Not for Profit Organizations

Eight times a day, the Reverend Bernard McCoy solemnly chants prayer in

Latin in the monastery chapel. He then goes back to his computer and telephone

to manage LaserMonks. McCoy and four other monks at The Cistercian Abbey of

Our Lady of Spring Bank in Sparta, Wisconsin, sell refilled inkjet and laser printer

cartridges from their Internet site and telephone mail order center. LaserMonks of-

fers the refills at prices 30% to 90% lower than offered at retail stores. Says McCoy, You get

quality products at great savings. We do good work with the extra income. Plus, the monks pray

for you. I dont think Staples ever offered to do that.

Sales increased from $2,000 during their first year of business in 2002 to $500,000 in 2003,

with a profit of $30,000. After expenses are paid for the business and the monastery, the money

pays for everything from a defibrillator for the local fire department to providing free computer

training for orphans in Vietnam. Worried about the monasterys not-for-profit status, LaserMonks

was established as a profit-making corporation owned by the abbey. According to McCoy,

through charitable, legal means, we channel money to the abbey, which is how we dont jeop-

ardize our tax-exempt status. . . . We pay business taxes like everybody else. Responding to the

concern that a monastery should not be involved in business activities, McCoy states, Were not

selling God; were selling black dust and ink so we can give our profits away to good causes. But

you do have to walk a fine line in your marketing and not be offensive to God, yourself, or any

other groups that have various relations to divine things.1

LaserMonks is an example of strategic piggybacking, a not-for-profit strategy that is as old

as Girl Scout cookies and museum gift shops. Todays not-for-profits are using profit-making

ventures as a way to diversify their revenue streams in tight financial times.2 Piggybacking is a

way for not-for-profits to earn money in a secondary business activity to support their primary

mission, which may be raising orphans or providing a free educational experience.

By the mid-1990s, most not-for-profit organizations were turning to strategic management

and other concepts from business to ensure their survival. According to Cynthia Massarsky,

Deputy Director of the Yale School of ManagementThe Goldman Sachs Foundation Partner-

ship on Nonprofit Ventures, Nonprofits are looking to be more efficient in the way they do

strategic issues in Not-for-ProfitOrganizations

W E B C H A P T E R C

C-2

Identify the types of not-for-profitorganizations

Explain how sources of revenue influencenot-for-profit strategic decision making

Compare and contrast the strategicmanagement of profit-making with not-for-profit organizations

Discuss popular strategies being used bynot-for-profit organizations

Learning ObjectivesAfter reading this chapter, you should be able to:

things. By taking a few lessons from the business world, perhaps theyve learned how to

operate a little more efficiently.3 This is a significant change from past attitudes because

most not-for-profit managers have traditionally felt that business concepts were not rele-

vant to their situation. According to Peter Drucker:

Twenty years ago, management was a dirty word for those involved in nonprofit or-

ganizations. It meant business, and nonprofits prided themselves on being free of the

taint of commercialism and above such sordid considerations as the bottom line. Now

most of them have learned that nonprofits need management even more than busi-

ness does, precisely because they lack the discipline of the bottom line.4

A knowledge of not-for-profit organizations is important if only because they ac-

count for an average of 1 in every 20 jobs in nations throughout the world. A study by the

Johns Hopkins University Institute for Policy Studies found that in nine countries between

1990 and 1995, nonprofit jobs grew by 23% compared to 6.2% for the whole economy.5

Not-for-profits employ over 25% of the U.S. workforce and own approximately 15% of

the nations private wealth.6 In the United States alone, in addition to various federal,

state, and local government agencies, there are about 10,000 not-for-profit hospitals and

nursing homes (84% of all hospitals), 4,600 colleges and universities, more than 100,000

private and public elementary and secondary schools, and almost 350,000 churches and

synagogues, plus many thousands of charities and service organizations.7

Typically, not-for-profit organizations (NFP) include private nonprofit corporations

(such as hospitals, institutes, private colleges, and organized charities) as well as public

governmental units or agencies (such as welfare departments, prisons, and state univer-

sities). Traditionally, studies in strategic management have dealt with profit-making firms

to the exclusion of nonprofit or governmental organizations. This, however, is changing.

Increasing numbers of not-for-profit organizations are adopting strategic management.

C-3 PART 6 Other Strategic Issues

C.1 Why Not-for-Profit?The not-for-profit sector of an economy is important for several reasons. First, society desirescertain goods and services that profit-making firms cannot or will not provide. These are re-ferred to as public or collective goods because people who might not have paid for the goodsreceive benefits from them. Paved roads, police protection, museums, and schools are exam-ples of public goods. A person cannot use a private good unless he or she pays for it. Gener-ally, once a public good is provided, however, anyone can use or enjoy it.

Certain aspects of life do not appear to be served appropriately by profit-making businessfirms yet are often crucial to the well-being of society. These aspects include areas in whichsociety as a whole benefits from a particular service but in which a particular individual ben-efits only indirectly. It is in these areas that not-for-profit organizations have traditionally beenmost effective. Libraries and museums are examples. Although most people do not visit li-braries or museums very often, they are usually willing to pay taxes and/or donate funds tosupport their existence. They do so because they believe that these organizations act to upliftthe culture and quality of life of the region. To fulfill their mission, entrance fees (if any) mustbe set low enough to allow everyone admission. These fees, however, are not profitabletheyrarely even cover the costs of the service. The same is true of animal shelters managed by theHumane Society. Although few people want abandoned pets running wild through city streets,fees charged for the adoption of these animals cannot alone pay the costs of finding and car-ing for them. Additional revenue is neededin the form of either donations or public taxation.Such public or collective services cannot generate a profit, yet they are necessary for any suc-cessful civilization. Which aspects of society are most suited to being served by not-for-profitorganizations rather than by profit-making business organizations? This is an issue that gov-ernments face when they privatize what has previously been provided by the state. See theGlobal Issue feature to learn more about this development.

