The Dysfunction of Non-Profit Organizations

I have almost always worked for non-profit organizations.  They’ve generally been great jobs, but I can’t say that I’m impressed by how they operate.  I understand that all organizations are flawed and inefficient, multiplying the flaws and inefficiencies of the people working for them.  But non-profit organizations strike me as particularly flawed and inefficient.

At the heart of the problem is that non-profit organizations lack the discipline of the profit motive.  There are no shareholders seeking to maximize the return on their investments.  Instead non-profit organization are answerable only to a board, who must ensure that the organization has sufficient resources to work toward a mission or set of missions that the board designates.

The need to raise funds can provide discipline to a non-profit organization, but if the non-profit receives government funds or has an endowment, the financial discipline of getting donors to voluntarily pay for operations is lacking.  The only source of accountability for endowed or government-supported non-profits is from the supervision of the board.  But we all understand that monitoring costs are very high for boards that are determined to exercise an accountability function.  And over time board are quite often captured by the employees of non-profit organizations, so they rarely attempt to exercise real supervision.

Without much financial accountability what do senior managers of non-profits tend to pursue?  There are limits to their salaries, so once they have obtained as much compensation as they can reasonably expect they tend to use their autonomy to build empires.  They tend to increase the size of their organization to employ more people, have more buildings, and have their hands in more activities.  Bigness increases the status and power of the non-profit managers since they have a larger patronage machine, shiny facilities to impress others, and can intervene in more arenas.

There has been insufficient attention to the problem of gigantism in non-profit organizations.  When for-profit organizations become too large they are either broken-up by regulators with tools like anti-trust or they are divided by shareholders who recognize that the parts are worth more than the whole.  The conglomerates of the 1970s fell victim to corporate raiders who made a fortune by breaking up overly large and inefficient profit-seeking organizations.

But where are the raiders in the non-profit world?  They don’t exist.  So nothing stops government funded or endowed non-profits from getting way too big.

I’m not talking about non-profits getting so big that they possess too much power or influence.  That’s a discussion for another post.  I’m simply talking here about non-profits getting too big to efficiently pursue their mission anymore.

I’m not sure what if anything should be done about this problem.  If donors endow a non-profit understanding that they can easily suffer from gigantism, then why should anyone else care if they are wasteful with their money?    Some might say that the government should care because it granted non-profits a tax-advantage for which it should expect the efficient pursuit of the public good.  But that perspective assumes that not having your money taxed is a privilege because all money ultimately belongs to the government.  I don’t believe that.  Besides, the government is almost certainly less capable of ensuring organizational efficiency than non-profit boards and would likely be even more wasteful if it received the money instead of the non-profit.

But I can’t help being bothered by the clear dysfunction of non-profit organizations.  I just hate waste.  Perhaps the real problem is that gigantism among non-profits crowds out the possibility of more efficient operations by profit-seeking organizations.  An overly large non-profit sector grabs more talented people who could instead be working more efficiently in the private sector.  Big non-profits also compete with services provided by profit-seeking organizations but their tax-advantage allows them to do so more inefficiently.

Perhaps all organizations, non-profit or profit-seeking, should be taxed in the same way and at the same level.  If the tax burden were spread across all types of organizations, the tax rate could be lower.  And as the Al Copeland Humanitarian Award has taught us, profit-seeking individuals and organizations often do far more good in the world than do non-profits who claim to exist for the public good.

And perhaps wealthy individuals should have a clearer understanding of the tendency of non-profits toward gigantism before they endow them.  They could address this problem with spend-down requirements so that non-profit managers cannot build a permanent empire for themselves.  They could also address this by investing more of their money in profit-seeing organizations rather than giving it away, since those profit seeking organizations may end up doing more good.

