SOCIAL ENTIRPRISE

What do you dowhen traditional

sources of fundingfall short}

ENTERPRISINGNONPROFITS

BY J. GREGORY DEES

LAST AUGUST, tbe American Med-I ical Association backed out of

an exclusive deal with SunbeamCorporation, a manufacturer of sucbbealtb-related products as ther-mometers and blood pressure moni-tors. Tbe deal would bave allowedSunbeam to display an AMA seal ofapproval on some of its products-products tbat would tben be pack-aged witb AMA sponsored bealthinformation. In return. Sunbeamwould pay a royalty to the AMA onsales of tbe endorsed products.

Tbe agreement sparked an outcryfrom tbe AMA's members and otberobservers wbo feared tbat it wouldcompromise tbe integrity of the 150-

ARTWORK BY CRAIG FRAZIER

year-old association. The reactionwas so strong tbat tbe AMA's boardof trustees was forced to rescind keyterms of tbe deal just one week afterannouncing it. Tbe revised policyspecified tbat the association wouldnot endorse products, accept royal-ties, or enter into exclusive arrange-ments with corporate partners. Sun-beam would be asked only todistribute tbe AMA's bealth infor-mation witb its products and wouldpay tbe association only enough tocover tbe costs of producing tbe in-serts. The AMA would not profitfrom the corporate use of its name.

Tbe AMA's experience bighligbtsbow turbulent tbe new tide of com-

mercialization in tbe nonprofitworld can be. Faced witb risingcosts, more competition for fewerdonations and grants, and increasedrivalry from for-profit companies en-tering tbe social sector, nonprofitsare turning to tbe for-profit world toleverage or replace tbeir traditional

/. Gregory Dees is an associate pro-fessor at the Harvard BusinessSchool in Boston, Massachusetts,where he specializes in social entre-preneurship. He is currently onleave working as a senior adviser tothe Mountain Association for Com-munity Economic Development inBerea, Kentucky.

55

5OCIAL ENTERPRISE ENTERPRISING NONPROFITS

sources of funding. In addition, lead-ers of nonprofits look to commercialfunding in the belief that market-based revenues can be easier to growand more resilient than philan-thropic funding.

The drive to become more busi-nesslike, however, holds many dan-gers for nonprofits. In the hest ofcircumstances, nonprofits face oper-ational and cultural challenges inthe pursuit of commercial funding.In the worst, commercial operationscan undercut an organization's so-cial mission. To explore the newpossibilities of commercializationand to avoid its perils, nonprofitleaders need to craft their strategiescarefully. A framework - what I callthe social enterprise spectrum-canhelp them understand and assess theoptions they face.

The Rising Tide ofCommercializationNonprofit organizations have tradi-tionally operated in the so-calledsocial sector to solve or amelioratesuch problems as hunger, homeless-ness, environmental pollution, drugahuse, and domestic violence. Theybave also provided certain hasicsocial goods-such as education, thearts, and health care-that societyhelieves the marketplace by itselfwill not adequately supply. Nonprof-its have supplemented governmentactivities, contributed ideas for newprograms and other innovations, andfunctioned as vehicles for privatecitizens to pursue their own visionsof the good society independent ofgovernment policy. Although somenonprofits have relied heavily onfees-especially those in the fields ofhealth care and education-govern-ment grants and private donationshave also accounted for a consider-able portion of the funding thatmany nonprofits receive.

Recently, however, an increasingnumber of nonprofits have beenseeking additional revenues hybehaving more like for profit organi-zations. Some are raising fundsthrough auxiliary commercial enter-prises. For example. Save the Chil-dren, an international developmentagency, sells a line of men's neck-wear. Such ventures are for the most

part hold, creative extensions of theold-fashioned bake sale or car wash:they get the word out about a non-profit organization and its cause and,if successful, generate cash.

More dramatically, a number ofnonprofits are beginning to commer-cialize the core programs throughwhich they accomplish their mis-sions; that is, they are looking forways to make these programs relyless on donations and grants andmore on fees and contracts. Some areaccepting contracts from govern-ment agencies, for instance, to runsocial service programs, schools, andjob-training programs for welfarerecipients. Others are performingfee-hased work for corporations orare charging beneficiaries directly

A new pro-businessZeitgeist has

made for-profitinitiatives more

acceptable in thenonprofit world.

for services that used to he free. Forexample, universities are engagingin contract research and are formingcommercial partnerships to capital-ize on the results of their noncon-tract research. Better Business Bu-reaus have explored charging a feefor reports on companies. Some non-profits are even launching husinessenterprises to serve the objectives oftheir missions. For instance, SanFrancisco's Delancy Street Restau-rant, run by the Delancy StreetFoundation, is staffed by ex-convictsand former substance abusers whoparticipate in Delancy's intensiveself-help program and work in therestaurant as part of their rehabilita-tion. Finally, a few nonprofits, mostnotably hospitals and health mainte-nance organizations, are convertingto for-profit status or are heing ac-quired by for-profit companies.

Nonprofit leaders are scramblingto find commercial opportunities fora number of reasons. First, a newpro-business Zeitgeist has made for-

profit initiatives more acceptable.With the apparent triumph of capi-talism worldwide, market forces arebeing widely celebrated. And withgrowing confidence in the power ofcompetition and the profit motive topromote efficiency and innovation,many observers are suggesting thatmarket discipline should exert moreinfiuence in the social sector-espe-cially when those observers havefundamental doubts about the per-formance of social enterprises.