A second reason why the not-for-profit sector is important is that a private nonprofit or-ganization tends to receive benefits from society that a private profit-making firm cannot ob-tain. Preferred tax status to nonstock corporations is given in section 501(c)(3) of the U.S.Internal Revenue Service code in the form of exemptions from corporate income taxes. Privatenonprofit firms also enjoy exemptions from various other state, local, and federal taxes. Undercertain conditions, these firms also benefit from the tax deductibility of donors contributionsand membership dues. In addition, they qualify for special reduced-cost mailing privileges.10These benefits are allowed because private nonprofit organizations are typically service organ-izations, which are expected to use any excess of revenue over costs and expenses (a surplusrather than a profit) either to improve service or to reduce the price of their service. This ser-vice orientation is reflected in the fact that not-for-profit organizations do not use the termcustomer to refer to the recipient of the service. The recipient is typically referred to as apatient, student, client, case, or simply the public.

Scholars and practitioners are concluding that many strategic management concepts

and techniques can be successfully adapted for not-for-profit organizations.8 Although

the evidence is not yet conclusive, there appears to be an association between strategic

planning efforts and performance measures such as growth.9 The purpose of this chapter

is, therefore, to highlight briefly the major differences between profit-making and not-

for-profit organizations, so that the effects of their differences on the strategic manage-

ment process can be understood.

WEB CHAPTER C Strategic Issues in Not-for-Profit Organizations C-4

C.2 Importance of Revenue SourceThe feature that best differentiates not-for-profit organizations from each other as well as fromprofit-making corporations is their source of revenue.11 A profit-making firm depends on rev-enues obtained from the sale of its goods and services to customers, who typically pay for thecosts and expenses of providing the product or service plus a profit. A not-for-profit organiza-tion, in contrast, depends heavily on dues, assessments, or donations from its membership, oron funding from a sponsoring agency, such as the United Way or the federal government, topay for much of its costs and expenses.

WHICH IS BEST FOR SOCIETY: BUSINESS OR NOT-FOR-PROFIT?

Many nations throughoutthe world are attempting to

privatize state-owned enter-prises to balance their budgets.

Privatization is (1) the selling ofstate-owned enterprises to private indi-

viduals or corporations or (2) the hiring of a private businessto provide services previously offered by a state agency. TheBritish government, for example, sold British Airways, itsstate-owned airline, to private investors. In the United States,many city governments now allow private companies to col-lect and dispose of trashsomething that had previouslybeen done by the city.

Problems can result, however, if privatization goes toofar. For example, in converting from a communist-oriented,centrally managed economy to a more democratic, free-market economy, Eastern European countries are findingthat profit-making business firms are unable to satisfy all ofsocietys needs. What used to be provided by the state freeof charge (but tax-supported) in Russia and other countriesmay now be provided only for the rich or not at all. Thesame problem is evident in the United States in the contro-versies over the provision of health care, retirement bene-fits, and private versus public education.

Some of the aspects of life that cannot easily be priva-tized and are often better managed by not-for-profit or-ganizations are as follows:

Religion Education Charities Clubs, interest groups, and unions Health care Government

The privatization of state-owned business enterprises islikely to continue globally because most of these enter-prises must expand internationally in order to survive in theincreasingly global environment. They cannot competesuccessfully if they are forced to follow inefficient, sociallyoriented policies and regulations (emphasizing employ-ment over efficiency) rather than economically oriented,international practices (emphasizing efficiency over em-ployment). The global trend toward privatization will prob-ably continue until each country reaches the point wherethe efficiency of business is counterbalanced by the effec-tiveness of the not-for-profit sector of the economy. As po-litical motives overcome economic ones, government willlikely intervene in that decision.

GLOBAL issue

SOURCES OF NOT-FOR-PROFIT REVENUERevenue is generated from a variety of sourcesnot just from clients receiving the product orservice from the not-for-profit. It can come from people who do not even receive the servicesthey are subsidizing. One study of Minnesota nonprofits found that donations accounted for


Customer/ClientGenerated

SponsorGenerated

(A)Profit-MakingOrganization

Profit-MakingOrganization

Customer/Client

(A)Total Funding

byRecipient of

Service

(B)Heavy Funding

byRecipient of

Service

(C)Partial Funding

byRecipient of

Service

(D)No Funding

byRecipient of

Service

Sponsor Sponsor SponsorClient Client Client

NFP*Organization

*NFP=Not-for-profit

NFP*Organization

NFP*Organization

(B)Private

University

(C)Public

University

(D)Charity,

GovernmentWelfare Agency

0%

Rev

enu

e

Source of Revenue100%

FIGURE C1 TheEffects of Sources of Revenue onPatterns ofClientOrganizationInfluence

SOURCE: Thomas L. Wheelen and J. David Hunger, The Effect of Revenue Upon Patterns of ClientOrganizationInfluence. Copyright 1982 by Wheelen and Hunger Associates. Revised 1991. Reprinted by permission.

almost 40%, government grants for around 25%, and program service fees for about 35% oftotal revenues.12 In other types of not-for-profit organizationssuch as unions and voluntarymedical plansrevenue comes mostly from the members, the people who receive the service.Nevertheless, the members typically pay dues in advance and must accept later whatever ser-vice is provided, whether they choose it or not and whether it is what they expected or not. Theservice is often received long after the dues are paid.

In profit-making corporations, there is typically a simple and direct connection betweenthe customer or client and the organization. The organization tends to be totally dependent onsales of its products or services to the customer for revenue and is therefore extremely inter-ested in pleasing the customer. As shown in Figure C1, a profit-making organization (orga-nization A) tries to influence the customer (through advertising and promotion) to continueto buy and use its services. Either by buying or not buying the item offered, the customer, inturn, directly influences the organizations decision-making process. The business is thusmarket-oriented.

