Nonprofit business plans have two proof points:
To illustrate this point, let me share a case study drawn from my own experience. While I was not part of the development or implementation of the business plan, I arrived in time to diagnose its failure and attempt to move the organization to a new approach. I have removed the names of the organization, the foundation that invested growth capital, and the consulting firm that developed the business plans. Recognizing that some readers may be able to guess at the identities of the parties, let me emphasize that the point of sharing this case is not to lay blame with one or more of the protagonists. There is plenty of blame to be shared. The point is to learn from this failure, to build a more sustainable approach to capital-intensive growth investing in the social sector.
The Case
XYZ, is a youth development nonprofit, focusing on teens who have dropped out of high school or are at high risk of doing so. The organization was founded in an old mill city that had seen better days. For its first 16 years, it operated as a single-site program, delivering workforce development services at the city's high school and in the surrounding community. The organization received both regional and national recognition for the quality of its programming, which drew the attention of a national foundation (referred to as The Foundation hereafter) in the early part of this decade. The Foundation was looking for opportunities to invest in high-risk youth programs with evidence-based results:
- Can the program model deliver on the value proposition to the client?
- Can the financial model deliver on the value proposition to the customer?
To illustrate this point, let me share a case study drawn from my own experience. While I was not part of the development or implementation of the business plan, I arrived in time to diagnose its failure and attempt to move the organization to a new approach. I have removed the names of the organization, the foundation that invested growth capital, and the consulting firm that developed the business plans. Recognizing that some readers may be able to guess at the identities of the parties, let me emphasize that the point of sharing this case is not to lay blame with one or more of the protagonists. There is plenty of blame to be shared. The point is to learn from this failure, to build a more sustainable approach to capital-intensive growth investing in the social sector.
The Case
XYZ, is a youth development nonprofit, focusing on teens who have dropped out of high school or are at high risk of doing so. The organization was founded in an old mill city that had seen better days. For its first 16 years, it operated as a single-site program, delivering workforce development services at the city's high school and in the surrounding community. The organization received both regional and national recognition for the quality of its programming, which drew the attention of a national foundation (referred to as The Foundation hereafter) in the early part of this decade. The Foundation was looking for opportunities to invest in high-risk youth programs with evidence-based results:
We believe that an effective and efficient way to meet the urgent needs of these youth is to make large, long-term investments in nonprofit organizations whose programs have been proven to produce positive outcomes and that have the potential for growth. Our funding consists largely of support for business planning, capacity building and program evaluation, so that grantees can expand while maintaining the quality of their programs, make an impact on the life trajectories of more young people, and eventually become organizationally, programmatically and financially sustainable. Our goal is to help develop a growing pool of organizations that serve thousands more youth each year with proven programs.
After a due diligence review of XYZ's programs, The Foundation made an initial grant of nearly $500,000 to support a business planning process. The grant largely funded the hiring of a nonprofit management consulting firm (referred to hereafter asThe Firm) that developed business plans for the majority of the Foundation's grantees. The Foundation explained the role that business planning played in its approach:
The plan, which is normally developed over six to 12 months, covers every aspect of the work that needs to be done, from strengthening programs and internal operations to enhancing information systems to boosting fundraising capabilities and other essential activities. Business planning introduces the organization to concepts more familiar to a for-profit business but just as relevant to nonprofit work: how to forecast costs and revenues under different assumptions, identify strengths and weaknesses in current operations, gauge and adapt to trends in the external environment, and achieve productivity gains while maintaining quality.
The Firm summarized XYZ's planning experience in an article it wrote about nonprofit business planning:
During business planning, XYZ’s leadership documented precisely whom they wanted to serve: youth ages 14 to 21 who faced significant barriers to post-secondary achievement. They specified what success would look like: their clients would earn academic credentials and/or secure stable employment. And they codified the program design at the heart of XYZ’s success: having field staff help youth navigate all the resources in the community, rather than providing all the resources they needed within the XYZ organization itself. They also specified characteristics of the communities they were best suited to serve (e.g., small, urban settings; convenient public transportation; proximity to prospective and/or existing XYZ sites) and the comprehensive set of services that had to be offered to achieve the desired results (e.g., job-development support, daycare, GED preparatory services).