Second, many nonprofit leadersare looking to deliver social goodsand services in ways that do not cre-ate dependency in their constituen-cies. Even many advocates for thepoor or disadvantaged believe thatinstitutional charity can underminebeneficiaries' self-esteem and createa sense of helplessness. As a result,some organizations are chargingbeneficiaries for at least a portion ofthe cost of services. Others seek touse business as a tool for helpingpeople develop self-reliance andbuild marketable capabilities. Oneimportant study of nonprofit busi-nesses that help the homeless andother disadvantaged groups becomeself-sufficient was recently pub-lished by Jed Emerson of the RobertsFoundation (now called the RobertsEnterprise Development Fund andoriginally created by George Robertsof the LBO firm, Kholherg, Kravis,and Roberts). The study documentsa host of job-creating nonprofit busi-nesses-such as bakeries, ice creamshops, and greeting-card and silk-screened T-shirt stores-all in theSan Francisco Bay Area.

Third, nonprofit leaders aresearching for the holy grail of finan-cial sustainabili ty. They viewearned-income-generating activitiesas more reliable funding sourcesthan donations and grants. Many ofthem now consider extensive depen-dency on donors as a sign of weak-ness and vulnerability. Self-fundingis the new mantra. At a minimum,organizations seek a diversity offunding sources to provide a cushionin case one source declines or disap-pears. Commercial funding is partic-ularly attractive because it is poten-tially unrestricted: owners of acommercial enterprise can use ex-

56 HARVARD BUSINESS REVIEW |anuary-Febmary 1998

ENTERPRISING NONPROFITS SOCIAL ENTERPRISE

cess revenues for wbatever purposesthey like, wbereas tbe use of grantsand donations to nonprofits is oftenrestricted to particular projects andpurposes. Furtbermore, commercialmarkets are potentially huge.

Fourth, the sources of funds avail-able to nonprofits are shifting tofavor more commercial approaches.Competition for philanthropic dol-lars is intense, hut money is becom-ing available for operating on a moreeommercial basis. Consider the fol-lowing changes: Today few founda-tions want to provide ongoing fund-i n g - e v e n to highly successfulprojects. Most choose to limit theirfunding to short periods in an effortto press grantees to become increas-ingly self-sufficient. At the sametime, government agencies arc shift-ing from providing services them-selves to contracting with indepen-dent nonprofit and for-profitorganizations. Such contracting cre-ates opportunities, but governmentgrant programs are heing cut ortbreatened. Finally, corporations arethinking more strategically aboutpbilanthropy. They are no longer de-ciding wbere tbeir grant dollars willgo solely on the merits of tbe pro-grams they will fund but on the val-ue tbey will derive from tbe relation-sbip with a particular nonprofit.Some corporations are exploring thebenefits of direct business relation-ships witb nonprofits, and otbersbave started paying for social ser-vices as an employee benefit-againcreating new commercial opportuni-ties in the social sector.

Fifth, competitive forces are lead-ing nonprofit managers to considercommercial alternatives to tradi-tional sources of funding. New for-profit companies bave made consid-erable beadway in health care andarc heginning to enter otber socialservices - sucb as running orpban-ages, managing charter schools, andproviding welfarc-to-work pro-grams. As for-profit companies enteran industry and some nonprofitsstart experimenting with commer-cial operations, otber nonprofits feelpressured to follow tbe lead of tbeircompetitors tbat are turning to com-mercial sources of revenue. For in-stance, many nonprofit hospitals

mimic the management styles andmethods of tbeir for-profit counter-parts. Similarly, if some major uni-versities subsidize tbeir operationsby commercializing research, otberswill do tbe same-if only to main-tain a competitive cost structure.Once commercialization in a social-sector industry begins, many non-profits jump on the bandwagon-

opportunities can be risky. Tbe oftenperilous currents of commercializa-tion in the social sector must be nav-igated witb care. There are a numberof dangers tbat nonprofit leadersshould be aware of.

Like the proverbial tail waggingtbe dog, new sources of revenue canpull an organization away from itsoriginal social mission. Consider the

An increasing number of nonprofits are seeking additional revenues bybehaving more like for-profit organizations.

even if questions remain about howsuccessful tbose operations ulti-mately will he.

Navigating DangerousCurrentsMarket-based funding approaches dobave an important role to play in thesocial sector. If those social pro-grams tbat are able to generate theirown income in fact do so, philan-thropic dollars can he allocated toactivities tbat truly need to be subsi-dized. But embracing commercial

YMCA. Tbe association today gen-erates substantial revenues by oper-ating healtb-and-fitness facilities formiddle-class families, but criticscbarge tbat tbe YMCA has lost sightof its mission to promote the "spiri-tual, mental, and social condition ofyoung men." Similarly, a formerhoard member of a major dance com-pany resigned hecause be felt tbecompany had neglected its artisticmission and bad become too com-mercial hy performing popularpieces to generate revenue. Of

HARVARD BUSINESS REVIEW faniiary-February 1998 57

SOCIAL ENTERPRISE ENTERPRISING NONPROFITS

course, changing a mission in orderto ensure the survival of a worth-while organization may he justifi-able. But nonprofits sbould be awarethat by seizing market opportuni-ties, they may he drawn incremen-tally and unintentionally into newarenas far from tbeir original focus.

Nonprofit leaders should also rec-ognize that creating a sustainahleand profitable business is not easy.Market discipline can be barsb.Some studies indicate that morethan 70% of new businesses failwithin eight years of tbeir inception.Substantial profits, although not im-possible to achieve, are bard to comehy. In perfectly competitive mar-kets, companies make only enoughto cover costs and to compensatecapital providers adequately. Run-ning a profitable business requiresskill, luck, and fiexihility. Nonprof-its may have some advantages wbencompeting in commercial markets.Those advantages include tbeir taxstatus and tbeir ahility to capitalizeon volunteer labor, to attract in-kinddonations and supplier discounts,and to use philanthropic money tohelp cover start-up costs and capitalinvestments. But those advantagesalone will not ensure profitability.