In the case of a typical not-for-profit organization, however, there is likely to be a very dif-ferent sort of relationship between the organization providing and the person receiving the service. Because the recipient of the service typically does not pay the entire cost of the service,outside sponsors are required. In most instances, the sponsors receive none of the service but pro-vide partial to total funding for the needed revenues. As indicated earlier, these sponsors can be


the government (using taxpayers money) or charitable organizations, such as the United Way(using voluntary donations). As shown in Figure C1, a not-for-profit organization can be par-tially dependent on sponsors for funding (organizations B and C ) or totally dependent on thesponsors (organization D). The less money it receives from clients receiving the service or prod-uct, the less market-oriented is a not-for-profit organization.

PATTERNS OF INFLUENCE ON STRATEGIC DECISION MAKINGThe pattern of influence on an organizations strategic decision making derives from itssources of revenue.13 As shown in Figure C1, a private university (organization B) is heavilydependent on student tuition and other client-generated funds for about 70% of its revenue.Therefore, the students desires are likely to have a stronger influence (as shown by an unbro-ken line) on the universitys decision making than are the desires of the various sponsors suchas alumni and private foundations. The sponsors relatively marginal influence on the organi-zation is reflected by a broken line. In contrast, a public university (organization C) is moreheavily dependent on outside sponsors such as a state legislature for revenue funding. Studenttuition and other client-generated funds form a small percentage (often less than 40%) of to-tal revenue. Therefore, the universitys decision making is heavily influenced by the sponsors(unbroken line) and only marginally influenced directly by the students (broken line).

In the case of organization D, however, the client has no direct influence on the organiza-tion because the client pays nothing for the services received. In this situation, the organiza-tion tends to measure its effectiveness in terms of sponsor satisfaction. It has no real measureof its efficiency other than its ability to carry out its mission and achieve its objectives withinthe dollar contributions it has received from its sponsors. In contrast to other organizations inwhich the client contributes a significant proportion of the needed revenue, organization D ac-tually might be able to increase its revenue by heavily lobbying its sponsors while reducing thelevel of its service to its clients!

Regardless of the percentage of total funding that a client generates, the client may at-tempt to indirectly influence a not-for-profit organization through the sponsors. This is de-picted by the broken lines connecting the client and the sponsor in organizations B, C, and Din Figure C1. Welfare clients or prison inmates, for example, may be able to indirectly im-prove the services they receive if they pressure government officials by writing to legislatorsor even by rioting. Students at public universities can lobby state officials for student repre-sentation on governing boards.

The key to understanding the management of a not-for-profit organization is thus learn-ing who pays for the delivered services. If the recipients of the service pay only a small pro-portion of the total cost of the service, strategic managers are likely to be more concerned withsatisfying the needs and desires of the funding sponsors or agency than those of the people re-ceiving the service. The acquisition of resources can become an end in itself.

USEFULNESS OF STRATEGIC MANAGEMENT CONCEPTSAND TECHNIQUES

Some strategic management concepts can be equally applied to business and not-for-profitorganizations, whereas others cannot. The marketplace orientation underlying portfolio analysis,for example, does not translate into situations in which client satisfaction and revenue are onlyindirectly linked. Industry analysis and competitive strategy are primarily relevant to not-for-profits that obtain most of their revenue from user fees rather than from donors or taxpayers. Forexample, as hospitals find themselves relying increasingly on patient fees for their revenue, theyuse competitive strategy to gain advantage versus other hospitals. Smaller not-for-profit hospitals


C.3 Impact of Constraints on Strategic ManagementSeveral characteristics peculiar to a not-for-profit organization constrain its behavior and af-fect its strategic management. Newman and Wallender list the following five constraints onstrategic management:

1. Service is often intangible and hard to measure. This difficulty is typically com-pounded by the existence of multiple service objectives developed to satisfy multiplesponsors.

2. Client influence may be weak. Often the organization has a local monopoly, and clientspayments may be a very small source of funds.

3. Strong employee commitments to professions or to a cause may undermine alle-giance to the organization employing them.

4. Resource contributors may intrude on the organizations internal management.Such contributors include fund contributors and government.

5. Restraints on the use of rewards and punishments may result from constraints 1, 3,and 4.18

stress the high touch of their staff over the high tech of competitors that have better diagnos-tic machinery. The concept of competitive advantage is less useful to a typical not-for-profit thanthe related concept of institutional advantage, which sets aside the profit-making objective ofcompetitive advantage. A not-for-profit can be said to have institutional advantage when it per-forms its tasks more effectively than other comparable organizations.14

SWOT analysis, mission statements, stakeholder analysis, and corporate governance are,however, just as relevant to a not-for-profit as they are to a profit-making organization.15 Port-folio analysis can be very helpful but is used very differently in not-for-profits than in businessfirms. (See the section on strategic piggybacking later in the chapter.) As with any corporation,nonprofits usually have boards of directors whose job is to ensure that the paid executive di-rector and staff work to fulfill the organizations mission and objectives. Unlike the boards ofmost business firms, nonprofit boards are often required, however, to take primary responsi-bility for strategic planning and fund-raising. Many nonprofits find that a well-crafted missionstatement not only helps in finding donors but also in attracting volunteers. Take the exampleof the mission statement of a local animal shelter:

To shelter and care for stray, lost, or abandoned animals and to responsibly place animals innew homes and enforce animal laws. We are also here to better educate people in ways to be so-lutions to animal problems, not causes.16

Strategic management is difficult to apply when an organizations output is difficult tomeasure objectively, as is the case with most not-for-profit organizations. Thus it is very likelythat many not-for-profit organizations have not used strategic management because its con-cepts, techniques, and prescriptions do not lend themselves to situations where sponsors, ratherthan the marketplace, determine revenue. The situation, however, is changing. The trend to-ward privatizing public organizations, such as converting subsidized community hospitals toindependent (nonsubsidized) status, usually means that the clients/patients pay a larger per-centage of the costs. As these not-for-profits become more market oriented (and thus client ori-ented), strategic management becomes more applicable and more increasingly used.17Nevertheless, various constraints on not-for-profits mean that strategic management conceptsand techniques must be modified to be effective.