The plan developed by The Firm had two objectives:
Program Expansion
The planning process initially focused on codifying and standardizing the organization's program model, more clearly defining the client market to be served by age range (14-21), risk characteristics (barriers to post-secondary achievement), and location (small, urban settings). Given that the organization had chosen its operating locations and program offerings based on contract and funding opportunities, the need to standardize the model was of utmost importance. In the lingua franca of the nonprofit consulting field, XYZ's first order of business was to establish fidelity to its program model before it could consider how to scale the model.
Researchers at University of Wisconsin explain why maintaining program fidelity is so important in Program Fidelity and Adaptation: Meeting local needs without compromising program effectiveness:
The Firm established the following criteria for the organization in assessing where to expand:
Sustainable Funding Model
While the plan made the building of a sustainable funding model one of its two objectives, note that of the 12 expansion criteria here, 11 were related to potential client demand. Only one (availability of funding) was related to customer demand, and that criterion was vague on the level or sustainability of funding.
The financial model in the XYZ business plan followed a standard venture philanthropy playbook. XYZ would expand into new markets, using the above criteria. The implementation funding that The Foundation would give to XYZ over the course of the expansion period (ultimately in excess of $7 million), would subsidize the initial operating losses sustained in opening new markets. Some funding was used to build the administrative capacity of the organization to operate at scale. As the new program sites established themselves, the venture philanthropy funding (national foundation funding in the graphic below) was to be replaced by sources generated by the organization.
Every organization that successfully follows an expansion plan uses some version of this financing strategy. The key test is whether the plan's hypothesis about how the venture funding will be replaced bears out. In the case of XYZ, the replacement funding was largely going to come from local foundations, businesses, and individuals:
The basis for The Firm's hypothesis on replacement funding was its benchmarking of XYZ with similarly sized and focused youth development organizations, some of which had received consulting services from The Firm. This is a common approach in the management consulting field (regardless of sector) and can provide valuable data, provided that one understands critical differences between the consulting client and the benchmarked organizations.
In the case of XYZ, the youth development organizations being benchmarked all operated in major philanthropic markets like New York, Chicago, and San Francisco. So the recommendation to pursue replacement funding from local philanthropic sources was based on benchmarking organizations in markets with access to this sort of capital.
XYZ chose to operate, for compelling mission-related reasons, in small, high poverty cities that had limited to non-existent bases of philanthropic support. For example, in one of the cities to which XYZ expanded, the organization would need to generate $85,000 in revenue beyond the core WIA contract, in order to break even on the delivery of services. Five local or regional foundations made grants to nonprofits in the city, and the combined total average gifts from these foundations was $29,325. So if XYZ successfully won grants from all five foundations in a given year (an unlikely 100% hit rate), it was likely to cover no more than 35% of the annual funds that it needed to raise.
The individual giving climate was no more promising. In this example, the average household income in the city was $38,500 and the cost of living index was 127.4 (above the US average of 100), meaning that the city was poor and expensive.
The funding base did not differ significantly in any of the markets to which XYZ would ultimately expand. The communities that met the expansion criteria were all characterized by a substantial need for services, limited philanthropy, and low household incomes. What is evident here is that while The Firm conducted extensive research into the client market,, it did not apply the same discipline to researching the customer market. A lack of experience with nonprofit fundraising on the part of staff at The Firm and The Foundation may be partially to blame for this lapse, but the more critical factor was a lack of understanding of the differences in philanthropic market potential. Both the consultant and funder were headquartered in large cities and had primarily funded and worked with organizations in these markets.
