Market

As noted in Part I of this series, in order to be successful, nonprofits require consistent, stable, and predictable funding that allows them to cover their fixed costs (e.g., salary, rent, etc.). The services nonprofits provide, particularly in social, health, and human services, can only exist with infrastructures that support highly specialized practitioners, long-term interventions, effective management, and afford practitioners sufficient flexibility to adapt to the changing and unpredictable needs of the populations they serve. Thus, funding and accountability measures should accommodate the realities of running a nonprofit by supporting the development of good management systems and implementing best practices.

There are many that assume that if nonprofits adjusted their systems to function more like a business, then nonprofits would be able to thrive and reach all of their objectives. However, this assumption is based on the mistaken belief that the nonprofit market works like the private sector market. Nothing could be further from the truth.

The revenue for nonprofits is considered an exchange transaction that is not driven by demand, but rather by the ability to pay for the delivery of services. Prices in the nonprofit market are not driven by cost, supply, and demand. Instead, they are determined by the number of donations and grant funding they receive. In addition, most funders place stipulations on how the funding can be used with limits on administrative, direct, and indirect costs. This often leaves nonprofits unable to cover all of their costs, especially in the face of rising insurance rates and the minimum-wage increase. Despite these counterintuitive circumstances, nonprofit managers who make a very complicated and restricted system work for clients, are often penalized in their audits and judged by the general public for not being business savvy. This misunderstanding of the situation is then chalked-up up by outsiders of the nonprofit field to the “inexperience” of nonprofit leaders. 

Some argue that if nonprofits cannot cover all of their costs, then they should not offer programs at all. However, this would take away services and supports from the most vulnerable, and also runs counter to the nonprofit ethos. As a result, when faced with no viable funding options, nonprofits will choose imperfect funding conditions. They will absorb the costs and run deficits instead of denying services to the general public. 

The realities of nonprofit management necessitate that the contracting, fiscal compliance, and program management parameters for nonprofits are treated differently than those of for-profit vendors who provide traditional goods and services (e.g., paper, supplies, trash collection, etc.).  

What Funders and Policy Makers Should Do in Order to Make Sure That They Support Nonprofits

Nonprofit funding should be flexible, cover all costs, and be simplified. Otherwise, there is a real risk that small and medium-sized organizations are likely to go out of business or be forced to merge. This would be a great loss to the industry since they are more likely to be housed in difficult-to-reach areas, and they are social entrepreneurs that come up with innovative approaches to public service.

The following funding approaches are harmful to the sustainability of nonprofits:

** Administrative caps should not be utilized in funding because there is no correlation between quality and administrative costs.  Administrative costs do not allow nonprofits to adequately represent true costs because they are set too low. They do not take into consideration the variability that exists across the industry. The overhead costs of a nonprofit that is driven and staffed primarily by volunteers are going to be significantly lower than the administrative costs of an organization that provides housing and 24-hour services for disabled populations that require specialists and round the clock support. 

Unrealistic administrative caps also compromise long-term quality. They result in decreased organizational efficiency, program quality, service delivery, and undermine hiring practices. As a result, nonprofits lose experts, cannot leverage people from within the organization, cannot maintain vital staff (e.g., bookkeepers), cannot support decent salaries, and have to compromise essential functions such as professional development, technology, and fundraising. 

** Administrative costs should be fully covered. Funding that does not cover all administrative costs does not improve efficiency, transparency, or enhance accountability. Instead, it undermines the very infrastructure that prevents corruption and mismanagement. A more suitable alternative to ensuring accountability is allowing organizations to develop an infrastructure that permits for good management, appropriate involvement and awareness from board members, and the implementation of best practices. 

** Performance-Based-Grants are not compatible with the nonprofit hybrid corporate model. This funding approach utilizes an unrealistic and inflexible approach to accountability that does not truly assess programs, outcomes, or impact, while making it difficult for small to medium size organizations to compete for funding. This funding approach also poses fiscal challenges for nonprofits because this type of funding, typically provided by government, often changes requirements pertaining reimbursable expenses, which stimulates deficits in organizations. In addition, new rules and programmatic changes often occur in the middle of services. No-shows are not reimbursed despite the fact that the staff member does show up and must still be paid. Lastly, the fee structure does not account for anomalies, which are frequent with difficult-to-reach populations. 

When a for-profit business experiences these types of challenges, it can find ways to adjust practices and fees to make-up the revenue and deficits. Nonprofits, on the other hand, either have to tap into their reserve, if they have one, or absorb the loss since they often cannot charge no-show clients due to their circumstances (e.g., homelessness, mental illness, drug addiction, victims of domestic violence, etc.).

** Cost-Reimbursement and Fee-for-Service require that nonprofits assume a disproportionate amount of risk. The assumption of risk by organizations is significant given the fact that nonprofits can receive a partial reimbursement for completed work, which stimulates deficits and fiscal instability. Cost-reimbursement and fee-for-service can be fiscally onerous funding approaches that precipitate problems with cash flow, financial losses, and force organizations to live paycheck-to-paycheck. Only organizations with significant reserves are likely to withstand the slow or partial reimbursement that nonprofits receive under this system.

For more information, click here and go to Chapter 3, Corruption Perceptions and Transitions: Balancing the Needs of NGO Clients and Organizational Sustainability.

Next Steps

Nonprofits should be afforded funding that is predictable and supports a nonprofit’s administrative infrastructure. They should also not be managed like or be expected to function within the same parameters as government or private businesses. Nonprofit funders would be able to better support organizations by restructuring their thinking with respect to nonprofits and allowing them to focus on solving society’s most complex problems. 

Funding opportunities should be based on an alignment of capacity, realistic expectations, and tasks needed to carry out the work. As a result, funders should consider taking the following steps:

** Government funding should be simplified and more efficient. Simple steps can be taken by funders, like using the same application form every year; maintaining information on record regarding the mission and corporate records so it does not have to be resubmitted; and extending the funding periods to reduce the number of applications nonprofits must undertake. 

** Philanthropic and corporate foundation funding should allow for capacity building dollars and funding critical services, even if they are not innovative. Philanthropic and corporate foundations are often more interested in funding nonprofits that are engaging in innovative work. Giving trends point to the fact that funders are not funding long-term direct human and health services or nonprofit administrative costs, which are increasingly experiencing diminished funding from government.

** Adequate funding formulas should be adopted that consider the nonprofit corporate structure, provide predictable and stable funding, and allow profit margins, growth capital, and overhead. Most nonprofits cannot continue to absorb increased responsibilities without adequate compensation to cover all costs of operation in the long run. In a time period of increased service demands and cutbacks in federal funding, policy brokers at all levels must reconfigure existing approaches to funding.

For more information on the ideal nonprofit funding model, click here.

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