The nonprofit sector is an important component of today’s society. Included within this sector are most of the nation’s premier hospitals and universities; orchestras; theater and opera companies; all religious congregations; family and children’s services, neighborhood development, antipoverty, and community health services organizations; professional associations; labor unions; and social clubs.
The term “nonprofit” is something of a misnomer, because these organizations can earn profit, i.e., their revenue can exceed their expenses. What is prohibited is the distribution of profits to organizational directors or managers. The number of nonprofit organizations in the United States is unknown, because a large portion of the sector consists of small community groups and partnerships that are unincorporated. In 2013 approximately 1.4 million nonprofits with revenues totaling more than $1.3 trillion were registered with the Internal Revenue Service.1
In addition to the challenges involved with providing services to their communities, most nonprofit organizations face chronic fiscal pressures. In the wake of 30 years of government funding cuts, nonprofits are called upon by their communities to provide more and improved services, while having to continually raise contributions to fund their operations and programs. In a 2009 survey conducted by the Johns Hopkins Center for Civil Society Listening Post Project, 80 percent of nonprofit organizations surveyed reported some level of fiscal stress, and close to 40 percent of them considered the stress to be severe or very severe.2
Contributing factors to this financial stress included declining revenue, increases in healthcare benefit and other operating costs, declining endowments, and decreasing cash flow resulting not only from the previously mentioned factors but also from restricted credit and government payment delays.
Causes of Decline, Failure
In addition to, and more common than, external problems are internal factors that cause nonprofit organizations to decline and fail. Not unlike for-profit companies, most nonprofits decline and fail because of internal problems that are within management’s control. These include poor management, ineffective boards of directors, and severe flaws in business models.
Management problems contributing to organizational failure include:
Most organizations that find themselves in crisis have ignored warning signs over an extended period of time. It is easy for a board to observe but ignore an annual erosion of a nonprofit’s financial performance, quietly hoping for better future results and fundraising. In many nonprofits, executive directors control the agenda and do not adequately disclose problems the organization faces to the board.
Nonprofit declines often last for years before board members feel sufficient urgency to launch an intervention. Another major problem with board intervention is that it can be difficult for board members to get an adequate sense of the inner workings of their organizations. In the face of a deep decline and crisis, many board members do not know what to do. A deeper issue is that many nonprofit board members are not a good fit to serve on a board of directors. Many volunteer because of their interest in the organization’s services or connection to clients rather than because of any expertise they bring to their roles and responsibilities.
An organization’s funding strategy, program selection, and revenue sources may not successfully accomplish its mission and financial objectives. Even a single program that performs poorly, especially a large program, can bring down an entire organization. When an organization’s business model is complex, the executive director and management team may lack the skills necessary to run such a business, including general business, management, and leadership expertise, as well as specific industry experience. For example, nonprofit agencies serving individuals with developmental disabilities often must manage a wide variety of business lines and complex funding sources. Such problems can be compounded in a period of rapidly changing business conditions.
Evaluation, Assessment, Intervention
The first major step in the turnaround of a nonprofit organization is to evaluate and assess the situation. The process often begins with the turnaround leader asking probing questions during the interview process. Once the turnaround leader is engaged, the assessment process should include:
The early evaluation stage of the turnaround process involves fact-finding and diagnosing the extent of the organization’s problems. Board members and managers in all key functional areas, including finance, program, fundraising, marketing, and human resources, should be interviewed to answer questions such as: How is staff held accountable for poor performance? How are decisions typically made? To what extent do staff and the board practice teamwork? What are the reasons behind declining revenues?
The assessment also must include a deep dive into the organization’s financial records, systems, and position. Financial factors that need to be assessed as soon as possible include:
The financial assessment should also examine the organization’s business model and involve:
As the turnaround leader starts to get a handle on the situation, an appropriate action plan must be developed to conserve cash and enable the organization to survive. The initial plan typically includes implementing a cash flow management system, including cash flow forecasting, new revenue collection, and expense control management processes; re-examining the mission and/or branding of the organization; eliminating or scaling back ineffective programs; terminating and replacing ineffective managers/employees; and seeking short-term financing and funding. Cash flow is the lifeblood of any organization; absent significant cash reserves, which organizations in crisis almost never have, the turnaround cannot be implemented unless the cash outflow can be contained.