Many nonprofits simply do nothave the business-specific organiza-tional skills, managerial capacity,and credibility to succeed in com-mercial markets. And huilding neworganizational capabilities can hecostly and difficult. Hiring peoplewitb business skills and marketfocus is not enougb. An organizationmust be receptive to and supportiveof new activities; it also must be ahleto integrate tbe skills and values oftbe new staff. Many MBAs who go towork in nonprofit organizations findthemselves ostracized by their col-leagues. One business school gradu-ate and former hrand manager at amajor corporation, who now heads adivision of a nonprofit devoted toenvironmental protection, spentseveral years overcoming the skepti-cism of core staff memhers. In thatorganization, scientific credentialsand a demonstrated commitment totbe environment were signs of pres-tige; husiness skills were suspect.The division head's staff feared tbat

he would focus on the bottom line totbe exclusion of the mission.

Indeed, tbe culture of commercecan conflict with that of the socialsector in several ways. Many whowork in nonprofits are uncomfort-able witb tbe style of operationscommon to for-profit organizations.Consider tbe conflicts that occurredat a major nongovernmental organi-zation operating in a developingcountry. On one side were the socialworkers who were committed tohelping tbeir poverty-stricken clien-tele. On the otber side were the loanofficers in tbe newly formed, self-sustaining microloan operation,which helps some of tbe sameclients start small businesses. Whentbe loan officers had to demand pay-

Like the proverbialtail wagging the dog,

commercialfunding can pult a

nonprofit away fromits social mission.

ments from a client, the social work-ers objected. They found this kind ofbusinesslike behavior offensive; itran counter to their sense of compas-sion. Although nonprofits bave be-come more accepting of business ingeneral, some nonprofit managersstill bristle at the use of husinesslanguage. Even the word customercan put people off. The leader of onecommunity-based arts organization,uncomfortable with the idea of he-ing customer driven, contends tbatber mission is to provide a forum foravant-garde African-American play-wrigbts, not to cater to the tastes of alocal audience. And sbe is far fromunique. Social workers, curators, ed-ucators, doctors, nurses, artists, sci-entists, and other professionals wbostaff nonprofits may balk when theyare expected to adapt more to busi-nesslike methods of operation.

Commercialization can also un-dermine tbe role a nonprofit organi-zation plays in its community. Com-munity-hased nonprofits often serve

as outlets for citizens to act on tbeirphilanthropic impulses-to join vol-untarily in efforts to improve tbeconditions of tbeir community. Theexecutive director of a major foodbank believes that the mission of hisorganization is not only to supplyfood for the needy hut also to provideopportunities for people from allwalks of life to volunteer, to servetbe poor, and to interact with oneanotber. Volunteers may not he soready to contribute their time tofor-profit programs. Altbougb com-mercialization need not drive outphilanthropic activities, tbe two im-pulses can he difficult to halance.

When nonprofits hecome morebusinesslike, they may run afoul ofpuhlic values and meet witb politi-cal resistance. For instance, the RedCross blood-hank system has comeunder attack recently for its attemptto create a national system of distri-bution, its allegedly aggressive pur-suit of donors, and its alleged failureto serve hospitals that favor otberblood providers. Of course, tbe RedCross bas defended itself againstthose charges, but the point is thatnonprofits are not expected to he-have like businesses. When tbey do,critics are ready to pounce.

Nonprofits that undertake com-mercial initiatives also face resis-tance from for-profit competitors.Nonprofits are perceived to bave tbeunfair advantages of tax hreaks andlower costs for labor, capital, andsupplies. Cross-sector competitionexists in industries from day care topublisbing to gift catalogs. For-profitproviders of adult education servicescomplain about nonprofit rivals.Local retailers don't like competingwitb university-owned stores thatsell not only textbooks hut alsoclothing, computers, records - itemstbat bave little to do with a school'seducational mission. If the competi-tion continues to heat up, for-profitrivals will step up the pressure for areconsideration of tbe tax exemp-tions offered to nonprofits.

Charting a Favorable CourseDespite the risks of commercializa-tion, nonprofit leaders can cbart a fa-vorable course through commercialwaters in their search for ways both

HARVARD BUSINESS REVIEW lanuary-February 1998

SOCIAL ENTERPRISE ENTERPRISING NONPROFITS

THE SOCIAL ENTERPRISE SPECTRUM

Purely Philanthropic Purely Commercial

Motives, Methods,and Goals

ehol

ders

1

Beneficiaries

Capital

Workforces

Suppliers

Appeal to goodwill

Mission driven

Social value

Pay nothing

Donations and grants

Volunteers

Make in-kind donations

Mixed motives

Mission and market driven

Social and economic value

Subsidized rates.or mix of full pa/ersand those who pay nothing

Beiovz-market capital, or mix ofdonations and market-rate capital

Beiow-market v ages, or mix ofvolunteers and fully paid staff

Special discounts.or mix of in-kindand full-price donations

Appeal to self-interest

Market driven

Economic value

Market-rate prices

Market-rate capital

Market-rate compensation

Market-rate prices

to reduce tbeir organizations' depen-dence on grants and to enbance theirmission-related performance. Tbechallenge is to find a financial struc-ture tbat reinforces tbe organiza-tion's mission, uses scarce resourcesefficiently, is responsive to cbanges,and is practically achievable.

To begin, nonprofit leaders mustunderstand the full range of avail-able options. A social enterprise iscommercial to tbe extent that it op-erates like a business in how it ac-quires its resources and distributesits goods and services. Tbe morecommercial an organization, the lessit relies on philanthropy. Few socialenterprises can or should be purelyphilanthropic or purely commercial;most sbould combine commercialand pbilanthropic elements in a pro-ductive balance. Many already do.(See tbe exhibit "The Social Enter-prise Spectrum," wbicb shows tberange of commercialization in termsof a nonprofit's relationsbips witbits key stakeholders.)

