The Private Sector Is Stupid. . . About Nonprofits

We’ve all heard that our friends in the private sector know best when it comes to running nonprofits. If we want to succeed, we need to adopt their tools and approaches. This makes sense if you believe nonprofits are just like for-profits—or would be if only they were better managed. But that's ridiculous.

Nonprofits have different values and exist for completely different reasons. Private sector companies are inherently extractive—they seek to capture as much value as possible from customers (and employees. . .). Hence, profit! Nonprofits exist to give value to constituents. For-profits amass resources; nonprofits distribute them.

The tools and approaches of for-profits have been created to help them succeed at making money. Can they ever help organizations that are not profit seeking? Maybe. But we should be very skeptical and, in particular, vigilant about unintended consequences.

Let's take a look at why tools and approaches that work so well in the for-profit context can be ill-suited to nonprofits. . .

Merit Pay. Paying more for better performance fits well with the central ethos of the for-profit world—make as much money as you can. But nonprofit employees usually haven’t signed on to maximize their earning potential. Applying merit pay to nonprofits fails for three reasons: 1) it mistakenly presumes that staff are motivated primarily by money; 2) it emphasizes individual achievement over the collective effort that nonprofits require for their success; and 3) it’s extraordinarily difficult to implement merit-judging systems that will be perceived as fair, increasing risks to morale and retention. A deeper dive into this pernicious issue and how nonprofits can better address compensation can be found here.

Fail fast. The quicker a for-profit company realizes that one business opportunity is not going to succeed, the sooner it can focus on others that might be more viable. Delay is tantamount to waste, and minimizing waste is essential to maximizing profit. Cut your losses, reallocate your resources, and move on to greener pastures.

For nonprofits, cutting losses isn’t so simple. Nonprofit programs—especially new and innovative approaches (those most susceptible to “failure”)—are dependent on relationships among staff, constituents, community partners and funders. Shutting down a program that isn’t meeting expectations can cause enormous damage to those relationships, raising questions about a nonprofit’s capacities and commitments, and undermining its ability to hire staff, attract partners and to fund future projects. Of course, nonprofits SHOULD monitor programs rigorously, courageously challenge assumptions and iterate. But that’s not failing fast; that’s learning fast.

Growth is good. Nothing could be more obvious to a for-profit—more business means more profit. Costs are spread over more units and bigger companies can leverage better deals from suppliers. Larger firms are able to capture markets and create barriers to entry for others while increasing their pricing power. Bigger is better.

For nonprofits, bigger is. . . complicated. Most are inherently local. But for those may be amenable to growth, the challenges are intense:

• Rapid growth can be challenging financially, making healthy reserves suddenly appear small, increasing overhead expense in ways that are often only partially funded, cash flow can become more difficult to manage and so organizational risk increases.

• Growth forces changes to culture and communication. It requires greater reliance on systems and processes, while stressing existing relationships and employee expectations.

• Contrary to the model of most for-profits, size often makes programs more expensive to implement. Growth means added layers of management and other infrastructure, increasing costs. Efficiencies that compensate for extra costs in the private sector, such as standardization of processes and procedures, resulting in lower costs per client, are often not available to nonprofits or can result in lower quality services.

• Growth makes it harder to live into values about engaging community and the needs of constituents, values directly tied to organizational success. As they get bigger and for a number of reasons, it becomes harder for nonprofits to absorb and incorporate information from outside.

While for-profits have every reason to pursue growth aggressively, nonprofits must proceed far more cautiously, with their eyes wide open to the substantial trade-offs involved.

Competitors. When the objective is to maximize resource capture in an individual company, literally everyone is a competitor. Not just other companies selling the same product into the same market, but vendors who drive up costs, and even employees who, umm, want to get paid. Merit pay systems encourage staff to see colleagues as competitors. Competition is essential to the whole concept of a market economy.

Few nonprofits envision meeting their mission all by themselves. They collaborate with others who share their goals. At the same time, other nonprofits attempting to achieve the same purposes are in fact competitors—for funds, attention and staff. So it’s complicated, even more so as relationships, needs and opportunities evolve over time. The for-profit view of competitors is simply too blunt an orientation for the highly nuanced nonprofit need to balance competition and collaboration.

Efficiency. In the for-profit world, efficiency is synonymous with lower costs. That means more profit. Efficiency is achieved by keeping wages low, enforcing employee work requirements and, most importantly, producing a standardized product.

While many nonprofits can enhance their impact by improving efficiency, other needs and values often push in the opposite direction. The relation-building and community engagement that are often so vital to nonprofit success are hugely inefficient (and sometimes a literal waste of time!). Maximizing value to constituents means providing services tailored to meeting their specific needs. Internally, nonprofits commit substantial resources to staff development and to addressing staff concerns. Not necessarily efficient, but essential to the organizational culture. Nonprofits are challenged to both take efficiency seriously, but not as an end itself. Again, it’s complicated. 

Of course, nonprofits, like for-profits, are businesses and a wide array of business tools and approaches may be applicable to both types of entities. But when we are working with tools and approaches from the for-profit world, we need to be cautious. Our private sector friends may encourage us to adopt their tools and approaches with the best of intentions. But what they don’t know can kill us.