Implementation Heartburn
Two years into implementing the three-year business plan, XYZ found itself dangerously overextended. The organization had used funding from the The Foundation to expand its fundraising capacity and had successfully won grants from most of the local foundations in the 19 markets to which it had expanded. Because those philanthropic bases were so limited, however, the organization had failed to replace the venture philanthropy. Holding aside that venture philanthropy, XYZ was losing money in every site it operated—an average of $1,894 per client and a total loss on operations of $2.3 million:
XYZ compounded its problems with several execution errors. The management team was made up almost entirely of homegrown talent, with little experience with rapid growth or multisite organizations, and there was little effort to bring in or acclimate outside talent. The financial systems and staff could not conduct cost-center analysis and had little idea just how much they were losing. The board members all had ties to the city where the organization was founded, only one represented the expansion regions, and none were in a position to offer or solicit substantial financial support. The organization struggled to maintain program fidelity in its expansion sites as it made compromises in order to secure funding. The limited program fidelity made developing a standard cost model more challenging (note the wide variation in cost/client above) and also meant that the organization was not eligible to participate in a program evaluation that met the strict standards of The Foundation.
The Foundation assigned a program officer without experience with fundraising, board development, or managing a nonprofit and was therefore not in a position to offer meaningful counsel or to recognize the execution errors. Indeed, of the key metrics that XYZ was required to report to The Foundation every six months, ten were programmatic and just two were financial. The financial metrics did not include cost/client or cost/site measures, and there was no requirement to show evidence of progress, on a site by site basis, toward raising local funds to replace The Foundation's support.
Midway through the third and final year of the business plan, The Foundation decided to discontinue funding, partially due to the execution problems but largely due to a dramatic decline in its endowment as the stock market crashed and a subsequent shift in philanthropic focus to larger organizations that were in a position to grow. At this point, funding from The Foundation represented nearly half of XYZ's budget, and the combination of limited local philanthropy and a bad economy left the organization without options to sustain the expansion sites.
Poor execution. Poor design.
While the problems in execution were substantial on the part of both XYZ and The Foundation, at the end of the day, they probably did not matter. The business plan had led XYZ to pursue a no-win strategy. They expanded into markets with an abundance of clients but a paucity of paying customers. Even if the organization had built a better management team and board and had maintained tighter program fidelity, it is highly unlikely that enough local revenue could ever be generated to replace the venture philanthropy that led XYZ into the expansion sites in the first place. At its core, this is a case of flawed design much more than flawed execution.
Millions of Americans now live in small cities with high poverty rates, like the ones into which XYZ expanded. Indeed, according to 2008 Census data, 1.5 million more Americans live in poverty in suburbs (which include small cities on the periphery of metropolitan areas) than in central cities. Poverty is growing faster in these communities, but services and the philanthropy to support those services has not increased in response.
It would be unfortunate if one concluded from this case that nonprofits would be wise to stay out of client-rich but customer-poor markets. As a sector, we have a moral obligation to determine how to serve those in need with evidence-based programs with sustainable financial models. That was certainly the intention of all of the protagonists in this case. We owe it to those who needed these services to take the lessons of this case and build a better approach to nonprofit business planning.
In coming posts:
- Expand programming to "full coverage," meaning to reach a substantial percentage of unmet need in XYZ's target market.
- Build a sustainable funding model.
Program Expansion
The planning process initially focused on codifying and standardizing the organization's program model, more clearly defining the client market to be served by age range (14-21), risk characteristics (barriers to post-secondary achievement), and location (small, urban settings). Given that the organization had chosen its operating locations and program offerings based on contract and funding opportunities, the need to standardize the model was of utmost importance. In the lingua franca of the nonprofit consulting field, XYZ's first order of business was to establish fidelity to its program model before it could consider how to scale the model.