For instance, colleges and univer-sities charge a tuition that does notcover operating costs because sucbinstitutions can draw on alumni do-

nations, research grants, and incomefrom endowments. Some nonprofitscross-suhsidize one program orclient group witb anotber. Many daycare centers use a sliding fee scale sotbat wealtbier families subsidizepoorer ones. Ballet companies oftenuse profits from holiday perfor-mances of the Nutcracker to supportartistically important hut unprof-itahle productions. Still other non-profits ohtain funding from third-party payers, such as governmentsand corporations. Health careproviders commonly receive thebulk of tbeir revenues from publicand private insurance plans. Socialservice providers can contract withstate government agencies to pro-vide tbeir services to state residents.

As tbey evaluate tbeir organiza-tions' potential to operate at tbecommercial end of the spectrum,nonprofit leaders sbould begin byidentifying all potential commercialsources of revenue. Potential payingcustomers include the organiza-tion's intended beneficiaries, thirdparties witb a vested interest in themission, and otbers for whom tbe or-ganization can create value.

Earned Income from IntendedBeneficiaries. In an ideal world, so-cial enterprises would receive fund-ing and attract resources only wbenthey produced their intended socialimpact-sucb as alleviating povertyin a given area, reducing drug abuse,delivering bigb-quality education, orconserving natural resources. Thebest strategy in this ideal worldwould he to ask tbe intended benefi-ciaries to pay full cost for services.After all, the beneficiary would bein a prime position to determine iftbe value created was sufficientlybigb to justify the costs of creatingit. In the real world, bowever, tbisapproacb works only for nonprofitsthat are in the husiness of servinga clearly defined and well-informedconsumer who is able to pay. Mem-bership organizations are one exam-ple; their heneficiaries, or memhers,pay for services tbrough memher-sbipfees.

Few nonprofits will he able to re-duce tbeir missions to that kind offormula. The intended beneficiariesof a social enterprise are rarely well-informed, viable, or appropriate pay-ers. In some instances, it isn't even

60 HARVARD BUSINESS REVIEW |anuary-fcbriiary 1998

SOCIAL ENTERPRISE ENTERPRISING NONPROFITS

clear who the intended beneficiariesare. Who is the intended beneficiaryof a project to save the whales fromextinction? The whales? The generalpublic? Future generations? In manysocial enterprises, the intended ben-eficiary is unable to pay anythingclose to the cost of the services de-livered. For instance, if developmentagencies such as CARE, Save theChildren, and Oxfam - agencies thatserve poor, distressed communities-relied exclusively on fees chargedto residents, they would be able tooperate only in relatively wealthycommunities.

In other instances, beneficiariesmay not be sufficiently knowledge-able to make an informed purchasedecision. Or they may not fully ap-preciate the value of the service be-ing offered. For example, abusivespouses who recognize that theyhave a problem but underestimateits severity might not realize thebenefit of counseling to themselvesand to their families until after theyhave gone through a program. If fullpayment were required, they mightnot undergo counseling at all. Be-cause collective goods are often atstake in the work of nonprofits, soci-ety might lose in such an exchangeas well. For example, society bene-fits from the drop in crime rates thatoccurs if addicts are treated in reha-bilitation programs; but if addictswere required to pay the full cost ofthe program, few would join.

Finally, requiring intended benefi-ciaries to pay may be inappropriate,even when it is feasible. Commer-cialization can often change thecharacter of a nonprofit's relation-ship with its beneficiaries. ImagineAmnesty International charging afee to the political prisoners who arereleased as a result of its activities orthe Red Cross charging disaster vic-tims for relief services. If Big Broth-ers and Big Sisters charged childrenor their families for a mentor's time,wouldn't the child suspect that thementor was there simply for the pay,and wouldn't that suspicion under-mine the relationship?

To understand the full range ofcommercial options, nonprofit lead-ers should evaluate potential rev-enues for all beneficiary groups.

services, and products. Assumptionsabout the viability and appropriate-ness of charging for services alsoshould be explored and questioned.For instance, should a group thatserves people with disabilities as-sume that its constituency could notor should not pay for any of the ser-vices it provides? In fact, it can be de-meaning to treat people with disabil-ities as charity cases. Asking for atleast some payment can give benefi-ciaries a sense of responsibility andenhance their commitment to thetreatment. In programs requiring theactive participation of beneficiaries,pricing serves to screen out thosewho are not sufficiently seriousabout the program. If the intendedbeneficiaries vary in their ability to

Commercializationcan often change the

character of anonprofit's

relationship with itsbeneficiaries.

pay, nonprofit leaders should exam-ine the feasibility and desirability ofcross-subsidization and discountedfees. The organization could usesliding fee scales, scholarships, spe-cial discounts, and other devices toallow access to people of lessermeans. It could also opt for deferredpayments along the lines of studentloans for higher education. A moreradical alternative to deferred pay-ments would he to encourage pre-payment or group payment usingmembership fees or an insurancescheme. Some colleges already offerto guarantee tuition rates manyyears into the future if parents paytuition in advance.

Earned Income from Third-PartyPayers with a Vested Interest. Facedwith the difficulties of charging in-tended beneficiaries for services ren-dered, social enterprises often needto search for next-best solutions. Tothat end, nonprofits can look tothird-party funding sources. Themost likely direct payers are govern-

ment agencies and corporations thathave a vested interest in an intendedbeneficiary group or in the enter-prise's mission. The government'srole as a source of revenue for certainnonprofit organizations is widelyrecognized. It has a vested interest incollective goods and in the welfare ofthe poor. Corporations play a similarrole when they subsidize such em-ployee benefits as health care, daycare, elder care, family counseling,and alcohol and drug rehabilitation.