It is true that several of these characteristics can be found in profit-making as well as in not-for-profit organizations. Nevertheless, as Newman and Wallender state, the frequency ofstrong impact is much higher in not-for-profit enterprises.19

IMPACT ON STRATEGY FORMULATION

The long-range planning and decision making affected by the listed constraints serve to add atleast four complications to strategy formulation:

1. Goal conflicts interfere with rational planning: Because a not-for-profit organization typ-ically lacks a single clear-cut performance criterion (such as profits), divergent goals and ob-jectives are likely, especially with multiple sponsors. Differences in the concerns of variousimportant sponsors can prevent management from stating the organizations mission in any-thing but very broad terms, if they fear that a sponsor who disagrees with a particular, nar-row definition of mission might cancel its funding. For example, a study of 227 publicCanadian hospitals found that more than half had very general, ambiguous, and unquanti-fied objectives.20 According to Heffron, an authority in public administration, The greateropenness within which they are compelled to operatethe fishbowl atmosphereimpedesthorough discussion of issues and discourages long-range plans that might alienate stake-holders.21 In such organizations, it is the reduced influence of the clients that permits thisdiversity of values and goals to occur without a clear market check. For example, when acity council considers changing zoning to implement a strategic plan for the city, all sorts ofpeople (including the press) will demand to be heard. A decision might be made based onpressure from a few stakeholders (who make significant contributions or who threaten to stirup trouble) to the detriment of the community as a whole.

2. An integrated planning focus tends to shift from results to resources: Because not-for-profit organizations tend to provide services that are hard to measure, they rarely havea net bottom line.22 Planning, therefore, becomes more concerned with resource inputs,which can easily be measured, than with service, which cannot. Goal displacement (ex-plained in Chapter 11) becomes even more likely than it is in business organizations.23

3. Ambiguous operating objectives create opportunities for internal politics and goaldisplacement: The combination of vague objectives and a heavy concern with resourcesallows managers considerable leeway in their activities. Such leeway makes possiblepolitical maneuvering for personal ends. In addition, because the effectiveness of a not-for-profit organization hinges on the satisfaction of the sponsoring group, managementtends to ignore the needs of the client while focusing on the desires of a powerful spon-sor. University administrators commonly say that people will donate money for a newbuilding (which will carry the donors name) but not for other more pressing needs, suchas the maintenance of existing buildings. In this situation, powerful department headsmight wine and dine the donor, hoping to get the money for their pet projects. This prob-lem is compounded by the common practice of selecting people to boards of trustees/directors not on the basis of their managerial experience but on the basis of their abilityto contribute money, raise funds, and work with politicians. (A major role of a not-for-profitboard is to ensure adequate resourcesusually translated to mean fund-raising.24)Directors usually receive no compensation for serving on the board. Their lack of inter-est in overseeing management is reflected in an overall not-for-profit board-meeting atten-dance rate of only 50%, compared with 90% for boards of directors of businesscorporations. This is one reason why boards of not-for-profits tend to be larger than areboards of business corporations. Eckerd College, for example, has a 52-member,extremely passive board of directors.25 Board members of not-for-profit organizationstend to ignore the task of determining strategies and policiesoften leaving that to the


paid (or sometimes unpaid) executive director. The larger the board, the less likely it isto exercise control over top management.26

4. Professionalization simplifies detailed planning but adds rigidity: In not-for-profit or-ganizations in which professionals play important roles (as in hospitals or colleges), pro-fessional values and traditions can prevent the organization from changing itsconventional behavior patterns to fit new service missions tuned to changing social needs.This rigidity, of course, can occur in any organization that hires professionals. The strongservice orientation of most not-for-profit organizations, however, tends to encourage thedevelopment of static professional norms and attitudes. As not-for-profits attempt to be-come more business-like, this may be changing. One study of Minnesota nonprofits re-vealed that 29% of the program directors and 15% of the staff had degrees or experiencein business administration.27

IMPACT ON STRATEGY IMPLEMENTATIONThe five constraining characteristics also affect how a not-for-profit organization is organizedin both its structure and job design. Three complications to strategy implementation in par-ticular can be highlighted:

1. Decentralization is complicated: The difficulty of setting objectives for an intangible,hard-to-measure service mission complicates the delegation of decision-making author-ity. Because of the heavy dependence on sponsors for revenue support, the top manage-ment of a not-for-profit organization must be always alert to the sponsors view of anorganizational activity. This necessary caution leads to defensive centralization, inwhich top management retains all decision-making authority so that low-level managerscannot take any actions to which the sponsors may object.

2. Linking pins for externalinternal integration become important: Because of theheavy dependence on outside sponsors, a special need arises for people in buffer roles torelate to both inside and outside groups. This role is especially necessary when the spon-sors are diverse (revenue comes from donations, membership fees, and federal funds) andthe service is intangible (for instance, a good education) with a broad mission and mul-tiple shifting objectives. The job of a Dean for External Affairs, for example, consists pri-marily of working with the schools alumnae and raising funds.

3. Job enlargement and executive development can be restrained by professionalism:In organizations that employ a large number of professionals, managers must design jobsthat appeal to prevailing professional norms. Professionals have rather clear ideas aboutwhich activities are, and which are not, within their province. Enriching a nurses job byexpanding his or her decision-making authority for drug dosage, for example, can causeconflict with medical doctors who believe that such authority is theirs alone. Because aprofessional often views managerial jobs as nonprofessional and merely supportive, pro-motion into a management position is not always viewed positively.

