As nonprofits struggle to secure private contributions and government contracts, one of the most enduring questions is how funders will evaluate these organizations. Their choice of standards will matter in who wins and who loses in the sector. Because nonprofits no longer operate in isolation from business firms in many key fields such as health and human services, the choice of criteria will also determine the division of work between the sectors and have profound financial implications for the nonprofit sector’s future development. While much uncertainty remains in this arena, one thing is now clear: if the prime criterion used by public and private funders turns out to be efficiency, nonprofits are in for a lot of trouble. To be successful in the future, nonprofit managers will need to move the performance conversation consciously away from narrow process measures of efficiency to broader measures of program outcomes and impact, where nonprofits may have some distinctive advantages.

Today, it is hard to think of a single concept in the business world that is more central to strategy than efficiency — or more particularly, cost efficiency. When a business firm sets out to evaluate how well it is doing, one of the very first things it will do is examine the cost efficiency of its production and compare it to that of other business competitors. This process works well in manufacturing because often the products produced by businesses are relatively interchangeable. In the personal computer industry, for example, cost efficiency is a critical driver of sales and success, because many of the products have similar components and features. Because all firms produce very similar products, no firm that is burdened by substantial inefficiencies in production can survive long-it would be forced to either charge more than other businesses or sell below cost. The rush of business firms to economize and become ever more efficient in their production has led over time to dropping prices and a hyper-competitive environment where only the leanest and most efficient producers are able to survive. A race to the bottom is the most visible sign of a market in which efficiency is the prime driver.

While for-profit computer makers compete with other for-profit computer makers, in a growing number of fields business firms compete with nonprofits. In the field of job-training and welfare-to-work services, for example, nonprofits and large business corporations are locked in a heated struggle to secure state contracts for the provision of services. Public managers will be key players in this new cross-sector competition, since they will have the final say over where to direct large blocks of critical funding. The temptation will be strong to rely on efficiency measures in deciding who gets government grants and contracts because efficiency-usually measured by taking the ratio of administrative expenses to total expenses-appears to be a neutral and fair criterion.

To date, many nonprofit leaders have simply accepted the idea that efficiency measures are important, if for no other reason than business organizations have long focused on efficiency. As business competition with nonprofits has heated up, one popular response among nonprofit organizations has been to express the need to manage better and more efficiently. Dozens of books now aim to help nonprofit practitioners improve their organizations and manage more efficiently. Many of these titles attempt to bring business concepts such as process reengineering and benchmarking to bear on the nonprofit sector, usually with the intent of tightening the level of organizational and program efficiency. A common theme that emerges from these texts is that the absence of a traditional bottom line in the nonprofit sector-far from freeing nonprofits to pursue their missions-means that these organizations must manage especially well and develop a special kind of cost-cutting discipline. Though rarely expressed directly, these books suggest that the management lag between nonprofit and business sectors can be closed with a direct transfer of managerial know-how.

Why have some nonprofits swallowed the managerial precepts of business hook, line, and sinker? The push toward efficiency and performance in the nonprofit sector has been fueled by three main developments. First, the rapid professionalization of large parts of the nonprofit sector over the past three decades has significantly changed the composition of the nonprofit workforce. Many professional staff want to bring a new rigor to their work and develop standards to measure their performance, both as the basis for their own advancement and in the effort to build a growing body of expert knowledge. For professionals, the ideas of installing controls and lowering costs are appealing because these efforts hold out the promise of supporting and justifying the move from volunteer labor to well compensated professional staffing. With their desire to avoid charges of amateurism that have plagued this sector in the past, the growing ranks of nonprofit professionals have turned out to be the perfect audience for claims that efficiency represents the new frontier of nonprofit management.

A second factor has been the explosive growth in the number of nonprofit organizations over the past three decades. Competition for contributed income has intensified, particularly among the growing legion of start-up organizations. Many nonprofit managers must now confront a situation in which several nonprofit organizations with similar missions are operating close by and competing for support. Given the difficulty in sorting out differences in program effectiveness, many of the nonprofits have gravitated to the simple ratio of administrative to total expenses as an understandable and marketable benchmark for performance that can be trumpeted in fundraising appeals. In the field of international relief, for example, the need to attract contributions has led directly to efforts at differentiation around overhead costs and programmatic efficiency. Knowing that individual donors to famine relief would, all other things being equal, prefer to see their funds reach those in need rather than be spent on overhead, many relief agencies have come to compete for the distinction of having the lowest administrative costs.

