I’m on vacation this week. This post originally appeared on March 3, 2007. I wrote this well before the Some Nonprofits Just Suck debate exploded. The fact that this post has been so widely read and a debate on the subject recently raged for two weeks shows that as a community, we have some important principals we need to hash out.

Nonprofits vs. For Profits

Employees of nonprofits, who toil away at below market rate pay scales (a scandal), must get really tired of the “new donors” who are demanding that they act more like for profit businesses and treat them like they aren’t very smart.

I think that the trend towards venture philanthropy, social enterprise and market-based solutions is very positive and should be encouraged. I think that it is terribly exciting that the Silicon Valley tech elite and the New York centered, “masters of the universe” financial wizards have turned their attention to philanthropy. At the heart of the technology and financial revolutions that have taken place over the past few decades is a focus on innovation. Applying this same innovation to improving the state of the world is going to have a dramatic impact.

But before we get carried away and start assuming that Google knows more about global warming than the Environmental Defense Fund, that Bill Gates knows more about vaccines than the World Health Organization, or that the founder of an online auction company knows more about the poor of India than Mother Theresa, let’s make sure these new donors know that nonprofits function differently than for profit businesses for a reason:

Nonprofits are paid by one customer (the donor) and deliver products and services to another customer (the cause there are advancing). This makes things tremendously complicated. I advocated recently that nonprofits need to remember that “the customer is always right” (See The Agitator’s post on when this isn’t true, which I completely agree with). But what happens when one half of the customer base is demanding something that hurts the nonprofits ability to serve the other half? Nonprofits do not exist to serve donors; they exist to serve a cause. The new donors need to understand that nonprofits will almost always know more about what is best for the cause than the donor does. So cut them some slack and don’t tell them to change until you’ve really done your homework.

Administrative expenses are not evil. There is such a thing as waste in both for profit and nonprofit financial statements. But the administrative expense by itself is not going to tell you that. I would venture that The Four Seasons hotel has higher administrative expenses than Motel 6. Does that mean Motel 6 is a better hotel? Sometimes great businesses have to spend more money to produce their product or service than their lesser competitors do.

Market based solutions are great when they are appropriate, but they aren’t always appropriate. Innovations like carbon trading are great alternatives to scolding people to think more about the environment. But the nonprofit sector exists because there are things people want that for profit businesses don’t deliver.

Markets are great when society is fine with whatever outcome is generated. If markets decided that athletic shoes are going to cost $120, you might think that is too high, but few people will believe it is “wrong”. But if society is unwilling to accept a market outcome (for example, electricity prices so high that elderly people can’t afford to heat their homes and die as a result), than you must impose some sort of modification to the market system. You can’t ask the “free market” to pick the most efficient quantity and price if you are unwilling to accept the outcome.

Markets are great when all costs associated with a product or service is borne by the trading partners. But markets cease to function when third parties have to pay. Cigarette smoking is the classic example. Since we know that smoking creates costs that people other than the tobacco company or the smoker pay (for instance health care costs generated by second hand smoke), than we know that the “correct” price and quantity of cigarettes will be miscalculated by a free market.

Markets are great when all benefits associated with a product or service is enjoyed by the trading partners. But when third parties enjoy the outcome, markets also cease to function. For example, the more people around you are vaccinated against a disease, the less likely you will be to get it. Therefore, people who do not pay for a vaccination derive benefit from people who do. Under these conditions, the market is generating incorrect prices and quantities, since the cost of the product does not reflect the value being gained by third parties.

For profit business models aren’t perfect. Neither are nonprofits. I don’t think the solution to the world’s ills is for nonprofits to act more “business-like”, instead I see a future where the line between the for profit and nonprofit business model begins to break down. Where for profit business recognize that doing “social good” does not have to be at odds with profits. And where nonprofits recognize that doing “social good” does not mean ignoring the lessons of the business world.