Social Enterprises Linked to Poor Performance in Nonprofits

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November 4, 2010; Source: Wall Street Journal | A new study by researchers at the Wilson Center for Social Entrepreneurship at Pace University, “Social Enterprise: Innovation or Mission Distraction?” has found that nonprofits who run income producing businesses tend to short change those they are meant to serve by “focusing on money making schemes.” Download the study here [PDF].

The study, done by Rebecca Tekula, analyzes tax forms from 700 social service organizations across New York County between 2000 and 2005. These nonprofits’ average budgets were $19 million and they each raised approximately $1 million in unrelated business income. The study found that nonprofits that engage in unrelated business activities often run less efficient organizations than their peers. “As income from peripheral businesses went up, the share of a contributed dollar that went to actual services went down,” according to the report.

Why might this be? Tekula, the Executive Director of the Helene and Grant Wilson Center for Social Entrepreneurship, observes, “Organizations with unrelated businesses were not investing profits in their mission-related services. Instead, profits were reinvested in the business, and losses were subsidized with funds that might have gone to clients.”

Tekula’s report concludes, “From a broad perspective, this work has an overarching motivation: myriad philanthropists, associations and now federal and local governments support with a growing fervor the social enterprise movement and the use of business practices and measures in the nonprofit sector, but without the benefit of much analysis on the appropriateness or the success of these practices and the programmatic output of these vital public service providers. Continuing exploration and critique of the applicability of business practices in the nonprofit sector is unarguably important not only for health of the nonprofit sector, but for the well-being of the general public which has come to rely so heavily on these organizations for human and social services.”

NPQ appreciates Tekula’s willingness to ask hard questions about this practice which is so widely promoted. And we absolutely agree that it needs further study.—Ruth McCambridge

  • JERR BOSCHEE

    “Unrelated business endeavors” are NOT social enterprises. In order to be a social enterprise, the products and/or services provided by the enterprise must DIRECTLY address social needs (in other words, be mission-driven). Unrelated business endeavors do not do this and I agree they are a distraction from the primary mission of a nonprofit. Ms. Tekula fails to understand the difference between the two types of businesses and therefore conflates them, then draws irrelevant conclusions.

  • Jeff Stern

    Jerr’s critique is right on target. While I agree that starting a social enterprise can be distracting to current staff, requires new skillsets and mindsets, and could threaten to create mission drift, the study cited only addresses a slim portion of social enterprises (and it is a portion that is often not included as “true” social enterprise by practitioners or academics, and is rather ghettoized as an “earned income venture” because it is unrelated to mission).

    The distinction between unrelated business income (as discussed in the survey) and related business income for non-profits is not academic. For example, TROSA (trosainc.org)is a residential substance abuse treatment facility that operates a number of businesses. The businesses are related to the mission, because the clients learn work skills as part of the organization’s mission. Therefore, these businesses are not subject to UBIT and this organization would not appear as a social enterprise in Tekula’s study. However, TROSA is the type of organization that *most* people are referring to when they discuss “social enterprise.”

  • Rebecca Tekula, PhD

    Jerr, Interesting comment, but many would disagree with your definition: Here’s a quote from the typology I reference in my work: “External social enterprises are often unrelated to mission; their business activities are not required to advance the organization’s mission other than by generating income for the its social programs or overhead.” — From Kim Alter’s (Virtue Ventures) Social Enterprise Typology

  • Rebecca Tekula, PhD

    Jeff, Your point is well-taken. I agree, this is a very focused sample of organizations pursuing business activities. But, if an organization is earning UBIT, and it comes at a loss to their mission-related activities, they certainly should start asking some hard questions. Thanks for your interest!

  • Whitney Brooks

    What are your thoughts on hybrid value chains as a model serve both social and profit

  • Rebecca Tekula, PhD

    Whitney, This is an interesting debate — but I think there are many cases in which profits and impact are mixed so that the whole is greater than the sum of its parts. Job training programs can be great candidates for this mix: Look at the Greyston Foundation where they say

  • John Plunkett

    The lead paragraph in the Wall Street Journal coverage of the study addresses social-service organizations involved in money-making

  • James L. Weinberg

    The saddest part about this sensationalized story is not just watching the author conflate unrelated business income with social enterprise and then to see the WSJ vilify “nonprofits on service” as a result, but rather is the old and largely flawed assumption about judging a nonprofit’s value and results based solely on a an IRS bookkeeping ratio.

