Tuesday, July 16, 2013

NonProfit or Social Sector: What's in a Name

The nonprofit sector is the only sector in society that is defined by what it does not do.  They do not make a profit.  Nowhere does it suggest, that nonprofits, unlike their for-profit counterparts, exist to provide a social good to some segment of society.  So what is wrong with this description?  In part it is this very term nonprofit that contributes to the low regard that this sector is held in by other sectors.
It is easy to not make a profit.  In fact, anybody can not make a profit.  It takes skills to run a business and make a profit year after year over the long run.  But to not make a profit, that does not require any definable skills.  If social sector or mission-based organizations were to be identified by what it is that they provide - a social benefit – it would be obvious then that leading these organizations requires a specific skill set.  These skills include the ability to maintain a viable and sustainable organization, provide a social benefit while also being a responsible steward of funds provided by others, and convincing others to invest in an organization even though they do not receive a direct benefit for their investment.  Not everybody can do that.  In fact, that requires a completely different skill set than running a for-profit corporation selling goods and services that return a profit.
According to a recent article in the Journal of Philanthropy titled, Nonprofit Weakness Starts With too Few Leaders and too Many Managers, “challenging economic times expose a common problem among nonprofit leaders: that they often work hand-to-mouth, chasing the next donation or grant, focusing on program and day-to-day operations. Operational expertise is essential to keep an organization running, of course, but nonprofits’ propensity to plug along without a strategic vision does not bode well for their long-term survival. “(Male, 2/10/13)  While the author makes the point that nonprofits must survive hand to mouth, he then falls back on the easy way out of blaming the victim.   Nonprofit leaders are forced to live hand to mouth, but then they are faulted for not thinking strategically and long-term.  When you do not know where the rent or next payroll is coming from, long-term thinking does indeed feel like a luxury.
For too long, and in far too many circles it has been assumed that there is a lower skill set to running a nonprofit and that if nonprofit leaders had a stronger skill set they would be in the for profit world where they could earn a real living.  In fact, the fiction goes so far as to suggest that nonprofit leaders are being paid too much – far more than they are worth.  One example of how this plays itself out is in state efforts to legislate nonprofit executive salaries.  In state houses across the country, legislators and governors are attempting to place limits on nonprofit executive compensation.  An executive order by Governor Cuomo in New York limits such compensation in nonprofit organizations that receive 30% or more of their revenues from the state.  In Florida the benchmark for regulating these salaries is if a nonprofit receives two-thirds or more of its revenues from state sources.  A similar measure passed in the Massachusetts House but failed in the Senate where an amendment called for a feasibility study.  However, in these same states, there has been no effort to limit the salaries of for-profit CEO’s whose companies earn large portions of their revenue from government. 
It is easy to see how a double standard plays itself out when it comes to politicians distributing the largesse of public funds under the guise of economic development. Governor Andrew Cuomo’s generosity to the film industry is legend in the form of an annual $420 million tax credit.  Nowhere in his selling of this tax credit did the governor call for salary limitations on those employed by or leading the industry.  In fact, the governor refuses to disclose how much of a tax advantage each company is receiving, and there is no contractual obligation to produce a minimum number of new jobs.  However, this same $420 million could be used to fund 5,000 new teachers or create 45,000 Head Start slots for low-income children.  But it seems that the governor trusts the for-profit film industry with public funds more than he does the nonprofit social sector.
When it comes to for profit corporations, with or without government contracts, it appears that the sky is the limit for employee and executive compensation.  One need look no further than the recent financial industry bailout.  The federal government invested more than $700 billion in taxpayer dollars to bail out the failed giants of the financial industry, and required very little in return, unlike the demands that are made on nonprofits that utilize government funds.  One case in point is AIG, the company at the very heart of the meltdown.  After receiving more than $165 billion in federal dollars, AIG proceeded to pay out more than $165 million in bonuses to the very executives whose stewardship oversaw the financial chicanery that caused the meltdown.
However, when it comes to oversight of government dollars going to private organizations, only nonprofit executive salaries receive scrutiny.  Dan Pallotta (2012) refers to this as double standard that exists between the for-profit and the humanitarian sectors.  He states that this “is not a zero-sum game.  The money paid to a valuable CEO is not money taken away from the cause.  It is an investment in the cause.”(pg. 32)
A 2010 New York Times article, “Lawmakers Seeking Cuts Look at Nonprofit Salaries,” reported on an attempt by four senators to block federal funding to the Boys and Girls Clubs of America, based upon the most recent compensation of its CEO who received almost $511,000 in salary and $478,000 in retirement benefits.  Senator Grassley (R-Iowa) requested that the Treasury Secretary review regulations on nonprofit salaries, because he stated they are “not tough enough in policing pay in the nonprofit sector and that regulations governing compensation are too weak.  Grassley, his Senate colleagues and the media reports all ignored the fact that in her eight-year tenure at the Girls and Boys club, the CEO tripled its revenues and more than doubled the number of children served.  In contrast to popular belief, her large compensation package did not take away form the needs of those being served, instead retaining a highly qualified and skilled CEO allowed the organization to serve more children with expanded programming.
