Applying business principles to philanthropic strategies
This article first appeared in the February 2007 issue of Philanthropy magazine.
Philanthropy is a growth business. Over the past two decades, the number of foundations has increased nearly threefold; some 1,300 were established in 2004 alone. A recent survey of donor-advised funds revealed a 21 percent increase in their collective grant awards between 2004 and 2005. Single gifts exceeding $5 million used to be unusual; in the past five years there have been at least 1,054 such "big bets." Total foundation assets in America now top $510 billion, and this is just the beginning.
The healthiest and wealthiest generation the world has ever known is now entering philanthropic prime time. As the baby boomers age, they will be part of a massive onetime wealth transfer estimated to amount to at least $40 trillion (with a possible upside of $88 trillion). This wealth can flow to only three possible destinations: family members (through inheritance), the government (through estate taxes), or nonprofit organizations including foundations (through gifts and bequests). So there will surely be even more philanthropists and more foundations, with even greater assets, giving away more money. Will this influx of philanthropic capital yield dramatically more social impact?
Considering that most donors already want their dollars to make a difference (and certainly don't want to see their hard-earned money go to waste), it's reasonable to wonder why such a question even needs to be asked. After all, leading foundations have long invested in formal evaluations to assess the impact of their grantmaking. Today, more and more grantmakers (individuals and institutions both) are pressing their grantees to develop metrics to quantify the results of their programs. Grantmakers themselves are wrestling with what it means to give "strategically." Nevertheless, this question holds for two reasons.
First, and perhaps most obvious, not all philanthropic giving is motivated purely by the desire to achieve results. Donors often make gifts based on perceived community obligations ("doing my share"), personal relationships ("can't say no"), giving back, returning a favor, or felt responsibility ("we need 100 percent participation from the board"). Such gifts may be relatively small (given one's circumstances), as in purchasing a table at a charitable event. Or they may be enormous, as evidenced by the large number of seven- and eight-figure gifts given to universities each year. Either way, the motivation behind the gift is primarily personal, based on private beliefs and individual priorities. When people choose to donate their time by volunteering, they are allocating a scarce resource to a cause or organization they care about. The same is true when they give away money (although, for many, time is the more scarce resource). Impact matters, of course, but impact is not the driving force.
Second, achieving and measuring impact is exceptionally difficult with certain types of philanthropy. In the complex world of giving away money, tangible philanthropy--constructing a new medical center, preserving acres of wetlands, endowing a senior center--is as simple as it gets. As donors, we can take pride in our contributions without the nagging suspicion that somehow we didn't get exactly what we paid for.
In contrast, the direct impact of other philanthropic endeavors--funding community health initiatives, sponsoring research on global warming, funding preschool literacy programs--is defiantly difficult to measure. We bet that such gifts and grants will "make a difference," but unlike a construction site, we cannot easily see that difference as it is being made, nor can we be certain that whatever consequences we do see were indeed a direct result of our intervention. This ambiguity and complexity heighten the risk that these philanthropic initiatives will fall short, risk that can be mitigated only through thoughtful and disciplined decision-making.
Successful businesses increase their impact and financial returns by continuously striving to achieve better results with the same or fewer resources. Imagine if, in aggregate, philanthropic grantmaking were to become 10 percent more effective? Or 30 percent? By business standards, such ambitions would by no means be considered "stretch goals." Yet for philanthropy's ultimate beneficiaries--children and communities in need, education, the arts, the environment--such an improvement would convert the emerging wealth transfer into a social watershed.
A Business View of Philanthropy
Business is the engine of our society's wealth. Business success in turn relies on disciplined, quantifiable, and financially centered bottom-line thinking--crunching numbers and keeping score. Businesspeople adore data: customer data, competitor data, marketplace data, financial data, even data on their own performance from bosses, peers, and direct reports. Mountains of solid data combined with thoughtful, rational decision-making are essential to achieving results. The right numbers, correctly crunched, provide a source of competitive advantage, which explains in part why so much time and money is wisely invested in sophisticated information systems and strategic planning exercises.