Researchers at University of Wisconsin explain why maintaining program fidelity is so important in Program Fidelity and Adaptation: Meeting local needs without compromising program effectiveness:
A major appeal of evidence‐based programs is their promise of effectiveness. These programs have shown, through rigorous evaluations, that they can significantly affect important outcomes for participants. The best of them have demonstrated positive effects in a number of different settings. For policymakers, funders, and program practitioners, that potential for effectiveness can make an evidence‐based program more attractive than an unproven program. However, we can only assume that a program will continue to have those effects if it is implemented according to the original program design. Staying true to the original program design is referred to as program fidelity. Unfortunately, true program fidelity is not easily achieved in practice. Practitioners often change or adapt evidence‐based programs as they implement them, whether intentionally or not.Having established what XYZ and The Firm believed was a core program model, the planning process shifted to its main purpose, to develop a growth strategy that would meet The Foundation's goal of scaling the program to serve "thousands more youth each year with proven programs." The Firm assessed the potential client market in New England (the initial focus of expansion efforts) and determined that there were a substantial percentage of youths in poverty not currently served by a contractor receiving Federal funding under the Workforce Investment Act (WIA) and that there were a substantial percentage of unemployed youths not served by WIA contractors.
The Firm established the following criteria for the organization in assessing where to expand:
All possible growth opportunities will be evaluated on the basis of:
-Demographic “fit” with XYZ’s target population
-Geographic clustering of targeted communities
-Availability of funding (e.g. WIA or other location-specific funding)
-Level of interest in/demand for XYZ (e.g. underperforming Workforce Investment Boards, lack of good providers)
-Presence of partners (e.g. career centers, educational and employment outlets, day care)
Demographic fit will be assessed using the following criteria:
-Population (20-300k)
-# of individuals in target age group (15-19 and 20-24)
-Urban (% of residents living in an urban area of the community)
-Availability of public transportation (% of workers who commute by bus/trolley/streetcar)
-Dropouts (% of ages 16-19 neither graduates nor in high school)
-Youth unemployment (% of unemployed ages 16-19 and 20-24)
-Education level of the community (% of ages 25+ who are not high school graduates)
-Poverty (% of families with children under 18 below the poverty level)
Sustainable Funding Model
While the plan made the building of a sustainable funding model one of its two objectives, note that of the 12 expansion criteria here, 11 were related to potential client demand. Only one (availability of funding) was related to customer demand, and that criterion was vague on the level or sustainability of funding.
The financial model in the XYZ business plan followed a standard venture philanthropy playbook. XYZ would expand into new markets, using the above criteria. The implementation funding that The Foundation would give to XYZ over the course of the expansion period (ultimately in excess of $7 million), would subsidize the initial operating losses sustained in opening new markets. Some funding was used to build the administrative capacity of the organization to operate at scale. As the new program sites established themselves, the venture philanthropy funding (national foundation funding in the graphic below) was to be replaced by sources generated by the organization.
Every organization that successfully follows an expansion plan uses some version of this financing strategy. The key test is whether the plan's hypothesis about how the venture funding will be replaced bears out. In the case of XYZ, the replacement funding was largely going to come from local foundations, businesses, and individuals:
The basis for The Firm's hypothesis on replacement funding was its benchmarking of XYZ with similarly sized and focused youth development organizations, some of which had received consulting services from The Firm. This is a common approach in the management consulting field (regardless of sector) and can provide valuable data, provided that one understands critical differences between the consulting client and the benchmarked organizations.
In the case of XYZ, the youth development organizations being benchmarked all operated in major philanthropic markets like New York, Chicago, and San Francisco. So the recommendation to pursue replacement funding from local philanthropic sources was based on benchmarking organizations in markets with access to this sort of capital.
XYZ chose to operate, for compelling mission-related reasons, in small, high poverty cities that had limited to non-existent bases of philanthropic support. For example, in one of the cities to which XYZ expanded, the organization would need to generate $85,000 in revenue beyond the core WIA contract, in order to break even on the delivery of services. Five local or regional foundations made grants to nonprofits in the city, and the combined total average gifts from these foundations was $29,325. So if XYZ successfully won grants from all five foundations in a given year (an unlikely 100% hit rate), it was likely to cover no more than 35% of the annual funds that it needed to raise.
The individual giving climate was no more promising. In this example, the average household income in the city was $38,500 and the cost of living index was 127.4 (above the US average of 100), meaning that the city was poor and expensive.