However, according to Pallotta (2102) in the same year that the Senate was scrutinizing nonprofit executive compensation, “Lockheed Martin received 83 per cent of its $45.2 billion 2009 revenues from US government contracts.  Its CEO’s 2010 compensation was $14.6 million.” (pg 33)  That represents a compensation package of more than fourteen times that of the Boys and Girls club CEO, but there was no mention of this in the Senate despite the fact that the federal government supported 83% of this salary.  Another example of this double standard of oversight is Booz Allen Hamilton, the federal government’s go to intelligence contractor that receives fully 100% of its revenue from the federal government and paid its five top employees $20 million in compensation.  However, Senator Grassley seemed to have no problem with the salary scale at this government contractor even though their CEO at $4.228 million earned more than ten times the President of the US and more than twenty-four times Grassley’s annual salary as a Senator.  But companies like Lockheed Martine and Booz Allen Hamilton have cadres of lobbyists, lawyers and friends on capital hill that protect them from the same oversight that is afforded nonprofits without the lobbyists, lawyers and friends.
The role and challenges of the nonprofit executive are both misunderstood and underrated.  One nonprofit executive who was overseeing renovation of factory space to house his agency tells this story as an illustration,
We were involved in a large renovation turning vacant factory space into a multi-service community center.  This space was on the second floor and part of the work included converting a freight elevator into a self-service passenger elevator.  Midway through the elevator conversion the buildings department sent an inspector to check on the progress.  Shortly after the inspector left the head of the elevator company called to inform me that additional work was needed and that it would double the cost of the conversion.  It seems that the building code required that the elevator shaft be closed so that the elevator could not go to the basement, which would not be safe, or other safety measures implemented.  I informed him that he should go ahead with the work, but I would hold him to the original contract cost.  I told him that I hired him as the expert and he should have known about this requirement therefore the original price was the price that I would honor.  We went back and forth and he insisted that he could not do it.  I then informed him that in my business of running a nonprofit, if I have funds left over at the end of a contract I must return them and if I run short by the end of a contract I must make up the difference.  Well he gave me the most incredulous look, scratched his head and asked how I am able to run a business like that.  Then he gave me an ultimatum, agree to the extra cost or he would pull his men off the job.  I did not, and he did.  Needless to day I called him back to complete the job and paid the extra costs.
Therein lies the difference between managing a for profit and a nonprofit.  For profit managers have the ability to raise fess, reduce costs, discontinue unprofitable product lines or services, all in service of their true mission to provide a fair return (profit) to their shareholders or to the owners.  They also have the freedom to fail miserably and count on the taxpayers to bail them out, without any calls for caps on their compensation.  Witness the bailout of the banks and auto companies that were then followed by record bonuses to CEO’s of the very same banks that the taxpayers bailed out.
Managing an organization for a social purpose means that you are judged by a different standard than a for profit manager.  Success is not measured in dollars and cents, but often by intangibles such whether or not you are making progress toward your mission, are the people you serve improving their lives, getting jobs, becoming permanently housed, etc., etc.   It is easier to impact the bottom line of an organization than it is to impact people’s lives.  If your business is to produce widgets or cars or manufactured homes your costs are predictable and you can base the selling price of each on a predictable set of factors.  If those costs increase, you have the option to increase the selling price, reduce the quality or cut back on your labor force.   You can predict the difference between the cost of manufacturing a good or providing a service and what that good or service can sell for.  Unlike a nonprofit executive who provides services to individuals, each with their own individual needs, abilities and challenges.  The cost can vary widely providing interventions for people with different needs and differing levels of resources.
In the social sector, organizations generally provide a service that is supported by or paid for by people other than those utilizing that service.  Providers of social services, mental health services, housing and income support services for example, rely on the generosity of government, foundations, corporate contributors and individuals for support.  For profit corporations generate their income from the people that they serve.  If they can provide a product or service that people want and are willing to pay for at a price that produces a desired profit the company succeeds.  Corporate managers have two constituencies to satisfy, and both are direct beneficiaries of the work of the corporation – their customers and their investors.  Social sector organizations have the same two main constituencies – their customers and their investors.  However the fundamental difference here is that in the social sector the customers usually do not pay the full cost of the services and the investors do not benefit directly from their investment, otherwise known as their contribution or donation.  In the private sector the customers pay the full cost of the goods or services plus an amount over the cost that produces the profit, but they benefit by obtaining the good or service that they can freely choose.  Private sector investors also benefit directly from their investment in the form of income on their investment.