Not surprisingly, businesspeople-turned-philanthropists often want to apply a similar sort of analytical thinking to their gift-giving. Some have gone as far as investing in research and writing that explain how business principles can be applied to philanthropy (for example, creating quantitative measures to calculate the social returns that nonprofit organizations generate). At the same time, more and more top-ranked MBA programs are developing content related to social enterprise, essentially designed to explore the application of business means to philanthropic ends. So it is fair to assume that as philanthropy continues to grow, fueled by businesspeople and their wealth, there will be more and more momentum to make giving more businesslike and to push foundations to be run more like businesses.
Is this a realistic approach toward higher-impact philanthropy? Yes--and no. There is no question that philanthropy, like all decision-making, requires and benefits from the application of good data and sound analysis. But philanthropists motivated primarily by the desire for impact also need a realistic view of the environment in which they and their grantees interact.
In philanthropy, accountability for delivering results is not imposed by the external pressure of customers, competitors, or marketplace dynamics. Most foundations are established in perpetuity; unlike businesses, they literally cannot fail. The only requirements they must satisfy are to give away a minimum amount of money each year (five percent of assets) and to maintain a "reasonable" cost structure. Any further accountability is entirely self-imposed. If grantors want to pursue excellence, fine. If they become satisfied with mediocrity, that is also fine. Performance objectives, if any, are established on the basis of internal motivation rather than external forces, which, again, tends to make even institutional philanthropy highly personal.
Self-imposed accountability is not a natural act. And it is especially unnatural in the absence of data--a condition that's not altogether rare in the nonprofit sector. For example, suppose a youngster enrolled in an inner-city mentoring program becomes a successful pediatrician. It's likely that the mentoring program contributed to this outcome, but how much it contributed and whether it was the critical factor and whether the outcome would have been the same had the youngster not been enrolled are questions impossible to answer.
While philanthropists may experience a dearth of hard facts, however, there is no shortage of feedback. The old saying that once a person becomes a philanthropist or foundation executive he has had his last bad meal and told his last bad joke has more than a kernel of truth. When you are in the business of giving away money, people have a tendency to tell you what they think you want to hear. Surrounded by smiling faces and awash in reassuring rhetoric, it's natural for even the most objective and disciplined grantmakers to begin to feel important, to think they really are achieving outstanding results. Personal incentives are surreptitiously aligned: grantmakers want to feel good about their activities, and current and potential grantees need to be liked if they hope to secure future funding. Without hard facts to intrude, the insidious nature of feel-good philanthropy can overwhelm the most well-intentioned individuals.
Behaviour That Undermines Results
The consequences of such philanthropic realities--the absence of external marketplace disciplines, the dearth of reliable data--are both understandable and unfortunate. On the one hand, they reinforce some perfectly natural assumptions and behavior on the part of grantmakers. On the other hand, those assumptions and behavior often lead to grantmaking practices which diminish the grantees' ability to achieve results. The net effect is that many philanthropists and foundations inadvertently undermine the social impact they set out to achieve.
Role Confusion: Acting Like a Principal
Achieving social impact requires a complex network of players that includes direct service organizations, their constituents, and the sources (public, private, or both) from which they receive their funding. Philanthropic gifts and grants help supply the raw material that fuels this system, but with few exceptions (for example, operating foundations that deliver programs themselves), foundations and individual philanthropists are not principals, but intermediaries whose impact depends almost entirely on the impact of the organizations they choose to fund. Nevertheless, most grantmakers think of themselves as principals. They have their own priorities and points of view. They have their own goals bolstered by their knowledge of the fields in which they give. And it is their money. They may even use the language of principals, calling themselves "investors," which implies legal ownership, or "partners," which implies co-ownership and shared destiny with the grantees.
This role confusion often gets played out in common grantmaking practices. For example, many foundations focus their grantmaking on specific program goals and provide restricted grants with only minimal support, at best, for overhead costs. They have their own strategies with their own objectives, and their grants often contain explicit milestones independent of those of their grantees. This behavior is perfectly natural, and yet implicit in it is a handful of dubious assumptions: that the foundation is more knowledgeable than the grantee and can therefore add significant programmatic value, that the foundation's strategy is more important and better designed than the grantee's, and that the foundation's behavior will in no way undermine the effectiveness of the grantee.