IMPACT ON EVALUATION AND CONTROLSpecial complications to evaluation and control arising from the constraining characteris-tics also affect how behavior is motivated and performance is controlled. Two problems, in par-ticular, are often noticed:

1. Rewards and penalties have little or no relationship to performance: When desiredresults are vague and the judgment of success is subjective, predictable and impersonalfeedback cannot be established. Performance is judged either intuitively (You dont seem


to be taking your job seriously) or on the basis of whatever small aspects of a job can bemeasured (You were late to work twice last month).

2. Inputs rather than outputs are heavily controlled: Because its inputs can be measuredmuch more easily than outputs, a not-for-profit organization tends to focus more on theresources going into performance than on the performance itself.28 The emphasis is thuson setting maximum limits for costs and expenses. Because there is little to no reward forstaying under these limits, people usually respond negatively to such controls.

Because of these and other complications, not-for-profits can waste money in many ways, es-pecially on administrative costs and expenses. Because of this, it is becoming increasinglycommon to calculate ratios comparing total support and revenue with the amounts spent onspecific service activities. For example, analysts become concerned when the total spent on themission of the organization (e.g., community service) is less than 50% of total income receivedfrom sponsors and activities. Other rules of thumb are that a not-for-profit should not spendmore than 35% on administrative expenses and that the costs of fund-raising should not ac-count for more than 15% of total income.29

C.4 Not-for-Profit StrategiesOne of the issues in the strategic management of not-for-profit organizations is the tendencyof nonprofits to make program decisions based on a mission rather than on a strategy. KasturiRangan points out that many nonprofits dont have a strategy at all; instead, they rally under aparticular cause, such as Fight homelessness or Save the children.30 Because that cause isso worthwhile, nonprofits tend to support any program thats even slightly related to the mis-sion, so long as there is money available (at least in the beginning) to support the new program.Without a clear long-term strategy, this will eventually stretch the not-for-profits core capabil-ities into unintended directions and create a budget with more expenses than revenues. The needto attract additional donors forces not-for-profits to go after grants or donations that fit withintheir broadly defined mission but only slightly fit their existing capabilities. The problem is thatsuch a grant usually contains restrictions that the funding be spent on a particular program orinitiative. Starved for money, not-for-profits accept these restrictions in order to obtain the fund-ing. Because the funds barely cover the direct costs of the additional activity, unanticipated in-direct costs force the not-for-profit to look for more funding, each time as a larger, less focused,and more cash-starved organization. The result is an organization with large bureaucratic over-head but not enough professionals to carry out all its programs effectively. This leads to increas-ing pressure to reduce costs and to use more volunteersboth of which may reduce the qualityof service to clients. Professional employees become demoralized because of increasing ser-vice demands, less support, and marginal pay raises.

The organizations executive director is usually too busy administering a convoluted bu-reaucracy, dealing with bickering professional employees, and fund-raising to do any seriousstrategic planning. It is therefore usually left to the board of directors to call a stop to thisactivity trap. The board must define achievable objectives and propose a strategy to make themhappen. It must decide not only what the organization will do but also what it will not do. Giventhat the primary mission is sacrosanct, the board should develop a narrow operational missionwith measurable objectives and a strategy to go with them.31 Once this is done, the organiza-tion is free to decide which programs to support and which to curtail.

If a not-for-profit organization has established an operational mission and measurable ser-vice objectives, it can consider various ways to support its priority programs without havingto accept mission-extending donor requirements. Increasingly, not-for-profits are choosing thestrategies of strategic piggybacking, mergers, and strategic alliances.


STRATEGIC PIGGYBACKINGCoined by Nielsen, the term strategic piggybacking refers to the development of a new activ-ity for a not-for-profit organization that would generate the funds needed to make up the dif-ference between revenues and expenses.32 The new activity is typically related in some mannerto the not-for-profits mission, but its purpose is to help subsidize the primary service pro-grams. It appears to be a form of concentric diversification, but it is engaged in not as part ofthe mission but only for its money-generating value. In an inverted use of portfolio analysis,the organization invests in new, safe cash cows to fund its current cash-hungry question marksand dogs. It is a type of social entrepreneurship, in which a not-for-profit organization startsa new venture to achieve social goals.

Although strategic piggybacking is not new, it has recently become very popular. As earlyas 1874, for example, the Metropolitan Museum of Art retained a professional to photographits collections and to sell copies of the prints. Profits were used to defray the museums oper-ating costs. More recently, various income-generating ventures have appeared under variousauspices, from the Girl Scouts to UNICEF, and in numerous forms, from cookies and smallgift shops to vast real estate developments. A study by the U.S. General Accounting Officerevealed that the amount of funds resulting from income-producing activities of not-for-profitshas significantly increased since the 1970s. Hospitals are offering wellness programs,ranging from meditation classes to aerobics. Some 70% of colleges and universities now offerauxiliary services, such as bookstores, conference rooms, and computer centers, as sourcesof income.33 The American Cancer Society earns millions annually by allowing its name toappear on products sold by private drug companies, such as GlaxoSmithKlines Nicorettechewing gum. The Metropolitan Museum of Art now has 16 stores outside the main museumand a fast-growing web siteall of which generate money. The Baptist Hospital of Nashville,Tennessee, built and operates a $15 million, 18-acre office and training-field complex, whichit rents to Nashvilles professional football team.