Third-party payment can takemany forms. The payers can issuevouchers to he used at the discretionof the beneficiary, can reimburse forservices chosen by beneficiaries, orcan contract directly for service de-livery. Contracting itself can rangefrom cost plus to flat rates per capita.In many cases, the beneficiariesshare some of the costs throughco-payments and deductibles. Thisapproach appealed to the founders ofGuateSalud, a health maintenanceorganization for the rural workingpoor in Guatemala. After strugglingto raise donations for their work, thefounders decided to market theirhealth services to the owners ofsmall coffee plantations who em-ploy poor migrant workers duringthe harvest season. The owners paida monthly fee for the service, andworkers paid token fees for visits tothe health facility and for pharma-ceuticals. The arrangement was asuccess: the owners got a healthierworkforce, and the workers gainedaccess to medical care and health ed-ucation that otherwise would nothave been availahle to them.

Nonprofit leaders considering thisoption need to ask how closely theinterests of third-party payers alignwith the organization's mission. Ifthe interests diverge from the mis-sion now or in the future, how canthe mission be protected? The chal-lenge nonprofit leaders face, then, isto find third parties whose interestsfit the enterprise's mission and tomaximize that alignment. Theyneed to conduct a thorough, fact-based assessment to determine theimpact of potential arrangements onthe mission. For instance, if it is im-portant for GuateSaiud to improvethe overall health of poor native

62 HARVARD BUSINESS REVIEW Tanuary-February 1998

ENTERPRISING NONPROFITS SOCIAL ENTERPRISE

Guatemalans, is contracting withthe plantation owners, who haveaccess to many of those workersonly during harvest, enough? Theanswer to that question depends inlarge part on whether a brief healthintervention at harvest time makesa significant difference in healthoutcomes. The question also mustbe weighed in the context of alterna-tives: if funding isn't available for amore substantial intervention, sucbas placing clinics in remote regionsor having health providers travelextensively, contracting with tbeowners may be better than nothing.

As they conduct their assessment,nonprofit leaders sbould also con-sider sucb practical matters as thecosts of negotiating contracts andmanaging tbe ongoing relationsbipwith a third-party payer. In somecases, particularly in tbe case of gov-ernment contracting, the nonprofitcan incur considerable incrementaladministrative costs.

Finally, nonprofit leaders sbouldevaluate how reliable the revenuestream will be over time. It can berisky for a nonprofit to have just oneor a few major payers because a can-celed contract would be a majorhlow to tbe organization. For in-stance. Leeway, a nursing home forpeople witb AIDS, depends heavilyon Connecticut Medicaid reim-bursements. A change in state policycould prevent Leeway from fulfillingits mission. A single funding sourcemay he tbe best available to an orga-nization sucb as Leeway, but leadersneed to consider tbe associatedrisks. Changing funding sources canbe quite disruptive and can require agreat deal of management time. Yet,some disruptions may he necessary,considering that the alternative-pbilanthropic fund-raising-is alsovery time consuming and uncertain.

Earned Income from Others. In ad-dition to obtaining direct paymentsfor mission-related services, non-profits can receive indirect sourcesof earned income from third parties.One common form of indirect com-mercial support is advertising. Cor-porations may pay for tbe rigbt topromote their products to a nonprof-it's target market. For instance, com-panies that make bahy products

migbt sponsor an educational pro-gram for mothers of low-birth-weigbt infants. So-called cause-related marketing, in wbich a com-pany uses its support of a nonprofitcause in its promotions, is an exten-sion of tbis idea, in addition, non-profits can use their name recogni-tion to co-brand products, such aspain relievers endorsed by the

Findmg indirect sources of rev-enue often requires creativity. Non-profit leaders should ask themselvesbow tbeir organizations could createvalue for someone who would pay.Because this source of earned in-come is the one least directly relatedto mission performance, it can riskpulling the organization off courseby diverting valuable management

Some nonprofits raise funds through auxiliary commercial enterprises;others launch businesses to serve the objectives of their missions.

Arthritis Foundation. Businesses andindividuals also can indirectly sup-port social enterprises by purchasinggoods and services. Local hotels andhospitals migbt contract for servicesfrom a commercial laundry operatedby a homeless shelter to provide jobtraining and income to residents. Insucb a case, tbe third parties are pay-ing tbe shelter not to provide train-ing for homeless people but to pro-vide laundry services; in other words,they are paying the shelter indirectlyto serve its primary constituency.

resources away from activities relat-ed to the organization's core mis-sion. As a result, leaders need to beparticularly careful to question tbeappropriateness of tbis kind of finan-cial relationsbip. Will tbe demandsof running a competitive commer-cial laundry create pressure to em-ploy only shelter residents whoalready bave good job skills, thoseleast in need of training? When cor-porations witb vested interests payfor research, will universities shiftresources from basic science to more

HARVARD BUSINESS REVIEW January-February 1998 63

SOCIAL ENTE^RPRISE ENTERPRISING NONPROFITS

applied areas? Will they become sci-entific advocates for the interests oftheir paying clients-

Choosing the Right VesselOnce nonprofits identify potentialsources of earned income, theyshould set clear and realistic finan-cial ohjectives. Commercial pro-grams don't need to he profitable tohe worthwhile. They can improvethe efficiency and effectiveness ofthe organization hy reducing theneed for donated funds, hy providinga more reliahle, diversified fundingbase, or hy enhancing the quality ofprograms hy instilling market disci-pline. Following are the possible fi-nancial approaches that a nonprofitmight adopt. They move roughlyfrom left to right on the social enter-prise spectrum.