In some situations, these assumptions may be entirely valid, but often they are unwarranted. For example, when a wealthy new foundation was launched a few years back, it recruited a cadre of very bright people, all of whom lacked deep knowledge or experience in the fields to be addressed. Over the course of a year, the foundation executives designed a "breakthrough" strategy and then identified potential grantees who they thought might execute their objectives. Prospective grantees were asked to explain what they could do to serve the foundation's needs, independent of their own strategic ambitions or cumulative knowledge. The nonprofits, chronically in need of funding, went along, creating compelling proposals even when those initiatives conflicted with their existing priorities. The unstated message from the foundation was clear, and clearly received: "If you want any of our money, you'd best do things our way."
By insisting on acting like a principal with control rather than an intermediary with influence, this foundation diminished its own impact. The foundation's executives were not more knowledgeable than its grantees, who had hundreds of years of cumulative experience in the field. The foundation's strategy was both untested and lacking in clarity. Worst of all, by demanding that grantees conform to its needs (as opposed to supporting its grantees' capabilities), the foundation actually undermined the strategies of the organizations it was trying to support. This was not a "partnership" of equal players with aligned incentives. It was money throwing its weight around to the apparent detriment of the causes it was hoping to serve.
Underestimating and Underinvesting
The old saying that "everything in life takes longer and costs more than you expect" should resonate particularly strongly for philanthropists. And yet the median grant made by America's larger foundations is less than $50,000, while the average duration is less than 18 months (although many are renewed). How many social problems can be solved with $50,000 over 18 months? Not many, I would venture to say. Small grants can certainly create social impact: consider the value of a college scholarship to a deserving youth. But problems arise when complex social problems are confronted with what, in context, are relatively tiny resources.
Consider the Annenberg Challenge. In 1993, Ambassador Walter Annenberg committed $500 million to help transform America's public schools. His unprecedented gift produced more than $600 million in matching funds from foundations, businesses, governments, and others. It also supported a host of reforms ranging from the creation of new urban schools to increased professional development opportunities for teachers. But in 2002, in a commentary as courageous as it was candid (given how tempting it is for philanthropy to declare victory and move on), the Annenberg Foundation itself described the results of the challenge as mixed. While $500 million was a gigantic sum in the world of philanthropy, it paled in comparison to the budgets of the large urban school districts (such as New York City's $11.4 billion) it sought to transform.
This mismatch between the resources that are required to get the job done and the grantmaking dollars that are actually available is far from atypical. Save the oceans for $5 million per year. Change national technology policy for $1.5 million per year. Transform the K-12 education system for $3 million per year. The problem is neither the objective nor the resources but the mismatch between the two. In the absence of a rigorous understanding of the problem, clarity about the impact they intend to achieve, and a pragmatic understanding of how that impact will be accomplished, philanthropists can easily fall prey to wishful thinking and the seductive allure of feel-good philanthropy, which is all the more alarming given the propensity of foundations to go it alone.
Philanthropy's natural tendency to underinvest in programs (or to overreach one's resources) is complemented by pervasive underinvestment in capacity-building. In the business world, it is widely understood that the effectiveness of an organization depends on the capacity of its people (their mutual commitment and capability), its processes and systems (from financial management to human resources to technology), and the resources at its disposal. In Good to Great (2001), Jim Collins rigorously analyzed thousands of corporations to uncover the ingredients that permitted a few "good" companies to become "great" companies. He concluded that no single element of success is more important than the quality and fit of the individuals in the organization. Average performers, it turns out, deliver average results; great results demand more.
Collins articulates an insight that is often repeated in business schools, boardrooms, and private equity firms. Achieving excellence requires an excellent organization. In most businesses, most of the time, people matter most. Or, as I observed in Aligning the Stars, "The people you pay are more important than the people who pay you." This may be the one business principle that transfers directly from the for-profit to the nonprofit world.
