Your Nonprofit Business Model: Is It Really That Healthy?
December 19, 2011 Thomas McLaughlin
It is difficult to talk about business models without sounding like a candidate for Wonk of the Year, but streetsmart managers know that the concept is at the heart of successful management. Strong business models bring programmatic and financial success, while weak ones bring irrelevance and even ruin.
The idea is not commonly accepted in the nonprofit world, even though some of the strongest and best-recognized brands are built on sturdy nonprofit business models. YMCAs were initially formed to assist individuals caught up in the sweeping migration of the American population from farm to factory. Big Brothers Big Sisters’ model is to broker healthy relationships between adults and children at risk. United Way’s workplace fundraising of the last century was a dominant model.
As with so many other things, there is no universally accepted definition of a business model. Here is an adaptation of Clayton Christensen’s work in for-profit business models. The classic nonprofit has to create a successful mix of three elements: resources, program design, and impact. All of these components have to be successful and fully aligned or the model won’t work. Any given nonprofit can be said to have a single business model for the entire entity, or it can have several models for different programs and services.
The resources that support a business model will take many forms. Revenue streams are perhaps the strongest shaping factor in a business model. By definition, public charities have to have sufficient revenue from public sources such as individual donations, foundation grants, and government revenue. Earned income is another proportionately more important source today. And then there are sources such as memberships and passive income (earned interest, rental income, etc.). Even subtle long-term fluctuations in a model’s revenue streams can change operations considerably.
Assets might be another component of a business model. Some nonprofit models require little more than staff time to carry out, while others demand significant investments in property or equipment. The acquisition and maintenance of these assets — or the lack thereof — will frequently determine the success of a model.
An organization’s capital structure is a major, albeit, poorly understood and often seemingly invisible part of a business model. Capital structure refers to the mixture of ways that an organization derives its financial core. For a nonprofit, capital can only come from profit, borrowing, or capital donations. Capital is rarely easy for a nonprofit to acquire, so maintaining it at the proper levels is crucial. The inability to acquire the right amount of capital can be a sign of a poorly executed (or poorly conceived) business model.
Unless a nonprofit exists solely to create new knowledge or experiments, it will have to figure out how to perform a related body of tasks over and over again. This is what the term program means in its simplest sense. In most nonprofits the single largest component of programming is its staff. The nature, culture, training, and management of staff members are the greatest determinant of program success.
Also important is having clear-cut processes for carrying out the program. These take the form of instructions, templates, guidelines, best practices, and institutional knowledge. Whatever end result the nonprofit and its consumers and funders desire, the mechanics of the programming is how they will achieve it. Using the performing arts as an example once again, the ability to put on a well-regarded play night after night is at the heart of the organization’s value. The actors, the script, the set and the props are all part of the programming that the organization has to master.
As a practical matter, the degree to which a program and its desired effect can be replicated is an integral part of the business model. This can be a tricky area for many nonprofits’ business models because if true replicability of results isn’t possible it undercuts the model’s value.
Impact is what donors and funders are paying for the nonprofit to provide. It consists of the changes in the service user and/or society as a whole that are achieved because of the first two components. In the for-profit world, this would be called a value proposition. For nonprofits, it must be the public benefit they achieve that justifies the donations and funding they receive and the tax exemption they enjoy. Owing to the widespread lack of agreed-upon metrics in the nonprofit sector (among many other factors), the inability to prove impact is often where nonprofits’ business models are the weakest. When this condition is true, the business model is always susceptible.
Business models don’t always function smoothly. There are many indicators of a broken business model. Some of the most common are described below.
Chronic deficits. The most recognizable sign of a broken business model is the presence of chronic deficits, either on a program level or for the entity as a whole. It should be noted that deficits, especially in specific programs, are not automatically a sign of business model problems.
Some activities that run consistent deficits might act as feeder systems for other, profitable activities. There might be external considerations warranting tolerance of deficits in exchange for less quantifiable benefits. Still, persistent entity-wide deficits are the surest sign of a business model that simply doesn’t work.
Declining cash balances. Chronic deficits will eventually result in cash shortages. The problem was recently noted in this column (Beating the Death Spiral, NPT, October, 2009). Flawed business models don’t cause all such situations, but many find a home there. Fixed obligations, such as ownership of a too-large building or outsized debt loads, are often behind this kind of insidious decline.
Too many unrelated programs and services. Better known as mission drift, an overload of unconnected and siloed programs and services can impose a kind of hyperactivity tax on an organization. The distinguishing characteristic here is not the sheer number of programs and activities but rather their starkly differing natures. When business models are lumped together the result is fragmentation and diseconomies.
For example, grouping together in one entity programs and services that depend on skilled staffing levels as part of a business model can produce synergies. Adding a program model that requires a heavy investment in real estate forces the nonprofit to create a whole set of competencies that don’t complement staff-intensive programming. Carried to an extreme, this actually weakens the organization.
Choosing business models is a classic way of implementing a strategy but sometimes an organization just doesn’t seem to get it done. Flavor-of-the-month strategies can be a sign that management is indecisive, but they can also be caused by poorly designed business models. Expanding a performing arts organization’s audience by reaching a new demographic can be a legitimate strategy, but a poorly conceived business model for doing so could doom the effort from the start.
Every nonprofit will have at least one business model, no matter if it is largely informal or even unrecognized internally. Entirely a conceptual construct, a business model can be a rock-solid foundation for strategy implementation. Unattended or poorly designed, it can be just as powerful in the wrong direction.
Shape it with care and use it to stay ahead of market changes, and your business model will be a powerful tool for shaping the affairs of your nonprofit.
Thomas A. McLaughlin is a Massachusetts-based consultant and educator. He has worked with the Nonprofit Finance Fund and is and a member of the faculty at the Heller School for Social Policy and Management at Brandeis University. His email address is firstname.lastname@example.org