    With the increasing professionalism of our sector over the past few decades, leading nonprofits have needed to pay higher salaries for top talent, to invest in technology and infrastructure, and to build their organizational capacity to deliver the highest quality services in the most sustainable ways. If we want to build enduring social institutions that can responsibly scale-up proven programs, we need to get over the idea that we can do it without investing in “overhead.”

    But because this type of old-school thinking has led to so many expenditure restrictions from traditional funders, nonprofits have been forced to look toward earned income to help cover infrastructural investments. Of course that is where those unrestricted dollars are being allocated…. because there are almost no other ways to cover such operating requirements.

    There may be some inefficiency in the market. There may be some nonprofits experimenting with earned income and incurring a loss. But it is shameful to imply that this somehow represent a malicious effort to take food out of the hands of starving people and redirect it toward some lower purpose, which the WSJ story fails to name but clearly implies. These are generally organizations struggling to make ends meet and serve their missions within an increasingly competitive and resource constrained landscape.

  • Jonathan Peizer

    I could not agree with John Plunkett’s comments more… The operative words are
    “unrelated business activities” which in itself would raise IRS flags aside from distracting from mission.

    The title seems to play into an orthodoxy and bias in some parts of the sector that self-made revenue pollutes the system — while dependence on subsidy income that often doesn’t adequately cover operational capacity and growth is the better way — even though it leads to inefficiencies in mission support of its own.

    Why is the NPQ article title taring even “related income” social entrepreneurship with the same brush by implying it’s all bad?

    As a former Program Director and grantmaker for a large foundation I can point to a variety of initiatives that prospered through such activities in mission and revenue — and more importantly were able to invest in their own capacity and grow with operational funds that philanthropy often did not provide.

    Let’s be realistic and look at the funding landscape. Total giving from all sectors peaked in 2007 and is stagnating at about 300 million per year disseminated to 1.5 million 501c3’s and related nonprofit’s without that designation… meanwhile the number of nonprofits created continues to grow by about 43,000 per year — does anyone really think 100% subsidy support is the best answer?

    For more on these stats visit my blog post here:
    http://www.internautconsulting.com/wordpress/?p=37

  • Newell Lessell

    First, I agree with the posters above who note that the study’s title is misleading in that it equates UBI activities with social enterprise. Had the study’s focus been on “internal” social enterprise I believe the title would be appropriate.

    Second, I have a great deal of concern regarding the utility of “external social enterprise” for most not for profits. However, the paper does not provide sufficient background on the data to have confidence in the findings. Are expenses related to UBI reported on the not for profit’s 990 as part of overall expenses? If so, the ratio of program expenditure to total expenditure will of course decline as the “social enterprise” expands.

    Regardless, it would seem to make more sense, if the rationale for “external social enterprise” is to generate additional resources for the parent not for profit, to look at growth in total program expenditure rather than program expenditure as a proportion of total expenditure.

  • Rebecca Tekula

    Newell, You raise interesting questions which are in fact covered in my study. For more information on UBIT check out the IRS Publication 598 http://www.irs.gov/pub/irs-pdf/p598.pdf

  • Rebecca Tekula

    John, I appreciate your passion for your work! However, I have yet to come across a published definition or typology of social enterprise which does not include the unrelated business income model I studied in my paper. I do think we as academics and practioners must move beyond anecdotes, and I look forward to more healthy debate and research that asks hard questions about this important sector of our economy.