It’s true that wealthy individuals can’t take it with them when they die, but they don’t have to permanently endow self-serving non-profit empires.  If they can’t think of any better way to control gigantism in non-profits, they could always just give their money to their fellow shareholders.  Yes, there are no tax-advantages for that way of disposing of one’s assets after death, but at least those wealthy individuals could know that the money was going to their business partners and hope that it would be reinvested in new, profit seeking enterprises that might make the world a better place.

14 Responses to The Dysfunction of Non-Profit Organizations

  1. Greg Forster says:

    Nobody is more eager than I to counter the naive romanticism about non-profits that is currently driving large numbers of young people away from productive careers. But why focus so much on non-profits when it comes to gigantism? Obviously gigantism isn’t always successfully countered among for-profits. Is it really so much more common among non-profits?

  2. You are entirely right, Greg, that gigantism is also a serious problem in the profit-seeking world. But at least that can be partially checked by anti-trust and/or corporate raiders.

    It is also true that gigantism has become a more serious problem among for-profits recently as organizations desire to become or stay too big to fail to obtain the implicit government guarantee. Shareholders are less likely to accept the advances of a corporate raider if they think they would lose that guarantee even if they would improve efficiency.

    All this being said, I’m focusing so much on gigantism among non-profits because I don’t hear others talking about it. Plenty of people are talking about gigantism among for-profits.

  3. Greg Forster says:

    That last point is true enough! But here’s a thought: what’s the difference between gigantism in non-profits and gigantism in personal households? I mean, if a rich guy blows all his money on fancy boats and Christmas displays, I assume you wouldn’t complain (Al Copeland, call your office). Yet I’d contend that’s just as “wasteful” as creating giant, ineffective foundations, if not more so. Yet in the latter case you complain about “waste.” Suppose we think of these foundations as the world’s biggest, tackiest Christmas light displays. Would that change your view of them? (Perhaps the “waste” consists of the foundations failing to fulfill their funders’ intentions, but if so, that’s a position I’d like to see developed. Shouldn’t the concept of waste be at least a little bit objective?)

    • I think we are in agreement, Greg. As I said in my post: “If donors endow a non-profit understanding that they can easily suffer from gigantism, then why should anyone else care if they are wasteful with their money?” They could instead waste their money on boats and Christmas decorations.

      There are only two things that argue against my inclination to let people do whatever they want with their money (including the money they give to non-profits): 1) rich folks may not be fully aware of the dangers of bloat in non-profits, and 2) the tax code encourages people to devote more of their resources to non-profits than perhaps they otherwise would if other uses of that money were treated similarly.

      So my recommendations are that rich folks should be more aware of these dangers and the tax code should treat all organizations similarly.

  4. Student of History says:

    What I see are really lousy, nonacademic, social change programs being sold on the basis that foundation money is readily available to finance devt and implementation.

    Plus a fair number of these non-profits are certainly profitable for their employees and those serving as advisors and directors. All that money not being paid in taxes appears to be available for benefits. And the revenue opportunities flow from political buddies granting monopoly vendor status.

    It’s nonprofit in that it does not pay to sustain the operating costs of the government programs it so richly benefits from.

  5. Dave Saba says:

    One example that looms large is TFA – from their 2010 Annual report –
    2008: 2,173 new teachers with $40 million operating costs
    2009: 4,075 new teachers with $148 million operating costs
    2010: 4,485 new teachers wtih $192 million operating costs

    So that is $18,407 per teacher to $36,319 per teacher up to $42,809 per new teacher. That is a lot of money – – seems a little bloated to me.

  6. Robert Enlow says:

    i have been involved in non-profits all my life, like you, and really value your comments, particularly about the profit motive, although i don’t think they are universally true of all non-profits as you seem to argue.