After the initial action plan has been implemented, the next step is typically to analyze the three key elements of organizational functioning that make up the strategic triangle3 (Figure 1): mission, capacity, and operating environment. As part of the turnaround process, turnaround leadership, board members, and management should evaluate how the organization functions within the elements of the triangle.
In most turnaround situations, organizations find that they lack the capacity and resources to fulfill their mission within their respective operating environments. Leaders often underestimate the amount of administrative resources needed to effectively carry out each of their programs. Without enough strength in each of the three corners of the strategic triangle, the organization may conclude that it does not have the strengths and resources, including financial and human resources and market demand, to sustain the organization.
Fixing the Business Model
Developing and cultivating a turnaround leadership team is key to a successful process. The organization is betting its future on the team that will design, implement, and operate the turnaround.
The leadership team should include the organization’s senior management team and the executive committee of the board. Board members selected to serve on the committee must have a sufficient understanding of the situation, the ability to commit the time necessary to effectuate a successful turnaround, and the authority for their decisions to be fully implemented. Success or failure of the entire process depends on solid performance. If management and/or board members impede change, the turnaround may never get off the ground.
Even though the incumbent executive director is usually willing to take some actions to turn the organization around, he or she often lacks the credibility to implement change because the individual is perceived to be part of the problem. Usually an experienced turnaround professional who has previously worked with nonprofit organizations should be engaged to lead the turnaround.
A successful turnaround requires a clear direction that is aligned with the market factors facing the organization and supported by a fully developed business model. In some turnarounds, the organization’s direction needs a serious makeover incorporating a new vision, including a new mission and rebranding campaign. However, organizational direction is usually not the problem. Instead, organizational failure and decline are primarily attributable to poor execution.4
Once leadership has provided clear direction consistent with the operating environment, the turnaround team turns its attention to the ineffective business model. The organization’s vision and mission must be supported by a financially viable business model. The business model in the context of nonprofit organizations is often misunderstood. In simple terms, a business model defines an organization’s strategies and systems for generating revenue and managing the expenditures required to provide its programs and deliver its services. Each line of business or program needs to work effectively for the business model to be sustainable.
Need vs. Market Demand. The business model should be aligned with the organization’s real market, not just community need. Nonprofits that fail to distinguish community need from market demand are at high risk of developing an ineffective business model. Most nonprofits do not derive revenue from their end customers, who have needs that the nonprofit fills. The real market is comprised of individual donors, foundations, corporations, and/or government agencies that contribute funds to nonprofits to provide their services. Many organizations confuse these two factors and try to fill the need for their services without proper market analysis.
Organizations also need to be cognizant of changing demographics, regulations, technology, economic factors, and priorities of funders, or their business model may become obsolete. If the priorities of a major funder change, agencies may be forced to change their programming quickly. For example, an Ohio agency that provides work experience for individuals with developmental disabilities recently found that the state’s Department of Disabilities no longer supports work shelter environments, which required the nonprofit to change its programming to a community integrated model.
Another good example of responsiveness to changing market conditions involved a nonprofit community health fitness organization that noticed a decline in the number of members. After reassessing market conditions within its geographical area, the organization found that competing for-profit health fitness clubs offered monthly payment plans for members. Although market surveys showed that the nonprofit’s facilities, fitness equipment, and services were far superior to those of its competitors, the organization learned that younger family members could not afford the upfront annual membership fee that it charged. By instituting a monthly payment plan, the nonprofit’s market share quickly returned.
Multiple Business Lines. Agencies that offer a broad range of programs and services face greater challenges in maintaining program effectiveness than do nonprofits that provide a single program. The challenges facing organizations with multiple programs include maintaining focus, avoiding spreading resources too thin, and accurately allocating costs to each line of business. Each line of business or program needs to be self-supporting.
If a business line is not self-supporting, then an analysis needs to be made to determine whether additional funds can be raised and whether the program is mission critical. Just because a program falls within the organization’s mission doesn’t mean that the offering should be maintained. Having other lines of business subsidizing nonperforming programs often gets nonprofits in trouble. This practice puts inordinate burdens on positively performing programs and pressures the development staff to raise unrestricted dollars to fund losses.
The financial reporting system needs to adequately detail the organization’s lines of business, enabling the turnaround leadership team to assess the sustainability of each line of business or program. Leadership must assess the likelihood of each business line attracting funding and the extent to which each is critical to the organization’s overall mission. For organizations in severe financial crisis, there is no room to carry programs that are not financially self-sustaining. Strong and successful nonprofits find ways to build programs that are both mission-driven and sustainable.