Yet it is a principle that philanthropists (most of whom earned their money in business) generally ignore. Only 20 percent of foundation grants are unrestricted, available to support whatever costs (organizational and programmatic) the grantee thinks are necessary. The vast majority of grantees strive to limit "overhead" (that is, organizational) expenses, in part because nonprofits are penalized if their overhead burden appears out of line. Grantmakers send an unambiguous signal (backed up by money): do not invest to recruit, retain, and develop the best people. Do not invest in the infrastructure necessary to support those people. Do not focus executive time and energy on management and organization-building. In other words, deliver exceptional programmatic impact on the cheap--and do it year after year.
Does this make sense if one genuinely wants to pursue higher-impact philanthropy? I think not. But there is a natural tendency to try to avoid "wasting" scarce philanthropic assets on "overhead." And because we can evaluate a nonprofit's costs far more definitively--and easily--than its actual results, we resort to measuring and minimizing inputs rather than maximizing the outputs those inputs create.
The Added Costs of Philanthropic Capital
Just as businesses incur a "cost of capital," nonprofit organizations pay a price for the money they raise. The true costs of fundraising, however, are rarely as modest as the 20 cents (or less) on the dollar that many of the better nonprofits report. Under certain selected circumstances, such figures may reflect reality. More often, they provide only a baseline of direct and measurable costs onto which must be added the indirect costs that philanthropists and foundations (despite their generally good intentions) often impose. These indirect costs, registered in the form of management disruption, organizational constraints, and strategic distractions, are never quantified, much less reported. Yet they erode the value of each philanthropic dollar, just as water flowing through a corroded pipe imperceptibly seeps away. And whereas a nonprofit may be able to reduce the direct expenses associated with development (for example, by attracting, inspiring, and retaining wealthy board members), these indirect costs are far less tractable because of the imbalance in power between those who have money and those who need it.
Grantees are seldom in a position to negotiate aggressively with potential contributors the way a business would with its capital providers. Their unending need for charitable funding generally requires them to accept whatever terms and conditions major contributors impose, even if those demands are costly and disruptive. Because these burdens are invisible to the grantmaker, however, few foundations strive to mitigate the unintended costs of their dollars. On the contrary, what is costly to the grantee is free to the philanthropist, which provides little incentive for behavior modification.
The tragicomedy that played out when a small but growing nonprofit approached a well-endowed foundation for a "significant" grant vividly illustrates the cost of management disruption. The program manager was encouraging, assuring the executive director that the foundation respected her organization and that its mission was congruent with the foundation's program priorities. Enthused, the executive director scheduled additional meetings and prepared pitch materials, actively involving the two other members of her senior team, who were equally excited about the $250,000 they desperately needed and hoped to receive.
Months went by, during which foundation staff cancelled and postponed meetings while the nonprofit responded to a barrage of requests ranging from evaluation reports to rewritten grant proposals. Fourteen months later, the final proposal was submitted. As the foundation's board prepared to meet, the friendly and supportive program manager called the executive director and said that things were "going well," although "it doesn't look like we will be able to come up with the full $250,000 during this grantmaking cycle." Heartbroken, but still hopeful, the executive director had no choice but to go along.
Two months went by without a word, and then a letter arrived, promising "exciting" news: the foundation's board had unanimously supported an initial grant of $50,000 and "was open to entertaining additional requests once the nonprofit was able to demonstrate results." The letter went on to request detailed annual evaluations of the programs, ongoing financial reports to ensure that overhead costs were being contained, and semi-annual progress reports. The executive director didn't know whether to laugh or cry.
Aside from money, senior management time is a nonprofit's most scarce resource. Small executive teams, limited infrastructure, and modest staff levels place enormous daily burdens on executive directors and their direct reports--burdens that the most well-intentioned foundations can unwittingly exacerbate. Grant proposals are written and rewritten, while grantmaking decisions stretch over multiple quarters (and even years). In an effort to measure program results, funders impose elaborate systems to complement existing forms of compliance, but measuring the immeasurable can become quite time-consuming. Meetings are called and groups are convened to discuss progress. Foundations generously pay for their grantees' travel expenses but overlook the cost of all those hours. The grantees' payroll accounting systems never report the true cost incurred, and because these hours are "free" to foundation executives, they are easily taken for granted. Nonprofits are in no position to complain, however, even if they are forced to invest massive amounts of time to comply with the demands of multiple donors, because those relationships are essential for future funding.