Full Philanthropic Support. Afterreviewing their options, tbe leadersof a nonprofit might decide that nopotential sources of earned ineomeare appealing, given the organiza-tion's mission and values. Theymust then decide on the right mix-ture of philanthropic sources: cashdonations, in-kind donations, andvolunteer labor. Very few nonprofitswill be staffed solely by volunteersand will acquire all their equipment,facilities, and supplies as in-kinddonations. For most organizations,cash donations provide a way toadopt more commercial lahor andpurchasing practices. For instance, amentoring program for disadvan-taged youth could have a paid staff,volunteer adult mentors, some in-kind donations, and a variety of cashoperating expenses, and could relyexclusively on grants and donationsto cover all out-of-pocket costs.Many new and small social-servicenonprofits operate this way, withnegligihle or no earned ineome.

Partial Self-Sufficiency. Otbernonprofits migbt conclude tbat tbesources of earned ineome availableto tbem will cover only part of tbeirnecessary operating expenses, evenwhen taking into account potentialin-kind donations and volunteer la-bor. Tbey will need cash donationsto pay for some out-of-pocket oper-ating expenses, as well as for start-up costs and capital investments.

Most institutions of higber educa-tion operate this way. Tuition coversonly a portion of total costS; donorssuhsidize the rest. The difficultysuch organizations face is determin-ing the right level of subsidy. To de-termine tbat level, tbey must assessnot only potential commercial andpbilanthropic revenues hut alsocompetitive dynamics, values, andmission-related objectives.

For example, Berea College inBerea, Kentucky, targets financiallyneedy Appalachian students andcharges no tuition. All studentswork, hut the college covers its costslargely through income from a siz-able endowment and annual giving.In eontrast, Vermont's BenningtonCollege decided from the start that

Nonprofits shouldkeep in mind that

commercialprograms don't needto be profitable to be

worthwhile.

it did not want to be heholden todonors wbo might interfere with itsmission. (Bennington was foundedas an experimental college forwomen and emphasized individual-ized, nontraditional courses ofstudy.) Tbe college did not run annu-al fund-raising campaigns and built anegligible endowment. Instead, itcharged a high tuition; in fact, itstuition was frequently one of thehighest in tbe nation.

Botb scbools have long deliveredhigh-quality education. So whichmodel is best? The answer to thatquestion depends hoth on how wellthe model serves tbe institution'smission and on tbe model's feasibili-ty for sustaining its institution. Ben-nington's model would not baveworked for Bcrea's mission servingtbe Appalachian poor. For a time inthe 1980s and early i9yos, it did notwork very well for Bennington'smission cither. Fligh costs and com-petition for students made the pay-as-you-go model difficult to main-

tain. Tbe college recently restruc-tured and bas launched a capitalcampaign to huild an endowment,but Bennington will not need an en-dowment as large as Berea's.

Cash Flow Self-Sufficiency. Manynonprofit social enterprises wantcommercial revenues but not mar-ket-based costs. They use earned in-come to cover out-of-pocket operat-ing expenses, but the costs theyincur are lower than market rates be-cause of their ready access to philan-thropic investment capital (sueh asgrants and below-market program-related investments made by foun-dations), volunteers [or below-mar-ket wages], and in-kind donations (ordiscounts). Sucb organizations aretechnically self-funding and mayeven generate excess cash to coverthe costs of strapped mission-relatedactivities, but they still depend onnoncasb philanthropic subsidies.

Help tbe World See (HTWS) andtbe new permanent eye-care clinicsit bas established in developingcountries illustrate bow this modelworks. When HTWS hegan, it sentvolunteer doctors with donatedglasses to developing countries toset up temporary clinics. Then fiveyears ago, the organization em-harked on a new strategy. It wouldestablisb permanent clinics, offeringaffordable ongoing eye care, tbatwould operate self-sufficiently on acash-flow hasis. Start-up capitalwould be donated; in-kind spacewould he provided by governmentsor sympathetic nongovernmentalorganizations; materials to produceglasses would he acquired at a dis-count from willing suppliers; andstaff training would be covered hygrants. But the organization wouldpay the staff and cover out-of-pocketoperating expenses hy charging asmall fee for glasses. The new strate-gy demanded a trade-off: the stand-alone clinics would not be ahle toserve-at least not initially - thevery poorest residents, who eouldnot afford even the small fee forglasses. |It was hoped tbat one daythe clinics would he ahle to generatea "profit" to pay for services for thevery poor.) But the clinics could stillserve many who were not ahle tofind or afford glasses any other way.

64 HARVARD BUSINESS REVIEW fanuary-February 1998

ENTERPRISING NONPROFITS SOCIAL ENTERPRISE

Operating Expense Self-Suffi-ciency. Nonprofits may be able tohave earned income cover all operat-ing expenses, even if those expensesare at market rates. They might oh-tain donations or helow-marketloans to cover some start-up expens-es and capital expenditures, butafter that, the operation would standon its own without relying on addi-tional philanthropy of any kind, in-cluding volunteer and in-kind dona-tions. Few social ventures launchedhy nonprofits can aspire to this de-gree of independence from philan-thropic support when it comes tooperations. One example of a non-profit organization that has adoptedthis model is the Kentucky High-lands Investment Corporation. Ithegan with nearly $15 million ingrants from the federal governmentto use as venture capital to stimulateeconomic development in severaldistressed counties in southeasternKentucky. Using returns from its in-vestments, the corporation has beenahle to cover its operating costs for

the venture fund and to make newinvestments - in the process preserv-ing the value of the fund.

Even when operating self-suffi-ciency is the goal, most new ven-tures will need some form of cashsuhsidy during the start-up period.But nonprofit leaders must decidehow long to subsidize the venture.Cutting one's losses in mission-related operations ean be difficult:when a new program cannot standon its own, a nonprofit may have todecide whether to continue the pro-gram even though it will need to besubsidized. Shutting down a pro-gram may have political costs or anunfortunate impact on an organiza-tion's mission. For instance, theBangladesh Rural AdvancementCommittee (BRAC) created a silk in-dustry from scratch in Bangladesh toemploy women and the landlesspoor. BRAC intended for all parts ofthe industry's value chain-fromgrowing mulberry trees to sellingthe products made with BRAC silk-to operate self-sufficiently. But the

silk-reeling plants were very ineffi-cient, in large part hecause of theinherently poor quality of the co-coons that were bred to grow inBangladesh. To pay its workers a liv-ing wage, BRAC had to accept losseson this stage in the productionprocess. Shutting down the plantswould have crippled the entire silkproject, hurting thousands of work-ers and strengthening the hand ofBRAC's fundamentalist political op-ponents. BRAC intends to work tomake the plants profitable, hut itwill be difficult to pull the plug onthis operation even if profitability isnever achieved.

