The economic downturn has thrown a spotlight on the complex flows of money, ideas, and influence that bind government and nonprofit groups together.
Nearly 30 percent of the $1.1-trillion in revenue reported by charities in the United States originated in fees and grants from government, according to 2005 data, the latest figures available. Those revenues are focused on especially critical needs as the nation grapples with the worst economy in decades: Demand is growing for nonprofit groups to provide food, housing, health care, and worker training — causes that traditionally operate with significant financing from government.
Perhaps just as important as the economy in putting attention on this issue, several prominent efforts by the Obama administration — including the economic-stimulus law and plans to provide millions of dollars to spur investments in "what works" — are reverberating throughout the nonprofit world.
As government and nonprofit groups collaborate more closely, it's time for government at all levels to examine how to:
- Channel a greater share of their dollars to high-performance organizations that consistently deliver good results.
- Finance nonprofit organizations in ways that preserve and enhance their effectiveness.
The White House Office of Social Innovation has drawn a lot of attention to the question of how government can channel money to top-performing groups. So has the Social Innovation Fund, housed at the Corporation for National and Community Service, which seeks to increase the flow of government and private dollars to America's most promising community organizations.
Those efforts will directly benefit government and will produce far greater indirect benefits as they influence how government, philanthropy, and nonprofit groups work together, through both the power of example and the knowledge generated about what approaches successfully solve social problems.
But even if federal support for nonprofit groups is transformed by efforts like the Social Innovation Fund, the change will affect just the tip of the iceberg — the real challenge will be in producing change at the state and local levels, where the bulk of decisions about which nonprofit groups receive government funds are made. It's not just the funds raised and spent at the state and local levels that matter so much but also the considerable portion of federal money that is handed to state and local governments to disburse.
What is more, the bulk of government financing of nonprofit groups at the state and local levels will not be for devising innovations and expanding high-performing nonprofit groups but rather for the workaday delivery of services to discrete beneficiaries in discrete areas. Too often state and local government agencies make grants or offer contracts to nonprofit groups that do not have clear records of delivering results, nor do they hold grantees accountable for achieving results.
For example, when we worked with one city government to help it improve education, job training, and health in a struggling neighborhood, we learned that the city was already providing $30-million annually to community organizations working on those issues in the neighborhood, with essentially no idea whether the money was making a difference.
In the absence of clearly demonstrated results, a host of other considerations, including vested interests on the part of the nonprofit groups attracting support, bureaucratic inertia, and the political logic of spreading a little money to a lot of providers, tend to determine contracting and grant-making decisions.
The quality of government financing decisions for nonprofit groups at the state and local levels thus needs to change. Nonprofit groups must get better at measuring, tracking, and improving their results — and at making the case that they can achieve such improvements at the same or lower costs. State and local governments will need to get better at shaping policies based on proof that an idea works and issuing contracts and grants based on an organization's performance.
Some states are making progress in emphasizing and investing in results. Tennessee, for example, sought in 2006 to reduce the cost of its foster-care system while improving results for the children within it. The state agreed to pay incentives to those nonprofit service providers that were able to reduce the length of time foster children stayed in care and to decrease the number of children who bounced back into the system after they had left it.
In the first fiscal year of this contract, Youth Villages, a Memphis nonprofit group, saved the children it was serving nearly 10,000 days in foster care and helped 22 percent more of them find permanent homes than otherwise would have been expected.
The ability to deliver better results in ways that lower total system costs has enabled Youth Villages to expand its work in Tennessee and spread its approach to other states. As Patrick Lawler, chief executive of Youth Villages, has observed, "We convinced the state that they shouldn't be buying beds; they should buy outcomes, successful outcomes."
Those dynamics should be reinforced as more state and local analogs to the federal Office of Social Innovation get started, as some already have, for example, in Louisiana and Texas, as well as in New York City. To be clear, though, while the trends toward results-oriented financing are promising, they remain nascent; they need to become much more pervasive to bring about the needed sea change in how state and federal financing works.
Even if that sea change does occur, it will not be enough to produce changes that better serve vulnerable Americans. Most government agencies want to support programs, not an organization's capacity to carry them out. For those nonprofit groups that increasingly rely on government money, this accelerates what we call the "nonprofit starvation cycle."
Indeed, government agencies are doing the most to perpetuate it. The Nonprofit Overhead Cost Study, conducted by the Urban Institute and the Center on Philanthropy at Indiana University, found that 36 percent of nonprofit leaders felt pressure from government agencies that support them to limit their overhead rates, compared with 30 percent feeling similar pressure from individual donors and 24 percent from foundations.
We recently worked with four youth-development groups to assess their true overhead costs — as opposed to what they felt they could report given the expectations of the government agencies that support them. We found that each nonprofit group was managing local-, state-, and federal-government contracts, none of which allowed for administrative and other overhead expenses to exceed 15 percent of the contract's value. But the actual overhead rates of these four organizations ranged from 17 percent to 35 percent.
It is worth noting that these illusory low overhead rates do not play out in all government financing of nonprofit organizations. Research universities, for example, which typically negotiate their overhead allowances instead of dealing with a low flat rate, receive an average overhead rate of approximately 45 percent, leading to the incongruous situation whereby a research institution studying a social-service organization could well receive an overhead rate up to 10 times that received by the organization it is studying.
Government agencies and nonprofit groups need to work together to increase open discussion about what it costs to administer contracts and deliver results, and government financing patterns need to change accordingly.
The nonprofit starvation cycle is especially acute for charities that knit together an array of services and programs to make their overall impact more than the sum of its parts. In the experience of our clients that provide multiple services, government agencies typically seek to support only one or two discrete programs in this mix and balk at paying for much-needed management improvements — even as they are increasingly turning to those same organizations for help in solving complicated and chronic problems in the country's most troubled neighborhoods.
In addition to these financial constraints, a broader set of pressures arising from government financing patterns can confound nonprofit missions at a more fundamental level.
As Steven Smith and Michael Lipsky documented more than 15 years ago in their book Nonprofits for Hire, and as other researchers have shown in the years since then, as nonprofit groups come to rely on government money they both become more bureaucratic, mirroring the structure of their patrons, and begin to behave a lot like for-profit contractors pursuing their next big government procurement deal.
Another issue our clients often face is the temptation of mission creep, when government agencies ask (and are prepared to pay) a high-performing group to deliver programs or take on beneficiaries that are not central to its work but that do preserve or enhance the nonprofit organization's access to government money. If the links connecting government and nonprofit organizations are going to be shored up in sustainable ways, government aid needs to reinforce — not distort — nonprofit missions.