Can Non-Profit Organizations Compete?

MonicaOss_blue 300 copyI’ve had some very interesting discussions over the past few weeks about the role—and competitiveness—of non-profit versus for-profit organizations in the health and human service field. On one hand, with tax-exempt status and no shareholders to satisfy, non-profit organizations should be able to compete with no problem. I’ve had many an executive of a non-profit organization state that they don’t see how a for-profit organization could take their place in a particular market.

In fact, the share of the dollars in the market that are either managed by or delivered by for-profit organizations is on the increase. This raises comments that for-profit organizations are taking the “cream” (to borrow a rural expression) in the market and leaving non-profit organizations with the segments of the market that are underfunded. At the same time, those for-profit organizations are paying their managers and service delivery staff far more than their non-profit competitors.

I think these perspectives on the current environment are due to some very fundamental changes in financing, reimbursement, and contracting. The market for health and human services is moving from a negotiated contract, cost-plus purchase model to a competitive purchase model. A situation that has caused the field, which has long been dominated by non-profit organizations, to have a growing footprint of for-profit organizations in all roles.

One of the legacies of the dominance of non-profit organizations is the creation of unrealistic funding expectations on behalf of many public payers. This is due, in large part, to many non-profit organizations not knowing their actual costs of operation in general and services in particular – and being willing, as good mission-based entities, to subsidize those services in a number of creative ways. The juxtaposition of the competitive market model with unrealistic payer expectations has created an interesting market phenomenon – for-profit organizations are “winning” the competition for services that are adequately funded (due to better productivity, economies of scale, marketing, cost management, etc.) leaving the non-profit organizations with a number of marginally-funded service opportunities.

Why is this happening? My observation is that many non-profit executive teams and boards are making decisions to accept underfunded contracts because they are focused on short-term survival. This has caused erosion of endowments by supplementing operating losses – a situation that is not sustainable in the long run. A great analysis of this phenomenon is The Nonprofit Starvation Cycle, a 2009 article in the Stanford Social Innovation Review. The article’s theme is that funding misconceptions have led to “a vicious cycle…leaving nonprofits so hungry for decent infrastructure that they can barely function as organizations – let alone serve their beneficiaries….In response to pressure from funders, nonprofits settle into a ‘low pay, make do, and do without’ culture.”

The authors also discuss the “big elephant” in the room – overhead. “The final driver of the cycle that starves nonprofit infrastructure is nonprofits’ routine misrepresentation of how much they actually spend on overhead.” How rampant is this? The authors report that a third of organizations report no fundraising costs, an eighth report no management or general expenses, and 75% incorrectly report grant costs. Whether this underreporting of overhead expenses is intentional or not, the implications are the same. It leads to unrealistic expectations on the part of funders. “Funders do not know what overhead rates should be….As a result, funders routinely require non-profits to spend unhealthily small amounts on overhead,” according to the authors. Or funders expect non-profit organizations to absorb the overhead costs as an ‘unfunded’ expense.

There are many non-profit organizations that operate with the same management rigor as their for-profit competitors. But, there are also a significant number that accept service contracts with unreasonably low (and unprofitable) contract rates – and further public funders unrealistic rate expectation. This is a self-perpetuating market cycle that I think is bad for the sustainability of the service delivery system, and bad for the consumers they serve.

Source:  OpenMinds, Writer Monica Oss, President

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