Full-Scale Commercialization.When an organization is fully com-mercial, revenue covers all costs atmarket rates, including the marketcost of capital, without a hint ofphilanthropic subsidy even for start-up expenses. The organization re-pays start-up capital at a market rateof return and is sufficiently prof-itable to attract new investment cap-ital for expansion. Few nonprofits

Entrepreneurial leadershipbegins at Babson.

Create growth opportunities within your Lonipany... he cnrrcprcncuriul. ,'\et]iure these leadership skillsat the School of E x e c u t i v e E d u c a t i o n at Babson C o l l e g e . For mf)rc i n f o r m a t i o n on theI99H projirams, call 1-800-882-EXEC or 781-239-4354. email excc@babson.cdii or write theSchool of Executive Education, Babson College, Bubson Park, MA 02157-0310.

Strategic Planning and Management in RetailingFebruai^^ 8-13 {Turkey), March 28-April 3 (Virginia), May 2-8(Babs(m) and May 23-29 (Ireland)Leadership and Influence May 11-15 and October 19-23

and Tlictics of Pricing May 27-29 and October 14-16and Managing Strategic Alliances June 14-17 and October 13-16

Makintj Teams Work June 14-17 and October 25-28 ^ C « ^ T A r>

» ^ B A D( I I L I I I L ( 1 ! I M I I ' T I V I I I l l l l A l i< I N

SOCIAL ENTERPRISE ENTERPRISING NONPROFITS

can achieve full-scale commercial-ization. Because nonprofits cannotaccept equity investments and it isdifficult to be financed totally withdebt, such organizations often arestructured as, or convert to, for-profitenterprises.

Nonprofits that are this stronglycommitted to commercialization-and to their independence from phil-anthropic subsidies-face a challeng-ing balancing act. On the one hand,they will need to act like husinesseshy preserving their flexihility and byheing willing to cut losses andsearch for new sources of revenue.On the other hand, they will have todo so within the constraints of theirmission. Ahsent a philanthropiccushion and a commitment to phil-anthropic supporters, nonprofitleaders will need to keep the enter-prise's mission in mind when react-ing to husiness pressures.

Mixed Enterprises. Finally, itshould he noted that many social en-terprises are actually multi-unit op-erations that run programs with dif-ferent financial objectives andfunding structures. A major muse-um might have both a profitahle cat-alog business and a highly subsi-dized research-and-acquisitionoperation. The Nature Conservancyestahlished a for-profit company, theEastern Shore Sustainable Develop-ment Corporation, in order to gener-ate profits and create johs whileprotecting the environment. Theconservancy has partnered with for-profit companies such as CeorgiaPacific to find profitable ways toconserve natural habitats, and itoffers ecological travel programs fora fee to its memhers. Yet many of itscore conservation activities still relyheavily on donations. (See the insert"Related Readings.")

Other multi-unit social enterpris-es are for-profit organizations withnonprofit affiliates. Shorebank Cor-poration, for instance, is a develop-ment hank with a social mission. Ithas commercial-banking and real es-tate operations, as well as an affiliatenonprofit community-developmentcorporation that is dependent ongrants. The corporation as a wholehas henefited from obtaining pro-gram-related capital investments at

below-market rates from founda-tions hut otherwise has very com-mercial methods of operation.

The Skills Needed to SailCommercial WatersIf nonprofits are to explore commer-cial options, it is essential hoth thatthey build husiness capahilities andthat they manage organizational cul-ture. Management skills are impor-tant for all nonprofit organizations,but commercialization calls for ex-pertise, knowledge, and attitudesmore commonly found in the busi-ness world. Nonprofit managersneed to become trained in husinessmethods if they are to explore com-mercial options effectively. One wayto gain such training is to reach out

In the end,for-profitoperations will not -

and should no t -drive out

philanthropicinitiatives.

for help. Nonprofit managers can he-gin in their own hackyards hy find-ing more effective ways to draw onhoard members with relevant busi-ness experience. The resulting ex-change will he a learning experiencefor both parties. Business hoardmembers are often an underutilizedsource of management expertise,and they need coaching and coaxingto adapt their business frameworksto the context of a social enterprise.They must understand the risks ofbecoming too businesslike and ofmoving too quickly. Nonprofit lead-ers also can reach out for pro bonoconsulting from volunteer husiness-people or from husiness school stu-dents. And nonprofits exploringcommercialization can form al-liances witb for-profit companies toprovide complementary skills andtraining in business methods.

Without internal staff expertise,however, the advice of hoard mem-hers, consultants, and partners maynot be worth much. The organiza-

tion needs staff that can understandand implement the new agenda. Or-ganizations can hire employees withbusiness skills, hut they will need toaddress the cultural conflicts andcompensation problems that couldarise. The new hires must be sup-ported fully, and care must be takento allow them to build credibilitywithin the core culture. Nonprofitleaders should anticipate culturalconflict and find ways to turn suchconflict into a healthy, creative ten-sion. They need to identify whereoperating styles are likely to clash,and they may have to launch inter-nal education and communicationsinitiatives in order to minimize theharmful effects of conflict and tohelp staff memhers agree on appro-priate operating styles.