    In my time, I have noticed that one of the attributes that funders of non-profits seem to value most is growth. There is this notion, which i believe to be misguided, that growth = success. If you raise more money year over year and provide more services year over year, basically grow, then you must be doing a good job as a non-profit. The trend towards gigantism seems to be a function of supply following demand. Donors demand success, which is seen in terms of growth as opposed to effectiveness, however defined, and non-profits, in an attempt to continue securing funds, supply donors with exactly what they want – evidence of growth. But consider this. Say a non-profit group raises 5 million in one year but the next year only raises 3 million dollars. The non-profit would be labeled as inneffective or dying or failing, even if they did more in year two to advance their mission than in year one. All this incentivizes non-profits to claim victories that are hollow, and to undertake activities that make it harder to get to real success. Moreover, it means that non-profits almsost never consider what their “competitors” are doing, and hence never really strategize on what activities they should undertake, besides all of them.

    Just some thoughts. I have to get back to running our effective, but small non-profit now.

    • Hey Robert — I don’t think all non-profits are dysfunctional, but they all certainly have the challenge of being efficient without the discipline of the profit motive. This problem is especially severe for endowed or government funded non-profits, since they don’t even have as much of a need to earn voluntary donations on a regular basis to fund operations.

      Your point that “success” for non-profits is often defined by donors as getting bigger is certainly part of the problem. If they can’t use profit, they use revenue as a proxy for success. But the managers of non-profits have their own reasons to favor getting bigger: they rule over a larger empire, they have more shiny buildings, and they have their fingers in more pies. Especially in endowed or government funded non-profits, where donor preferences are less important, the push for gigantism comes mostly from management.

  7. Ciro Curbelo says:

    I think the issue is not “for profit vs. non profit”, it is “third party pays vs. customer directly pays”. Board do not hold organizations accountable in the for profit world, customers do.

    Customers, when they may a choice to spend money to acquire a product or receive a service, are the only accountability mechanism that works.

    So fee-for-service non-profits are run as well as for profits. the problem is nonprofits who rely on foundations or government to fund services that they provide to customers for free. That will lead to inefficiencies and waste.

  8. Ciro Curbelo says:

    sorry for the typos – let me try again.

    I think the issue is not “for profit vs. non profit”, it is “third party pays vs. customer directly pays”. In the for profit world, boards do not hold organizations accountable, customers do.

    Customers, when they make a choice to spend money to acquire a product or receive a service, are the only accountability mechanism that works.

    So fee-for-service non-profits are typically run as well as for profits.

    Inefficiencies and waste is typically scene in nonprofits that rely on foundations or government to directly fund the services that they provide to “customers” for free.

  9. Hal says:

    As a thought experiment, I will try to list taxes that would be even less popular than taxing non-profit organizations that pursue philanthropic missions. Here is an initial try:

    1. Diaper Tax = We know the environmental damages from both disposable (land fills) and cloth (energy for washing) diapers.

    2. Apple Pie Tax = This uniquely American dish contributes to health issues that burden the whole country.

    3. Grandma Babysitting Tax = Imputed income from services rendered could be calculated.

    I suppose you could make a left-wing argument … profitable organizations and individuals should pick up the tab for government … or you could make a right-wing argument … government is finding too many ways to grab more money … from this thought experiment.

    While there are several valid point on inefficiencies above, it seems the most practical course is for fund donors and board members to seek good metrics and accountability for their contributions to non-profit organizations.

  10. Stuart Buck says:

    Interesting thoughts here about changing the charitable deduction:

  11. Dave Saba says:

    Combining forces in non-profits can work as well. Pulling together the best board from two non-profits, combining requests to funders and building improved efficiencies can work! National Math and Science Initiative and Laying the Foundation have merged to form one incredible STEM organization – this is what more non-profits need to do.

  12. Laura DG says:

    @ Jay P. Greene – I am writing a paper on this subject and have gone off the assumption that profit motive drives efficiency and thus lack of profit motive leads/may lead to inefficiency. But to write an academic paper, I will need concrete sources. Have you based this blogpost on any particular theories/authors which claim this thought? Are there any legitimate sources to which I can refer to during my research? Would appreciate your help!

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