While both the social sector and the private sector must demonstrate over and over that their goods and services are wanted or needed by their customer base, only the private sector has the sanction to discontinue or redesign these at will.  Change in the social sector is slower as a result of grants and contracts given for specified programs or interventions over a specified period.  Once that grant or contract is awarded, the organization is not free to make changes that it may deem necessary from lessons learned providing that good or service.  There are many examples of how this works in the private sector.  In 1985, amid much fanfare and significant financial investment, Ford Motor Company introduced the Edsel.  This was going to be the flagship car of its newest division.  The car was an instant failure and after three years the Edsel line was discontinued, Ford absorbed its losses and moved on.  Similarly Coke introduced its “New Coke” in 1985 and discontinued the original formula.  Despite heavy investment in marketing, their customer base rejected the New Coke, forcing Coca Cola to reintroduce its original formula, now dubbed Classic Coke.  The New Coke was discontinued seven years later.
Both of these cases illustrate how private corporations are free to introduce and discontinue products at will depending on market studies and customer demand.  They do not have to go back tot their investors for prior approval nor do their investors attach strings to their investments.  People invest in companies because they believe that they will be profitable and because they have confidence in the company’s ability to increase its market share.  This includes introducing new and profitable product lines, and eliminating those that are not profitable or do not produce a high enough profit. 
The leadership style of Laura Sen, the much-lauded CEO of BJ’s Wholesale Clubs, demonstrates the difference between the leadership in the two sectors. Catherine Elton the Boston Globe  describes Sen’s management style,
It’s Sen’s management style that sets her apart: She has flattened out the company’s traditionally top-down way of doing business, spent an unheard-of amount of time on the floors of BJ’s stores, given everyone from rank-and-file wage workers to those at the home office an unprecedented level of input and responsibility in the running of the business, and made herself accessible to and supportive of her suppliers and employees alike.
  While her leadership style may seem more tailored to a nonprofit setting, her management decisions are definitely those of a for profit manager.  In her first full year as CEO, BJ’s posted a five per cent increase in revenues in stores open at least one year.  As a result of its growth and potential, two private equity firms began the process of purchasing the company to take it private.  To make the company more attractive to these investors, Sen made strategic decisions based solely on making the company more marketable.  In spite of the growing profitability of the company, its positive outlook,  and as described by Elton her unique management style that brought her into contact with all levels of workers, Sen ordered the closing of five stores and the layoffs of more then 500 employees.
Sen described the move in this way, “Our management team has been working for several months on a strategic plan to optimize our performance and build for the future. In making these very difficult but necessary choices, we eliminated positions held by team members who have contributed to our success. We will be supporting affected team members in many ways to help ease their transitions.’’  Employees are expendable in the name of maximizing profits.  But this is not an isolated example.  Another example, among many is when AT&T laid off 10,000 employees in 1995 its CEO received a salary of $3.3 million and a bonus of 750,000 stock options worth $9.7 million (The Spokesman Review).  It seems that laying off workers is good business as it decreases costs and increases profits returned to shareholders.  However, these business practices are not only seen as acceptable, they are subsidized by federal tax dollars.  In the two year period ending in 1995, the year of the large layoffs and even larger CEO compensation package, AT&T received more than $3 billion in tax subsides from the federal government (Citizens for Tax Justice)
In spite of the fact that the nonprofit sector is an economic driver, it is still seen by many as a drag on the economy.  However, according to a 2012 study by the Center for Civil Society, the nonprofit sector employs 10.7 million workers, which is 10.1% of total employment. (These numbers do not include public schools or public hospitals) It is the third largest sector in the US economy, behind retail and manufacturing.  However, as pubic mistrust of the nonprofit sector grows, more services traditionally provided by this sector are being taken over by for profit ventures.  In the decade from 2000 to 2010, for profit employment increased more rapidly than nonprofit employment in education, health care and social services.  These facts portend poorly for the sector as more and more of these services are provided by for profit enterprises with their eye on the bottom line and the profit margin.  While a nonprofit executive must keep both eyes on the bottom line and on the services provided, the for profit emphasis on the bottom line first may result in shorter interventions and choosing less costly clients and services.  While nonprofits have a social mission, in the words of Nobel winning economist Milton Friedman “"there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits”(New York Times, 9/13/70)  But if you lead a nonprofit, there is a different purpose and measure of success;  a bit more elusive than maximizing profits and harder to come by.