September 9, 2011

Five Ways for Human Service Nonprofits to Reset their Funding Models

What we have found is that for the vast majority of large nonprofits, especially for those with budgets of $50 million and up, it pays to focus, not diversify across different sources. Larger nonprofits typically secure the preponderance of their funding from one primary source—government or philanthropy or individual contributions, etc.

By: Daniel Stid

The long-term fiscal problems our government is facing present the nonprofits that rely primarily on public funding to sustain their work both the need and the opportunity to revisit their funding models. My Bridgespan colleagues William Foster, Peter Kim, and Gail Perrault have defined a funding model as "a methodical and institutionalized approach to building a reliable revenue base to support an organization’s core programs and services." These colleagues have fleshed out a powerful way of thinking about funding models and the challenge of nonprofit sustainability in a series of articles in the Stanford Social Innovation Review over the last four years, including "How Nonprofits Get Really Big," "Ten Nonprofit Funding Models," and, in the most recent issue, "Finding Your Funding Model."

The thinking in all of these pieces is grounded on a basic but often overlooked premise, and has gotten its legs from a counterintuitive empirical finding. The basic premise is that most nonprofits have in effect two customers— the beneficiaries they are supporting, and the funders who are paying for the work. In most instances (unlike business) these are not the same parties. A nonprofit that wants to sustain its work therefore needs to plan as carefully for how to secure the funding it needs as it does for how to achieve the impact it seeks to have. But this is a balance that very few nonprofits manage to strike; the lion’s share of their energy and focus goes into their program model, not their funding model.

The big empirical finding runs counter to the conventional wisdom that nonprofits need to diversify their funding across multiple funding sources— foundations, high net worth donors, small individual contributors, corporate philanthropy, government, etc.— in order to grow and become more sustainable. What we have found instead is that for the vast majority of large nonprofits, especially for those with budgets of $50 million and up, it pays to focus, not diversify across different sources. Larger nonprofits typically secure the preponderance of their funding from one primary source – government or philanthropy or individual contributions, etc. There are two drivers at work here. First, for most mission-driven work, there tends to a prevailing natural constituency or funding source that values the mission sufficiently to pay for it. Second, on a related note, the capacity and skills that nonprofits must develop to maximize the funding from their primary source are very different from those needed to maximize others. Nonprofits attempting to be jacks of all sources fall behind those determined to be masters of one.

This will resonate with most human service nonprofits that have come to rely primarily on government as the natural funding constituency for the work they are undertaking on behalf of foster youth, homeless families, impoverished seniors, etc. And in the process these same organizations have developed considerable wherewithal in working with government agencies and their procurement shops in order to win, manage, and renew contracts over time (a set of dark arts if there ever was one!).

Therein lies the rub for these organizations: the implicit funding model they have come to rely on appears to be eroding right before their eyes, as the government agencies they have long contracted with cut back on funding, drive down prices, delay payments for agonizing stretches, and generally make life miserable for the nonprofit providers ostensibly serving as their "partners." But what would alternative and more sustainable funding models look like for these organizations? It is not like high net worth individuals or foundations are lining up to fund human service nonprofits’ ongoing operations with large, unrestricted, and renewable donations and grants. Public funding will almost certainly remain the primary source of funding for these nonprofits, but the approach they are using in securing it will definitely need to change if they are going to survive. As a starting point, these nonprofits need to rethink at least five elements of the traditional government funding model if they are going to sustain their missions.

Get real about prospects for sustainable growth: For the past several years, much "strategic philanthropy" has gone into providing growth capital for scaling and replicating high-performing nonprofits. More recently the federal government has gotten into the act alongside philanthropy through such programs as the Social Innovation Fund and the i3 fund. An underlying premise of this approach is that once the organizations have taken advantage of the influx of funds to scale up and/or replicate, they will be able to sustain their expanded operations through renewable and reliable funding sources. In the case of human services nonprofits, the assumption is almost always that the source will be public funding. As we have seen in recent years, however, public funding is anything but renewable and reliable. Amidst the fiscal shakeout bearing down on us over the next decade or two, the situation is going to get worse, not better. Many of the nonprofits that are expanding in this way are thus going to be left with the same operating budget shortfalls they’ve always wrestled with, only now at a much larger scale. (For more on the uses and misuses of growth capital, see William Foster’s article, "Money to Grow On.")

Diversify within government: Attempting to diversify to any great extent across different types of funding sources outside of public funding is not likely to be a recipe for success for large human service nonprofits that have come to rely on it. Yet they can and should diversify their funding streams across different government agencies, programs, and contracts in order to reduce their exposure to the risks inherent in relying too much on any one funder. One straightforward way for agencies to do this is to take services being contracted for in one jurisdiction and secure contracts to deliver the same services in adjacent jurisdictions— i.e., serve the same population in the same way but in a different place. Another more intricate form of diversification is to offer an integrated continuum of care— for example, a youth serving agency that offers intensive residential services with therapeutic foster care and other community based supports. This approach, while harder to pull off, can provide more of a competitive advantage vis-à-vis less integrated nonprofits because of the ability to offer a range of solutions to government agencies depending on client needs. The point in both instances is for nonprofits to avoid becoming so reliant on one contract or agency that they cannot walk away if / when the economics of doing so go too far south.

Treat government agencies like customers: It is difficult for nonprofits to conceive of government agencies as customers. They see beneficiaries as their customers. Also, the power that government agencies wield over the fate of these nonprofits produces anxiety, resentment, and frustration instead of a responsive, customer-service ethic. Nevertheless, if nonprofits that rely on service delivery contracts with government want to be successful, they need to think differently. They are the ones doing the selling, and government agencies are the ones who are going to buy from them— or not. Moreover, viewing government agencies as the problem to work around instead of a customer that needs to be served overlooks the fact that the agency decision-makers themselves have big problems, headaches, and constraints that they don’t know how to resolve. In our experience, the nonprofit organizations that are the most successful in building up and securing their public funding base make a point of approaching and seeking to understand and meet the needs of the government agencies they are contracting with in much the same way that an enterprising business selling services to other businesses does.

Supplement public funding (where it makes sense): Some human service nonprofits are taking the imperative of diversification beyond public funding sources given the bleak outlook for government contracting. "If you rely completely on government for your future, you are done," one CEO recently told us. Some clients, for example, are having success serving beneficiaries covered by private insurance. The reimbursements can be generous relative to government rates, but this upside has to be weighed against what can be disruptive changes in the preferred service delivery model due to payer requirements for shorter lengths of stay, different treatment protocols, billing processes, etc. Similarly, foundations can usefully underwrite one-time infrastructure investments that don’t entail ongoing costs, and in select instances may help underwrite aspects of work for some types of clients. But here too there is a need to guard against disruption in established approaches to doing and funding the work. One rule of thumb for nonprofit leaders is to ensure that the time they invest cultivating funding sources is roughly proportionate to their budget contributions. If 80% of an agency’s funding comes from government but 80% of the CEO’s funding work is courting philanthropists, there is something wrong with the picture.

Do your homework, plan carefully, and follow through: Human service nonprofits will find that determining what particular combination of these strategies or others is optimal for resetting their funding models and executing against them is difficult but not especially complicated. It requires much the same data gathering and analysis, self-assessment, priority setting, detailed planning, and sustained implementation that optimizing a program model requires. My colleagues have developed a systematic approach and corresponding toolkit to help you in this process that can be freely downloaded. We hope you find it useful— please let us know if you have any comments or questions about it.

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