In addition to depleting management time, foundations often impose constraints that hamstring the entire organization. As noted earlier, foundations strongly prefer funding specific programs to providing unrestricted operating support, and as a general rule, grantmakers prefer that their grantees minimize overhead costs. Even when these preferences are not explicitly stated, they have a profound impact on nonprofits and their boards, who automatically assume that any costs not directly associated with programs are undesirable and, as such, ought to be minimized. For example, many nonprofits, perhaps most, would view the addition of a chief operating officer as a discretionary overhead cost that increases staffing levels. Yet that "cost" might well yield a significant net benefit if, as a consequence, the organization becomes more productive and efficient--freeing up more of the executive director's time for fundraising, for instance.
Grantmakers' intense bias against "overhead" costs reinforces the natural inclination of nonprofit leaders to concentrate on service delivery rather than management and organizational capacity-building (or what one executive director disdainfully referred to as "administrivia"). Taken together, the absence of both funding and attention from leaders means that expenditures associated with people, systems, and internal management processes are kept to bare minimums. Bookkeepers are hired when chief financial officers are required. Individuals rarely receive regular performance reviews, much less development and training. With limited recruiting budgets, organizations are forced to hire whomever they can and then hope that each person can be motivated and capable enough to perform well. So-called capacity-building is viewed as an unaffordable luxury rather than what it is--an undeniable necessity.
Strategic distraction is the last but not least of the indirect costs of philanthropic capital. Strategy is the allocation of scarce resources to achieve desired results. Like foundations, which attempt to use their assets in ways that will lead to certain desired outcomes, nonprofits also have strategies (although these are often not as rigorous or explicit as they might be). Nonprofits almost always confront severe financial and organizational constraints to pursuing their strategies, however. And unlike endowed foundations, they have to both raise annual funds and implement programs. A foundation can "waste" resources without any direct consequences to the institution or its executives (and quite possibly without even knowing that the resources were indeed wasted). But if a nonprofit wastes its resources, it not only impairs its ability to attract future funding but also handicaps its ability to serve its constituents. The more a nonprofit's strategy is disrupted, the less likely it is that it will deliver impact.
Whenever grantmakers impose their strategic imperatives on grantees, they run the risk of eroding impact. Given limited resources, organizations must make choices about what they will do and what they won't do. Saying "no" is as important as saying "yes." Because the top priority of most nonprofits is funding, however, they find it impossible to say "no" to funders, even if a particular grant is somewhat inconsistent with their strategy. In fact, in order to appeal to the widest possible set of funders, a broad (or sometimes even ill-defined) strategy can be helpful, because it allows donors with different priorities to add their own pieces to the organization's crazy quilt of activities. Focus may be essential for allocating resources and delivering results, but it can complicate fundraising; and ultimately fundraising effectiveness is even more essential, because without money there are no programs.
Moving Toward Higher-Impact Philanthropy
Anyone can give money away. The simple act of writing checks or approving grants demands no particular skill, rigor, or accountability, yet it is virtually guaranteed to generate recognition, praise, and goodwill. Thankful beneficiaries need their benefactors to feel appreciated; hopeful beneficiaries need to position themselves for future grants. So the cycle of high-cost, feel-good philanthropy is perpetuated, occasionally netting social results but often falling short.
Breaking this cycle begins at home: in a sense, motive matters most. Philanthropists who are genuinely committed to increasing the impact of their grants and gifts accept that how they give is as important as what they give to. They supplement their own opinions and perspectives with the best facts available and (if need be) pay more attention to the latter than the former. They place their grantees' needs and strategies ahead of (or at least on par with) their own. They subordinate the understandable inclination to act like principals to playing the less-glamorous role of financial intermediary. They combine the excitement and appeal of supporting programs with the more mundane activity of building capacity. Such logical (but by no means natural) acts are essential if higher impact really is the primary objective.