The U.S. Small Business Administration, however, views this money-making activity asunfair competition. The U.S. Internal Revenue Service (IRS) advises that a not-for-profit thatengages in a business not substantially related to the organizations exempt purposes mayjeopardize its tax-exempt status, particularly if the income from the business exceeds approxi-mately 20% of total organizational revenues. The IRS requires not-for-profits to pay an unre-lated business income tax on commercial activities that dont relate to the organizations centralmission. So far, not-for-profits are still considered tax exempt if their businesses are staffed byvolunteers or if almost all their merchandise is donated. According to Marcus Owens, Directorof Tax-Exempt Organizations for the IRS, The ultimate question is should these institutionscontinue as tax-exempt entities. And its being raised more than ever before.34 This has causedmany not-for-profits such as The Cistercian Abbey mentioned earlier to establish two separateentities. Doing all the separate bookkeeping, accounting, and cost allocations can be a bit bur-densome, time-consuming and distracting, says Jeffrey Tanenbaum, a lawyer specializing inrepresenting nonprofits.35

Although strategic piggybacks can help not-for-profit organizations self-subsidize theirprimary missions and better use their resources, according to Nielsen, there are several poten-tial drawbacks.36 First, the revenue-generating venture could actually lose money, especiallyin the short run. Second, the venture could subvert, interfere with, or even take over the pri-mary mission. Third, the public, as well as the sponsors, could reduce their contributions be-cause of negative responses to such money-grubbing activities or because of a mistakenbelief that the organization is becoming self-supporting. Fourth, the venture could interferewith the internal operations of the not-for-profit organization. To avoid these drawbacks, a not-for-profit should carefully evaluate its resources before choosing this strategy. See StrategyHighlight C.1 to see the resources needed for a piggyback.


RESOURCES NEEDED FOR SUCCESSFUL STRATEGICPIGGYBACKING

Based on his experience as aconsultant to not-for-profit or-

ganizations, Edward Skloot sug-gests that a not-for-profit should have

five resources before engaging in strategic piggybacking:

1. Something to sell: The organization should assessits resources to see if people might be willing to payfor goods or services closely related to theorganizations primary activity. Repackaging theBoston Symphony into the less formal Boston PopsOrchestra created a way to subsidize the deficit-creating symphony and provide year-round work forthe musicians.

2. Critical mass of management talent: Enoughpeople must be available to nurture and sustain anincome venture over the long haul. This can be verydifficult, given that the most competent not-for-profitprofessionals often dont want to be managers.

3. Trustee support: If the trustees have strong feelingsagainst earned-income ventures, they could activelyor passively resist commercial involvement. When the

Childrens Television Workshop began licensing itsSesame Street characters to toy companies andtheme parks, many people criticized it for joiningbusiness in selling more things to children.

4. Entrepreneurial attitude: Management must beable to combine an interest in innovative ideas withbusiness-like practicality.

5. Venture capital: Because it often takes money tomake money, engaging in a joint venture with abusiness corporation can provide the necessary startupfunds as well as the marketing and managementsupport. For example, Massachusetts General Hospitalreceived $50 million from Hoechst, the Germanchemical company, for biological research in exchangefor exclusive licenses to develop commercial productsfrom particular research discoveries.

SOURCE: Reprinted by permission of the Harvard Business Review.From Should Not-for-Profits Go into Business? by E. Skloot, JanuaryFebruary 1983. Copyright 1983 by the Harvard Busi-ness School Publishing Corporation; all rights reserved.

STRATEGY highlight C.1

The U.S. National Association of College and University Business Officers predicts thatwithin a few years, more than 90% of colleges and universities in the United States will be us-ing strategic piggybacks.37 A similar trend is expected for other not-for-profits that heavily relyon donations and taxpayer support for their revenue.

MERGERS

Dwindling resources are leading an increasing number of not-for-profits to consider mergersas a way of reducing costs through economies of scope and reducing program duplication andraising prices because of increased market power.38 For example, the merger of Baptist HealthSystems and Research Health Services created Health Midwest in Kansas City. The New YorkHospitalCornell Medical Center and ColumbiaPresbyterian Medical Center combined toform the New York and Presbyterian Hospitals Health Care System. Since 1990, more than45% of U.S. hospitals have been involved in mergers and acquisitions.39

STRATEGIC ALLIANCESStrategic alliances involve developing cooperative ties with other organizations. Not-for-profitorganizations often use alliances as a way to enhance their capacity to serve clients or to ac-quire resources while still enabling them to keep their identities.40 Services can be purchasedand provided more efficiently through cooperation with other organizations than if they were


End of Chapter SUMMARYNot-for-profit organizations are an important part of society. Understanding their reasons forexistence and their differences from profit-making corporations is therefore important. Thelack of profit motive often results in vague statements of mission and unmeasurable objectives.Coupled with a concern for maintaining funding from sponsors, these factors can cause a lackof consideration for the very clients the organization was designed to serve. Programs that havelittle or no connection with the organizations mission may develop. Nevertheless, not-for-profitorganizations are usually established to provide goods and services judged valuable bysociety that profit-making firms cannot or will not provide. Judging their performance simplyon the basis of economic considerations is dangerous because they are designed to deal withconditions under which profit-making corporations could not easily survive.

I N F O - B I T S Countries with the highest number of people in prison

per 100,000 population are the United States (707),Russia (638), Belarus (554), Kazakhstan (522), Turk-menistan (489), Bermuda (447), Suriname (437), Ba-hamas (416), Ukraine (416), and South Africa (404).42

Countries with the most hospital beds per 1,000 popu-lation are Japan (17.0), Norway (14.0), Russia (13.1),Moldova (12.9), Estonia (12.0), Belarus (11.8), theNetherlands (11.5), Martinique (10.7), Georgia (10.5),and Kirgizstan (10.4).43

D I S C U S S I O N Q U E S T I O N S1. Are not-for-profit organizations less efficient than profit-

making organizations? Why or why not?2. How does the lack of a clear-cut performance measure,

such as profits, affect the strategic management of a not-for-profit organization?

3. What are the pros and cons of strategic piggybacking? Inwhat way is it unfair competition for not-for-profits toengage in revenue generating activity?