The funding base did not differ significantly in any of the markets to which XYZ would ultimately expand. The communities that met the expansion criteria were all characterized by a substantial need for services, limited philanthropy, and low household incomes. What is evident here is that while The Firm conducted extensive research into the client market,, it did not apply the same discipline to researching the customer market. A lack of experience with nonprofit fundraising on the part of staff at The Firm and The Foundation may be partially to blame for this lapse, but the more critical factor was a lack of understanding of the differences in philanthropic market potential. Both the consultant and funder were headquartered in large cities and had primarily funded and worked with organizations in these markets.
Implementation Heartburn
Two years into implementing the three-year business plan, XYZ found itself dangerously overextended. The organization had used funding from the The Foundation to expand its fundraising capacity and had successfully won grants from most of the local foundations in the 19 markets to which it had expanded. Because those philanthropic bases were so limited, however, the organization had failed to replace the venture philanthropy. Holding aside that venture philanthropy, XYZ was losing money in every site it operated—an average of $1,894 per client and a total loss on operations of $2.3 million:
XYZ compounded its problems with several execution errors. The management team was made up almost entirely of homegrown talent, with little experience with rapid growth or multisite organizations, and there was little effort to bring in or acclimate outside talent. The financial systems and staff could not conduct cost-center analysis and had little idea just how much they were losing. The board members all had ties to the city where the organization was founded, only one represented the expansion regions, and none were in a position to offer or solicit substantial financial support. The organization struggled to maintain program fidelity in its expansion sites as it made compromises in order to secure funding. The limited program fidelity made developing a standard cost model more challenging (note the wide variation in cost/client above) and also meant that the organization was not eligible to participate in a program evaluation that met the strict standards of The Foundation.
The Foundation assigned a program officer without experience with fundraising, board development, or managing a nonprofit and was therefore not in a position to offer meaningful counsel or to recognize the execution errors. Indeed, of the key metrics that XYZ was required to report to The Foundation every six months, ten were programmatic and just two were financial. The financial metrics did not include cost/client or cost/site measures, and there was no requirement to show evidence of progress, on a site by site basis, toward raising local funds to replace The Foundation's support.
Midway through the third and final year of the business plan, The Foundation decided to discontinue funding, partially due to the execution problems but largely due to a dramatic decline in its endowment as the stock market crashed and a subsequent shift in philanthropic focus to larger organizations that were in a position to grow. At this point, funding from The Foundation represented nearly half of XYZ's budget, and the combination of limited local philanthropy and a bad economy left the organization without options to sustain the expansion sites.
Poor execution. Poor design.
While the problems in execution were substantial on the part of both XYZ and The Foundation, at the end of the day, they probably did not matter. The business plan had led XYZ to pursue a no-win strategy. They expanded into markets with an abundance of clients but a paucity of paying customers. Even if the organization had built a better management team and board and had maintained tighter program fidelity, it is highly unlikely that enough local revenue could ever be generated to replace the venture philanthropy that led XYZ into the expansion sites in the first place. At its core, this is a case of flawed design much more than flawed execution.
Millions of Americans now live in small cities with high poverty rates, like the ones into which XYZ expanded. Indeed, according to 2008 Census data, 1.5 million more Americans live in poverty in suburbs (which include small cities on the periphery of metropolitan areas) than in central cities. Poverty is growing faster in these communities, but services and the philanthropy to support those services has not increased in response.
It would be unfortunate if one concluded from this case that nonprofits would be wise to stay out of client-rich but customer-poor markets. As a sector, we have a moral obligation to determine how to serve those in need with evidence-based programs with sustainable financial models. That was certainly the intention of all of the protagonists in this case. We owe it to those who needed these services to take the lessons of this case and build a better approach to nonprofit business planning.
In coming posts:
- Implications of the suburbanization of poverty for philanthropy, government, and the nonprofit sector.
- What a sustainable business planning model could look like.