Of course, nonprofit leaders couldopt to segregate commercial activi-ties from philanthropic operations.Such an approach should reduceconflict, provided that the separateunits do not need to interact on aday-to-day hasis. Even so, staff onthe more philanthropic side of oper-ations may view their commercialcolleagues with animosity or envy.Compensation is one possihlesource of friction between the twocultures. New hires from the busi-ness world may require higher com-pensation than internal staff mem-bers with comparable levels ofeducation and years of experience.Pay equity has to he dealt with ex-plicitly, or it will fester.

A former Wall Street banker whonow heads a major internationaleconomic-development organiza-tion is grappling with precisely thisissue. His operations have becomeincreasingly sophisticated and re-quire skills typically held by MBAgraduates who could land invest-ment-banking johs. But he cannotpay anything approaching the in-vestment-hanking salaries to ac-quire the talent he needs. It was achallenge to get his board to let himmake offers at salaries less than halfthose that qualified candidates couldcommand in mainstream financialinstitutions. Yet even those salarieswere well ahove existing wages inthe organization, and the leader wasconcerned ahout pay equity with the

HARVARD BUSINESS REVIEW January-February 1998

ENTERPRISING NONPROFITS SOCIAL ENTERPRISE

organization's current staff. Raisingeveryone's salary eould he extremelyeostly. Not doing so could under-mine morale.

Engineering a new culture is nevereasy or quick. Building internal ex-pertise has to be a deliherate strate-gic process. It cannot he accom-plished overnight. Managers mustcreate a new culture that hlendscommercial values with the tradi-tional philanthropic principles thatdrive the organization. At the sametime, they must work with keystakeholders to huild understandingof and support for commercial activ-ities, or they may find themselves inthe awkward position that the AMAfaced in its deal with Sunheam.

Nonprofit leaders also need to getlegal and tax advice hefore launchingany commercial activities. Unfortu-nately, tax laws often lag hehind in-dustry developments. It is not al-ways clear how current InternalRevenue Service regulations willtreat new hyhrid forms of organiza-tions. In some cases, it will he hetterto set up a for-profit suhsidiary andpay the appropriate taxes. As thehoundaries hetween nonprofit andfor-profit organizations fade, pres-sure will mount for new regulationsand possihle revisions in the taxcode. Becoming more commercialhas political risks and puts the hur-den of proof on social entrepreneursto show that their organizations areserving social missions that justifycontinued tax exemption.

Steering into New SeasThoughtful irmovation in the socialsector is essential if organizationsare to leverage limited philanthropicresources. Nonprofit leaders canhenefit from finding effective waysto harness commercial forces for so-cial good. But misguided efforts toreinvent nonprofits in the image ofhusiness can go wrong. Nonprofitmanagers are only beginning to learnwhat it means to search for new so-lutions to social problems and formore effective ways to deliver so-cially important goods.

Strategie and structural innova-tion should focus on improving mis-sion-related performance. Caughtup in the current wave of commer-

RELATED READINGS

Jed Emerson and Fay Twersky, co-editors. New Social Entrepre-neurs: The Success, Challenge,and Lessons of Nonprofit Enter-prise Creation. San Francisco,CA: Roberts Foundation, 1996.

Ronald Grzywinski. "The NewOld-Fashioned Banking." HBRMay-June 1991.

David C. Hammaek and DennisR. Young, editors. Nonprofit Or-ganizations in a Market Econo-my: Understanding New Roles,Issues, and Trends. San Francisco,CA: Jossey-Bass Publishers, 1993.

Alice Howard and Joan Magretta."Surviving Success: An Interviewwith the Nature Conservancy'sJohn Sawhill." HBR Septemher-Octoher 1995.

cialization, nonprofits risk forget-ting that the most important mea-sure of success is the achievement ofmission-related objectives, not thefinancial wealth or stahility of theorganization. The benefit of findingattractive sources of earned incomelies more in the leverage this incomeprovides than its sustainahility. Butgenerating more funds for ineffec-tive or inefficient programs is not aproductive use of resources. Truesocial-sector entrepreneurs are thosewho find not only additional sourcesof funds hut also new methods tolink funding to performance. Moreimportant, they develop more effec-tive ways to improve conditions onthis planet. To that end, social entre-preneurs shouldn't focus on com-mercial approaches alone hut shouldexplore all strategic options alongthe social enterprise spectrum, in-cluding their ability to use socialcauses to tap into philanthropic mo-tivations. In fact, multi-unit opera-tions may well be the wave of the

William H. Shore. Revolution ofthe Heart: A New Strategy forCreating Wealth and MeaningfulChange. New York, NY: River-head Books, 1995.

Edward Skloot, editor. The Non-profit Entrepreneur: Creating Ven-tures to Earn Income. New York:The Foundation Center, 1988.

Richard Steckel with Robin Si-mons and Peter Lengsfelder.Filthy Rich and Other NonprofitFantasies: Changing the WayNonprofits Do Business in the90s. Berkeley, CA: Ten SpeedPress, 1989.

future hecause they recognize and,when it makes sense, utilize a fullrange of options on the social enter-prise speetrum.

In the end, commercial operationswill not-and should not-drive outphilanthropic initiatives. Manyworthwhile ohjectives cannot effec-tively he pursued hy relying on mar-ket mechanisms alone. In any case,people tend to get something out ofgiving that they cannot get out ofmarket transactions. People want tomake eontrihutions to the commongood, or to their vision of it. Thechallenge is to harness these socialimpulses and marry them to the bestaspects of husiness practice in orderto create a social sector that is aseffective as it can he.

Tbe autbor would like to tbank ElaineBacktnan for her contributions to the clL-vclop-mem of tbe social enterprise spectrum.

Reprint 98105To order reprints, see the last page of tbis issue.

HARVARD BUSINESS REVIEW January-Fcbmary 1998 67