  • Saoirse

    This is a fascinating discussion. My interest in social enterprise has been more from the perspective of someone with questions about the bigger picture. I remember being a humble transcriptionist (like Steven Heller), listening to the proceedings of Harvard University’s Kennedy School of Government’s Social Enterprise class (then, a mere forum), and thinking to myself, “Hmm. Government regulation + private financing – participation of folks for whom this social engineering tool purports to help = fascism.” I’ll never forget the snickers of the Latino students when the guest speaker, a member of the free-marketeers in Argentina that had participated in the defeat of public-owned newspapers, railed against the fourth estate collectives – now, almost entirely gone. I think, given the police state in which we live in America today and the popular calls for rights for property owners only (of the Libertarians, the Tea Partiers, even the organization to which Ginny Thomas belongs about which we recently heard under the cover of a story about her demanding an apology from Anita Hill for Hill’s opposition to her husband’s appointment to the Supreme Court), that the discussion about the effectiveness of social enterprise be raised beyond the fight over tax status, which are always selectively enforced. All these discussions seem to be orchestrated conflict — deliberate misdirection — to keep folks talking about these obvious facts. But who in the non-profit sector is going to say these things? Your jobs are secure with the fascists in control of our government.

    http://www.dontfearyourfreedom.blogspot.com

  • ephraim

    very interesting study

    Rebecca: the study looked at 2000-2005. Is it possible that maybe non-profits have improved their “for profit” schemes and are putting more back into serving their constituents? with the bad economy, more non-profits are looking for ways to make more $$. I’d like to think (though I work in the non-profit sector and know this isn’t always true) that with less funding sources available, non-profit management are more creative with opening “for profit” businesses and more efficient with how they use the profits

    have you seen anything to suggest this or do we need to wait a few more years?

  • Newell Lessell

    I see that the equation does address the ratio question but I don’t see where you examine the impact on total program expenditures. I think the practical implication of your findings is that funder’s should understand that a $1 of UBI is worth less than a $1 of grant support. However, from the not for profit’s perspective, which presumably does not have the luxury of choosing between a dollar of grant support and a dollar of UBI, once they have maxed out their grant revenue incremental UBI dollars still contribute to mission (program expenditure) albeit at a lower marginal rate than grant dollars.

  • firebus

    I agree with these comments, and also feel that impact is an important component of efficiency that the author overlooks in her study.

    An organization that directs a large proportion of income to mission-related programs that fail to produce any real imapact is NOT more efficient than an org that spends more on overhead but runs high-impact programs.

    Is it possible that organizations experimenting with UBIT are learning skills that they can apply to the program-side of the enterprise?

  • Rebecca Tekula, PhD

    Newell,

    I would say that the practical implication of my study is that less of a donated dollar will go towards mission in a human service organization *with* unrelated business activities than an equivalent organization *without* unrelated business activities. Another major finding of my study that was not picked up (yet) by any media outlets is that the UBI-involved orgs were also more likely to be in financial distress. Causality (chicken or egg question) is unclear.

    Finally, I would encourage you to read through to the conclusion of my study, where I do address many commenters’ concerns. Here’s an excerpt: “While this research is a first step…there is much work to be done in this area. My analysis focused clearly on unrelated business income, which social enterprise scholars and practitioners would consider an ‘external’ funding model in which the source of funds is not related to the exempt mission of the organization. A large-sample empirical analysis of the relationship between proportion of program expenditure and related or ‘internal’ earned income would also be beneficial to the current body of literature.” But this kind of measured discussion/conclusion is not always news-worthy!

    Hopefully we will see follow-up studies that reveal whether the internal or hybrid model (to which many commenters refer) is of benefit to the average nonprofit. But, Stephanie Strom’s recent article in The New York Times brings this model into question as well: http://www.nytimes.com/2010/10/26/business/26hybrid.html?pagewanted=1&_r=1&src=busln

    An important take-away is that my research in no way indicates that this model never works, but that on average it is associated with inefficiencies in human service nonprofits.

    Thanks again for your interest, I welcome your questions and will try to address them as I can.

  • Rebecca Tekula, PhD

    Ephraim, You bring up a valid question. I have not seen anything to indicate that what you suggest is true, and considering that the unrelated business income model has been around for a long time, there is no reason (that I can think of) that this model has changed since 2005. There *is* always a lag in the availability of this data, and I hope to update my sample sometime next year.