A commitment to higher-impact philanthropy also requires a willingness to bet on future outcomes, outcomes over which the donor has limited control. The bigger the bet (in the context of one's overall resources), however, the greater the risk; so, not surprisingly, some donors try to reduce the risk by making relatively small grants to numerous grantees. The implicit premise is that by spreading resources this way, donors will minimize the downside of any particular bad bet. In actuality, small tentative commitments may often be the riskiest bets of all, because they sustain chronically undercapitalized organizations, which, in turn, underperform and struggle to deliver results.
In contrast to this "peanut butter" approach to philanthropy, donors committed first and foremost to impact are likely to make fewer, bigger grants over longer periods of time. Such grantmaking is grounded in the belief that focus matters and that enduring impact cannot be achieved overnight. For example, the Edna McConnell Clark Foundation devotes its resources to a relatively small network of high-potential youth development organizations. Ray Chambers has concentrated his Amelior Foundation for years on revitalizing Newark, New Jersey, and expanding youth mentorship nationwide. Mario Marino has focused the portfolio of Venture Philanthropy Partners on a handful of promising nonprofits in Washington, D.C. The Pisces Foundation has concentrated on developing and expanding KIPP academies. Variances in scale notwithstanding, all these philanthropists are big bettors.
Mitigating the risks inherent in big bets like these requires a rigorous approach: strategy, anchored in objective facts, is essential to guiding resource allocation and decision-making. So is the discipline to say "no," repeatedly, to enticing possibilities that don't fit the strategic imperatives. Intensive (and relatively costly) due diligence is necessary to vet opportunities before bets are placed. There is no free lunch: generating above-average impact requires an above-average investment of time and money in the grantmaking process. Instead of considering these costs as a necessary evil, however, it is more useful to think of them as assets--essential inputs designed to maximize returns. Spending more time on due diligence is wise as long as such incremental investment generates better decisions with a higher probability of future impact.
That brings us to a final issue: the chronic philanthropic conundrum of measuring impact. As noted earlier, in many philanthropic endeavors, measuring the direct impact of a particular grant is virtually impossible. Established foundations spend millions of dollars on sophisticated assessments that attempt to evaluate the efficacy of particular social programs, and still the findings are often ambiguous. Just because a direct return on investment cannot be quantified, however, doesn't mean the investment should be foregone. It simply requires developing approaches that address the inherent ambiguity in measuring results.
For an analogy, consider television advertisements. Each year U.S. companies spend billions of dollars on television ads. Marketers can crunch numbers that provide approximate indications of how many people saw a particular advertisement. Detailed sales tracking can identify purchasing patterns before, during, and after the ad campaign. Sophisticated mathematical models can calibrate "spend effectiveness." Yet despite a degree of precision which would have been unimaginable 20 years ago, measuring the effectiveness of advertising is still something of an art.
Philanthropists can also use imperfect proxies--and judgment--to assess impact. An organization's strength, reputation in its field, quality of services, and cost per unit of service can all be calibrated on a relative basis--relative to similar organizations and/or relative to the organization itself over time. Likewise, while we may not be able to measure precisely the return on investment for a particular grant, we can certainly develop an informed point of view about whether an organization is--or is not--performing well. The bigger the bet, the more important such performance indicators become.
Moving toward higher-impact philanthropy is challenging but not impossible. After five years of experience in this arena, my own understanding of these dynamics is at best incomplete. Nevertheless, I am certain of one truth: society deserves, and desperately needs, philanthropists and foundations to increase the real impact of our giving. Satisfactory underperformance, complacency, and "feel-good" philanthropy notwithstanding, our own lives will be just fine. It is others who will suffer unnecessarily as a consequence of philanthropy as usual. This is our opportunity. And because all philanthropy is personal, it is also our choice.
Editor's Note: This article originally appeared in Philanthropy and was adapted from a chapter in the book Taking Philanthropy Seriously: Beyond Noble Intentions to Responsible Giving, edited by William Damon and Susan Verducci (Indiana University Press).