4. What are the pros and cons of mergers and strategic al-liances? Should not-for-profits engage in alliances withbusiness firms?

5. A number of not-for-profit organizations in the UnitedStates have been converting to profit making. Whywould a not-for-profit organization want to change itsstatus to profit making? What are the pros and cons ofdoing so?

done alone. For example, four Ohio universities agreed to create and jointly operate a newschool of international business. Alone, none of the business schools could afford the $30 millionto build the school. The Collaborative Ventures Program of the Teagle Foundation hasgiven more than $4 million in grants to help colleges set up money-saving collaborations.While only a handful of consortia existed in 1995, by 1998 there were at least 21, represent-ing 125 colleges and universities.41

Strategic alliances and mergers are becoming commonplace among not-for-profit organizations. The next logical step is strategic alliances between business firms and not-for-profits. Already, business corporations are forming alliances with universities to funduniversity research in exchange for options on the results of that research. Business firmsfind it cheaper to pay universities to do basic research than to do it themselves. Universi-ties are in need of research funds to attract top professors and to maintain expensive labs.Such alliances of convenience are being criticized, but they are likely to continue.


S T R A T E G I C P R A C T I C E E X E R C I S E S1. Read the Global Issue feature in this chapter. It lists six

aspects of society that it proposes are better managedby not-for-profit organizations than by profit-makingorganizations. Do you agree with this list? Should someaspects be deleted from the list? Should other aspectsbe added?

2. Examine a local college or universityperhaps the oneyou may be currently attending. What strategic issues is it

facing? Develop a SFAS Matrix (see Figure 61) of strate-gic factors. Is it attempting to use any strategic manage-ment concepts? If so, which ones? What sorts of strategiesshould it consider for continued survival and futuregrowth? Is it currently using strategic piggybacks to obtainadditional funding? What sorts of additional piggybacksshould it consider? Are strategic alliances with another col-lege or university or business firm a possibility?

K E Y T E R M Scomplication to evaluation and control

(p. C-9)complication to strategy formulation

(p. C-8)complication to strategy

implementation (p. C-9)constraint on strategic management

(p. C-7)

defensive centralization (p. C-9)institutional advantage (p. C-7)not-for-profit organization (p. C-2)pattern of influence (p. C-6)private nonprofit corporation (p. C-2)privatization (p. C-4)profit-making firm (p. C-4)

public governmental unit or agency (p. C-2)

public or collective good (p. C-3)social entrepreneurship (p. C-11)strategic piggybacking (p. C-11)

N O T E S1. R. Imrie, Ink Venture Reaps Profits for High-Tech Monks, Des

Moines Register (February 27, 2004), p. 3D; G. Williams, Char-ity Begins at Work, Entrepreneur (December 2005), p. 40.

2. C. Penttila, Heart of Gold, Entrepreneur (September 2004),pp. 1922.

3. Ibid., p. 22.4. P. F. Drucker, What Business Can Learn from Nonprofits,

Harvard Business Review (JulyAugust 1989), p. 89.5. The Non-Profit Sector: Love or Money, The Economist (No-

vember 14, 1998), pp. 6873.6. G. Rudney, The Scope and Dimensions of Nonprofit Activity,

in The Nonprofit Sector: A Research Handbook, edited by W. W.Powell (New Haven, CT: Yale University Press, 1987), p. 56; C. P. McLaughlin, The Management of Nonprofit Organizations(New York: John Wiley & Sons, 1986), p. 4.

7. M. ONeill, The Third America (San Francisco: Jossey-Bass,1989).

8. K. Ascher and B. Nare, Strategic Planning in the Public Sec-tor, International Review of Strategic Management, Vol. 1, ed-ited by D. E. Hussey (New York: John Wiley & Sons, 1990), pp.297315; I. Unterman and R. H. Davis, Strategic Managementof Not-for-Profit Organizations (New York: Praeger Press,1984), p. 2.

9. P. V. Jenster and G. A. Overstreet, Planning for a Non-Profit Ser-vice: A Study of U.S. Credit Unions, Long Range Planning(April 1990), pp. 103111; G. J. Medley, Strategic Planning forthe World Wildlife Fund, Long Range Planning (February1988), pp. 4654.

10. J. G. Simon, The Tax Treatment of Nonprofit Organizations: AReview of Federal and State Policies, in The Nonprofit Sector:A Research Handbook, edited by W. W. Powell (New Haven,CT: Yale University Press, 1987), pp. 6798.

11. B. P. Keating and M. O. Keating, Not-for-Profit (Glen Ridge,NJ: Thomas Horton & Daughters, 1980), p. 21.

12. K. A. Froelich, Business Management in Nonprofit Organiza-tions, paper presented to the Midwest Management Society(Chicago, 1995).

13. J. D. Hunger and T. L. Wheelen, Is Strategic Management Ap-propriate for Not-for-Profit Organizations? in Handbook ofBusiness Strategy, 1989/90 Yearbook, edited by H. E. Glass(Boston: Warren, Gorham & Lamont, 1989), pp. 3.13.8. Thecontention that the pattern of environmental influence on the or-ganizations strategic decision making derives from the organi-zations source(s) of income agrees with the authorities in thefield. See R. E. Emerson, Power-Dependence Relations,American Sociological Review (February 1962), pp. 3141; J. D. Thompson, Organizations in Action (New York: McGraw-Hill, 1967), pp. 3031, and J. Pfeffer and G. R. Salancik, TheExternal Control of Organizations: A Resource DependencePerspective (New York: HarperCollins, 1978), p. 44.

14. M. Goold, Institutional Advantage: A Way into Strategic Man-agement in Not-for-Profit Organizations, Long Range Planning(April 1997), pp. 291293.

15. K. Ascher and B. Nare, Strategic Planning in the Public Sec-tor, International Review of Strategic Management, Vol. 1, ed-ited by D. E. Hussey (New York: John Wiley & Sons, 1990),pp. 297315; R. McGill, Planning for Strategic Performancein Local Government, Long Range Planning (October 1988),pp. 7784.

