Revisiting the concept of "not for profit"

In what is, to date, my most viewed article, I discussed how I would never recommend to a student graduating college to enter the not-for-profit world to make a difference.  Rather, they should focus on an idea that will change the world and seek to make that venture work in a traditional for-profit enterprise.  I still stick by that thinking, but I open the door with a huge caveat...

If someone changes the model of not-for-profit industry, then Katy bar the door.

A friend recently turned me onto a TED talk given by Dan Pallotta about the nature of social innovation and social enterprise in the modern era.  Outside of the historical context for the development of charities (the predominant view of NFP enterprise) as penance for the Puritan pursuit of capitalistic profit, there was a clear summary of my thoughts on the scale of impact an individual can attain through charitable or not-for-profit work:

It's cheaper for that person [a Stanford MBA making an average of $400,000 per year at the age of 39] to donate $100,000 every year to the hunger charity [where the CEO makes on average $86,000], save $50,000 on their taxes...so still be roughtly $270,000 a year ahead of the game.  Now be called a "philanthropist" because they donated $100,000 to charity.  Probably sit on the board of the hunger charity, indeed probably supervise the poor SOB who decided to become the CEO of the hunger charity and have a lifetime of this kind of power, and influence, and popular praise still ahead of them.

Even critics of Pallotta's talk and ideas (of which there is much, for example here and here) agree with the basic premise that non-competitive compensation and current fiscal measures of organization effectiveness completely miss the point of any corporate activity, even more so when evaluating not-for-profit activity.  Non-profits and charities are expected to "keep expenses down", minimize their overhead, and raise money for their cause either through for-profit-like models or through philanthropy.  Foundation and corporate grants that provide a significant portion of the funding for charitable organizations specifically exclude the organization receiving funds from using the grant to pay for fundraising or operations.  This is, to a point, understandable because the foundations or corporations want to be able to report to their stakeholders that any contributions when specifically to a project, program or activity that they can easily identify.  This significantly limits what a not-for-profit organization can do.  If everyone who gave money to a charity or NFP corporation had that same restriction, the organization would have no structure or backbone on which to build.

The solution to this problem comes not in eliminating not-for-profit enterprise, as many have suggested...either replacing it with for-profit enterprise or government.  Rather, it comes in changing the cultural norm we have relative to organizations that do not center their enterprise on increasing the monetary value to shareholders, but rather measure solely on the accomplishment of a mission.  It starts with terminology, and instead of focusing on the terms for-profit and not-for-profit, we should more accurately refer to them as investor-based and mission-based corporations.  Then, we can accept mission-based corporations not as "not for profit", but rather for what they are, companies that strive to create profits, but instead of returning the profit to investors, they use the profit to further their mission.

In the traditional for-profit, what I am calling investor-based, model, a group of individuals provide capital to an enterprise with the expressed goal of receiving that capital plus an additional return over some pre-planned time period.  The success of the enterprise comes from those investors meeting or exceeding that monetary gain.  The enterprise may serve a social mission - for example, a grocery store that provides easy access to food, but the driving force is the expectation of fiscal return for the capital invested.  No matter how successfully the business meets a social goal, if the capital is not returned, then the business closes down and the investor cuts their losses.

In the mission-based model, the organization targets a social benefit to provide to a community, region, country, or even larger population.  The investors who provide the capital to the organization do so expecting a certain outcome from the organization.  In Pallotta's hunger charity example, it might be as simple as meals provided to an underserved population, or it may be a more ambitious goal of moving a number of people from an impoverished or "hungry" state to one where they have regular access to sufficient nutrition.  Although many mission-based organizations use internal metrics of lives impacted to report to stakeholders, the outward financial reporting focuses on salaries, compensation to board members, and overhead - strict fiscal measures of organizational frugality.

If, instead of focusing on fiscal reporting similar to investor-based organizations, we reported and measured mission impact, then investors would have a similar ability to determine how to invest their capital as with investor-based organizations.  A potential investor could look at metrics like: number of high school dropouts, amount of food waste averted, or progress toward cure for a disease.  That investor could then compare the investment in one organization against others (both investor-based and mission-based) and determine where their capital will have the most impact.  If an organization has a higher overhead than its competitors, that organization will have to adjust or lose market share.  If another group needs five years of growth and network building to make an impact, a good CEO will communicate that effectively with those who have invested, and if the organization has a clear path, their patience will be rewarded.  If not, then the investors will pull their support, "cut their losses" and find another avenue for their capital.

Evaluating mission-based organizations by their potential or realized performance means that if an organization wants - or needs - to pay a competitive salary, or invest in marketing/advertising, or put resources toward fundraising, the organization will evaluate it based upon the potential for impact instead of how much grant funding they will lose because their balance sheet "looks bad".  As Pallotta suggests, if an organization with 5% overhead can better the lives of 100 people, it should not be praised as better than an organization with 35% overhead that betters the lives of 1,000,000 people.  If there is an organization that can help 1,000,000 to the same quality of life at lower than 35% overhead, that organization will compete and take the place of another, but using arbitrary measures of performance limits the opportunity in those industries where mission-based organizations have a better chance of success.

This approach to evaluating investor- and mission-based organizations also allows for better transition from one to the other.  Much work is happening around food deserts in our nation's cities.  Mission-based organizations have stepped in to provide both consumer education as well as low-priced, healthy food options to create a marketplace for food that retailers need to sell to turn a profit in a traditionally low-profit-margin industry.  Once mission-based organizations have built the marketplace to a critical point, investor-based organizations (in my personal view, IBO that include local community investors) can step in and maximize the efficiency with which the community receives its nutritional staples.  The MBO then moves onto another community to continue the process.  This flow of MBO-to-IBO provides a stable and sustainable process by which philanthropists and government can provide seed money to solve a community issue, work through several competing MBO to find the right approach to solving the problem, then create a maintainable IBO marketplace.

Several people contacted me about my article, noting that the central point was sound, but that there will always be a need for not-for-profit enterprise, so we should not discount it.  I could not agree more, but we have to move away from the concept that good business management is less valuable in mission-based organizations than in investor-based organizations.  We have to stop thinking that an engineer working on energy improvements in mission-based organizations provides less value than an engineer working in the investor-based energy services industry.  And we have to stop assessing mission-based organizations on simply their ability to do a little with nothing at all.  An engineer managing disaster relief for Engineers Without Borders and an engineer managing infrastructure projects for Halliburton should be compensated equally for equal work.  If a community-based energy coop needs to lose money for three years in order to build the market and infrastructure for a twenty-year benefit of low-cost, stable energy resources, it should have the same flexibility as an investor-based energy company.

When that day comes, I look forward to being able to officially recant my article.  I cannot today, but I hope that day comes soon.

Author's note:  My current research focuses on evaluating the MBO-to-IBO model against traditional for-profit and not-for-profit enterprises to maximize community resiliency.  Resiliency measures the ability of a community to withstand shocks to material and energy flows in maintaining quality of life.  The hypothesis is that a class of MBO investors can provide the capital necessary to evaluate the marketplace and identify opportunity for improving community stability, the MBO can then test various business models across MBO, IBO and government that address resource consumption and the loss of community capital, and then the MBO can manage a transition to the most effective model.  The community then has the tools to reevaluate performance regularly and make adjustments as needed.  The Center for Ecology in Economic Development will continue this research and provide regular updates on the viability of certain business models in various types of community structures.