    I would speculate that nonprofits are seeing just as much difficulty with their income-generating activities as all corporations have during the last two years, and we know that they are also having difficulties raising donated funds.

    In the meantime, check out Stephanie Strom’s recent article in the NYTimes: http://www.nytimes.com/2010/10/26/business/26hybrid.html?pagewanted=1&_r=1&src=busln

  • Agnes Vishnevkin

    This study is misleading because of its focus on nonprofits that earn unrelated business income. Some organizations operate revenue generating businesses (social enterprises) that are directly related to their missions. They were not included in this study because the revenue they generate is related to their mission and is not considered unrelated business income.

    While some organizations do consider starting businesses at the encouragement of a major donor or because they read a case study about another organization, some innovative nonprofits have operated businesses related to their missions for decades.

    Here are some good examples from around the United States:
    TROSA http://trosainc.org, North Carolina’s largest long-term residential program for recovering substance abusers. TROSA operates a moving company, lawn services, frame shop, and other businesses to provide vocational training to its clients.

    Women’s Bean Project http://www.womensbeanproject.com
    helps women break the cycle of poverty and unemployment by providing employment in its own gourmet food production business.

    MDI http://www.mdi.org serves people with disabilities by offering employment opportunities in business enterprises.

  • ephraim

    Rebecca-
    first- thanx for the link. that was a very interesting article

    second- so what are your operational conclusions from the study?
    – non-profits should stay out of the business world?
    – if starting a social enterprise make sure the non-profit has enough funds to hire a proper business consultant?
    – better business plans?

    I’m very curious to hear your thoughts. here in Israel social enterprise is becoming the next “big thing” (we’re always a few years behind)& the non-profit I work for is looking into it.
    now that I’ve seen the study and will be more cautious when approaching this issue, what advice do you have?

    thanx in advance

  • GF

    The proposition is interesting and not discussed enough. Non profits have come under federal funding. The pressure for this federal money has made some reliant on those funds and programs that are failed business models(eg CNCS grants~volunteer hiring). As Congress cleans its House from all the legslation and huge spending we may see some of these programs cancelled even though they are little money,but they pay little anyway. We cant all be Kennedy~Harvard and make the govts money ours.

  • Rebecca Tekula, PhD

    As I mentioned above: I have yet to come across a published definition or typology of social enterprise which does not include the unrelated business income model I studied in my paper. I do think we as academics and practioners must move beyond anecdotes, and I look forward to more healthy debate and research that asks hard questions about this important sector of our economy.

  • Jacob Model

    Rebecca,
    First, I wanted to say that this is certainly an important topic and I applaud you for looking into it. However, I just wanted to raise a few new issues that I didn’t see in the other comments.

    1) The questionable quality of NCCS UBI data. There are strong disincentives for nonprofits to report UBI on their 990s. After all, they typically have to pay taxes on any profit. I believe it is very unlikely that nonprofits would report UBI activities. Just like nonprofits under report overhead (http://www.ssireview.org/images/articles/2009FA_feature_Gregory_Howard.pdf) and fund raising costs (http://nccsdataweb.urban.org/kbfiles/313/Brief%201.pdf) on their 990s, they almost certainly under report UBI. http://tippie.uiowa.edu/accounting/mcgladrey/workingpapers/02-19.pdf

    2) In addition misreporting, UBI does not include many other sources of what you term to be “external” income. For example, nonprofits can also skirt reporting UBI if they own for-profit subsidiaries. For example, Community Wealth Ventures is a for-profit 100% owned by Share Our Strength, a nonprofit. Revenue reported from Subsidiaries or investments may not be reported as UBI. Besides dodging UBI, there are other reasons (e.g., access to capital) that organizations would structure unrelated business ventures this way (or through other legal structures).