16. Lorna Lavender, Supervisor of Ames (Iowa) Animal Shelter,quoted by K. Petty, Animal Shelter Cares for Homeless, ISUDaily (July 25, 1996), p. 3.

17. E. Ferlie, The Creation and Evolution of Quasi Markets in thePublic Sector: A Problem for Strategic Management, Strategic


Management Journal (Winter 1992), pp. 7997. Research hasfound that profit-making hospitals have more mission statementcomponents dealing with principal services, target customers,and geographic domain than do not-for-profit hospitals. SeeR. Subramanian, K. Kumar, and C. C. Yauger, Mission State-ments of Hospitals: An Empirical Analysis of Their Contentsand Their Relationship to Organizational Factors, Journal ofBusiness Strategies (Spring 1993), pp. 6378.

18. W. H. Newman and H. W. Wallender III, Managing Not-for-Profit Enterprises, Academy of Management Review (January1978), p. 26.

19. Ibid., p. 27. The following discussion of the effects of these con-straining characteristics is taken from pp. 2731.

20. J. Denis, A. Langley, and D. Lozeau, Formal Strategy in Pub-lic Hospitals, Long Range Planning (February 1991), pp.7182.

21. F. Heffron, Organization Theory and Public Administration(Upper Saddle River, NJ: Prentice Hall, 1989), p. 132.

22. V. K. Rangan, Lofty Missions, Down-to-Earth Plans,Harvard Business Review (March 2004), pp. 112119.

23. F. Heffron, Organization Theory and Public Administration(Upper Saddle River, NJ: Prentice Hall, 1989), pp. 103115.

24. R. T. Ingram, Ten Basic Responsibilities of Nonprofit Boards,2nd ed. (Washington, DC: National Center for NonprofitBoards, 1997), pp. 910.

25. A. C. Smith, Endowment Use Overlooked, St. PetersburgTimes (June 23, 2000), p. 3B. Eckerds board was stronglycriticized because it had tolerated improper financial practiceson the part of the president and had allowed the colleges en-dowment to dissipate.

26. I. Unterman and R. H. Davis, Strategic Management of Not-for-Profit Organizations (New York: Praeger Press, 1984), p. 174;J. A. Alexander, M. L. Fennell, and M. T. Halpern, LeadershipInstability in Hospitals: The Influence of BoardCEO Relationsand Organizational Growth and Decline, Administrative Sci-ence Quarterly (March 1993), pp. 7499.

27. K. A. Froelich, Business Management in Nonprofit Organiza-tions, paper presented to the Midwest Management Society(Chicago, 1995), p. 9.

28. R. M. Kanter and D. V. Summers, Doing Well While DoingGood: Dilemmas of Performance Measurement in NonprofitOrganizations and the Need for a Multiple-Constituency Ap-proach, in The Nonprofit Sector: A Research Handbook, editedby W. W. Powell (New Haven, CT: Yale University Press,1987), p. 163.

29. J. P. Dalsimer, Understanding Nonprofit Financial Statement: APrimer for Board Members, 2nd ed. (Washington, DC: NationalCenter for Nonprofit Boards, 1997), p. 17.

30. V. K. Rangan, Loft Missions: Down-to-Earth Plans, HarvardBusiness Review (March 2004), pp. 112119.

31. Ibid., p. 115.32. R. P. Nielsen, SMR Forum: Strategic PiggybackingA Self-

Subsidizing Strategy for Nonprofit Institutions, Sloan Man-agement Review (Summer 1982), pp. 6569; R. P. Nielsen,Piggybacking for Business and Nonprofits: A Strategy forHard Times, Long Range Planning (April 1984), pp. 96102.

33. D. C. Bacon, Nonprofit Groups: An Unfair Edge? NationsBusiness (April 1989), pp. 3334; Universities Push AuxiliaryServices to Generate More Revenue, Wall Street Journal (April27, 1995), p. A1.

34. M. Langley, Nonprofit Hospitals Sometimes Are That in Littlebut Name, Wall Street Journal (July 14, 1997), p. A1. See alsoD. Brady, When Nonprofits Go After Profits, Business Week(June 26, 2000), pp. 173178; E. Skloot, Should Not-for-ProfitsGo into Business? Harvard Business Review (JanuaryFebruary1983), p. 21; E. Felsenthal, As Nonprofits Add Sidelines, IRSTakes Aim, Wall Street Journal (May 3, 1996), p. B1.

35. C. Penttila, Heart of Gold, Entrepreneur (September 2004), p. 22.

36. R. P. Nielsen, Piggybacking Strategies for Nonprofits: AShared Costs Approach, Strategic Management Journal (MayJune 1986), pp. 209211.

37. Universities Push Auxiliary Services to Generate More Rev-enue (Business Bulletin), Wall Street Journal (April 27, 1995),p. A1.

38. R. A. Krishnan, S. Joshi, and H. Krishnan, The Influence ofMergers on Firms Product-Mix Strategies, Strategic Manage-ment Journal (June 2004), pp. 587611.

39. Ibid.40. K. G. Provan, Interorganizational Cooperation and Decision

Making Autonomy in a Consortium Multihospital System,Academy of Management Review (July 1984), pp. 494504; R. D. Luke, J. W. Begun, and D. D. Pointer, Quasi-Firms: Strate-gic Interorganizational Forms in the Health Care Industry,Academy of Management Review (January 1989), pp. 919.

41. More Colleges Are Opting for Mergers, The (Ames, IA) DailyTribune (August 12, 1998), p. B3.

42. Pocket World in Figures 2004 (London: Economist and ProfileBooks, 2003), p. 95.

43. Ibid., p. 83.

Documents

Not for Profit Organizations