A third factor driving the move to a greater focus on efficiency has been the growing transparency of the nonprofit sector, as seen in the easy availability of nonprofit organizations’ financial data. Although nonprofits have long been required to file a financial disclosure form on an annual basis with the Internal Revenue Service and make this information available to the public upon demand, this data never found very broad use except by a few large institutional funders. Now, however, with the emergence of Guidestar and other Web-based sources of data on nonprofit finances, the availability of data on the underlying finances of nonprofits has increased significantly. Web sites allowing potential donors to both examine a nonprofit’s efficiency ratio and contribute online have simply raised the stakes around these ratios and made them harder for nonprofits to ignore. Of course, the categorization of costs as either administrative or programmatic is a subject of considerable dispute and little precise guidance exists. This imprecision, in turn, has had the effect of intensifying the inclination of nonprofits to enter into the efficiency positioning game in many of these new, voluntary information clearinghouses, since standards for challenging claims of efficiency are difficult to locate.

Although powerful forces are aligned that are leading nonprofits to emphasize efficiency, there is reason to suspect that nonprofit organizations may not be well served if they push for greater and greater cost efficiency in their organizations, especially given the growing amount of competition that is coming from business firms across a range of fields. Given their commitment to missions and their aversion to client creaming, nonprofits are ill equipped to win a race to the bottom. Increasing efficiency is not, and can never be, a formula for sustained success in the nonprofit sector because cost-cutting moves are always easily matched by other firms, especially business firms. There will always be providers willing to cut more corners, exclude difficult clients, and do what is needed to drive down costs.

Instead of letting efficiency drive key decisions, which only creates a rise in debilitating competitive battles that damage the viability of nonprofit organizations, nonprofit managers need to do something quite different: find a unique and valuable position rooted in an identity and set of programs that are difficult to match. The most critical work for nonprofits is to clarify their organization’s overall strategy, defined as the unique mix of activities that make a nonprofit organization stand out from others. The neglected core of nonprofit strategy ultimately lies in the values and commitments that animate most nonprofit activities and that constitute the sector’s important expressive, non-instrumental dimension. The expressive character of nonprofit activity-the way nonprofits allow people to demonstrate commitment to social ends and values-is what significantly differentiates nonprofits from one another and what separates nonprofits from organizations in the business and public sectors. Recapturing, validating, and emphasizing the expressive, value-driven side of nonprofits-and its contribution to programmatic effectiveness-is a crucial part of developing a sustainable strategy in today’s turbulent and competitive environment.

As a first step in this direction, nonprofit managers must see through the forces pushing the nonprofit sector ever closer to embracing the shallow promise of efficiency. As a second step, managers need to learn to make the case to funders that effectiveness is a far more potent measure of value creation than the narrow pursuit of efficiency.

How can this shift be accomplished in practice? Consider the work of Midtown Educational Foundation (MEF) in Chicago. MEF operates after-school tutoring, mentoring, and college orientation to middle and high school girls and boys in two separate facilities on the city’s largely minority West side. What makes MEF’s approach noteworthy is the clarity and distinctiveness of its mission: by focusing on kids that are getting by in school with Cs and occasional Bs, MEF seeks to help average and underachieving students perform at levels that will allow them to attend quality four-year institutions, rather than simply settle for community college or no college at all. This strategy is markedly different from the many other programs that focus on the most at-risk children or the most gifted. Associated with Opus Dei, MEF’s programs embody strong values and reinforce life skills and a serious work ethic. In recent years, MEF has enjoyed substantial success and has been replicated in other cities. It has expanded substantially over the years in large measure because it has a distinctive market position, a strategy grounded in values, and an ability to document the educational outcomes of its students. While the ratio of administrative to total expenses is probably low given the frugality of MEF’s culture, efficiency is not what has made this organization strong or attracted funders to it. MEF’s values and mission do that.

I think it is fair to say that efficiency has never been and will never be a lasting solution in the nonprofit sector. Creative and successful nonprofit managers need to build strategies based on the core missions and values that animate their organizations and allow them to achieve important programmatic results. This work does not start and end with the preoccupations of the business sector or the thin concept of cost efficiency. It must be anchored in the core commitments and deeply held beliefs that drive nonprofit action.

Peter Frumkin is an assistant professor of public policy at Harvard’s Kennedy School of Government and a senior fellow of the New America Foundation.