    3) Finally, I’m unclear why you chose to restrict your sample to a small geographic region. Considering the effort The Urban Institute makes for the SOI data, why not use the whole thing?
    4) I think the fact that you use program expenditures as a measure of “efficiency” is also problematic. Even if I agree with your measure of efficiency (which I don’t – see the nonprofit starvation cycle article referenced above), it still is inadequate. Considering the incentives for nonprofits to report as little as possible UBI (if they’re reporting at all), they may be encouraged to include a portion of what should be considered program expenses in UBI activities in order. For example, if a manager in a nonprofit operates in both the UBI business and the charitable organization, they could easily report the manager’s salary in the UBI business to depress their reported net income. If a nonprofit did this, one would expect that the program expense to total expense ratio to be lower.

    The bottom line for me is that NPQ’s tag on your article is seriously misleading. As you recognize in your paper, you’ve really only captured a very small subset of 1) conventional definitions of social enterprise 2) Geography and 3) Types of service organizations.

    Moreover, though I recognize that NCCS is kinda the only player in the game, the data is really weak. To claim that up to your study that “hard evidence from large sample empirical studies did not exist” is simply too strong for the reasons I raise above (and likely several others I missed). Your paper should address these flaws and better articulate the well-known (and documented) data limitations of NCCS and the SOI.

    I look forward to your comments.

    Best,
    -JM

  • Rebecca Tekula, PhD

    Jacob,

    I wonder how your suggestions would change my findings. You imply that nonprofits are underreporting UBI

  • JM

    Rebecca,
    I understand the smaller sample if there were capacity limitations. And I recognize that NCCS is commonly used by academic researchers and has been shown to be reasonably reliable for basic information such as total expenses and revenues (see Froelich et al. 1996 and 2000 Froelich et al. for more info on this). And academic researchers are always going to be resource constrained (especially if you’re double-checking all the forms as the Urban Institute suggests). But really, those are just more sideline quibbles and more about recognizing the limitations of the data, certainly not implying that NCCS is worthless – it’s kinda the only game in town.

    However, I don’t feel as though you’ve address the larger issues. I don’t understand how nonprofits that have what you would classify as “external” income but don’t report it would help strengthen your argument. From where I stand, it seems like it would have to potential to significantly bias your sample.

    Perhaps if you thought that they were pushing program expenses there to increase their program expenses/ total expense ratio, it would strengthen your argument. But that brings me to the more significant criticism which I alluded to though did not explicitly state – there’s a substantial literature on why your chosen dependent variable is flawed. Rating groups such as Charity Navigator, are explicitly moving away from these ratios of program expenses explicitly because they are not good measures of efficiency (see more are http://www.tacticalphilanthropy.com/2010/11/charity-navigator-2-0). Though this would not affect your findings, you might infer another conclusion. It very well might be harder for nonprofits to hide overhead expenses when they have significant UBI than if they don’t.

    After all, if I’m an IRS auditor, wouldn’t seeing substantial UBI alongside a very low overhead rate be a strange combination – maybe a even “red flag”?

    Best,
    -JM

  • Rebecca Tekula, PhD

    Jacob,

    I closely follow the debate on using program/total expense ratios and the pros and cons. Yet I am interested to know if you have another measure to suggest that is both exogenous and simple to measure in a large sample.

    As for the reliability of tax returns, I stand by my assertion that they are our best and least biased insight into the financials of nonprofit organizations in the U.S.

    You may not agree with my model, but it is surely an appropriate methodology for consideration in the marketplace of ideas that constitutes academic research.

    Regards,
    Rebecca Tekula, PhD

  • Kate Barr

    Rebecca –
    I’m glad that you bring up the study’s conclusions related to the correlation between UBI and financial distress. You used liability to asset ratio as the indicator of financial distress. Unless you are able to set a benchmark to act as a baseline measure of financial distress I think that all that you have measured is the different levels of leverage used by the organizations in your study. Leverage in and of itself is not necessarily a measure of distress. In fact, the types of assets used for programs operated by the organization is very predictive of leverage. Any of the human service organizations in the sample that either own a building on which they have a bond or mortgage, or that operate affordable housing programs that are generally financed with debt, will necessarily have a higher leverage ratio because of the composition of their capital structure,. That doesn’t necessarily mean they are in financial distress.