Charity vs Business: The Business Case
May 8, 2009
If you had $1,000,000 to make an impact on poverty, how would you spend it? Would you give a grant to a nonprofit or would you make an investment into a for-profit? This is the challenge that some grantmakers face (for those who consider the tools of PRIs and MRIs) – but is a question that few have attempted to answer definitively.
In the past several weeks, I’ve had the privilege of attending some phenomenal events in the social enterprise space. Two weekends ago I was at the Global Social Venture Competition’s Symposium on Social Entrepreneurship and last week I was at a Northern California Grantmakers briefing titled “Stepping into New Territory: Rethinking Social Enterprise.” Both events were informative, but for different reasons. The GSVC Symposium had exceptionally informative sessions for practitioners (I attended the panels on Financing Social Ventures, Critical Legal Issues for Social Enterprises & Social Enterprises, and Social Enterprises in Emerging Markets: Trends, Challenges, and Surprising New Markets – notes to come) while the NCG event provided insight into the black box world that is philanthropy (shout out to Judi and Lucy for organizing and facilitating the event, respectively).
What these events make clear is that there is a growing realization by both philanthropic funders and practitioners that charity no longer has a monopoly in creating social impact (which was not the case a few years ago). The false dichotomy that nonprofits create only social value and for-profits only create financial value has been shattered. Each generates both social and financial return – the million dollar question is: which one generates more social impact per $.
Unfortunately, I think it’s impossible to accurately quantify and measure the social impact of any organization, whether they are nonprofit or for-profit, and skeptical whether we will be able to find useful metrics that enable us to make comparisons (I think there’s a reason why we haven’t seen any convincing analysis for one organization, let alone an entire industry – one reason I’m partially skeptical of ideas like global social investment exchanges for nonprofits). Thus, without the ability to perform sound quantitative analysis and comparisons, any attempt at comparison will likely be unsatisfying to some degree.
Nonetheless, there has been recent anecdotal evidence in mainstream publications like Time, Business Week, Forbes, and the New York Times and bloggers who cover the social enterprise space like Anne Field of Not Only For Profit, Amie Vaccaro of ecofrenzy, and Nathaniel Whittemore of socialentrepreneurship.change.org, that take a cursory look at the comparative advantage of for-profit companies compared to their nonprofit counterparts. My personal experience as a long-time observer of the social enterprise space and as a mentor to social enterprises (mainly through the BASES Social Entrepreneurs’ Challenge and my experience as a Teaching Assistant at Stanford’s Social Entrepreneurship Collaboratory) also confirms this trend of for-profits being more effective than nonprofits.
So I’m going to go out on a limb here and say that I think investments in for-profits will generally have more impact per $ than nonprofits* – and offer four key bullet points that articulate why I think this is the case:
1. Charity is (Always) Limited
Here’s a passage from Philanthrocapitalism, which describes a disagreement between Muhammad Yunus and Pierre Omidyar on a business versus aid approach to microfinance:
At issue was Omidyar’s belief that microfinance could lift millions more people out of poverty, far quicker, by running it for profit rather than as a nonprofit like the Grameen Bank founded by Yunus in Bangladesh in 1974. The two men had clashed at the home of legendary venture capitalist and philanthropist John Doerr, who was hosting the meeting as a fundraiser for microfinance. Omidyar had declined to add his own money to the $31 million that the other philanthropists had used to encourage banks in poor countries to lend more, and at lower interest rates, to local microfinance institutions. Instead, Omidyar left the meeting convinced that, if it was pursued as a for-profit business, microfinance could reach a massive scale. He calculated that meeting the needs of all the potential poor borrowers would require about $60 billion – way beyond the capacity of the traditional charitable and government donors. “There is not enough nonprofit and aid capital in the world to get microfinance to the scale it could achieve. Relying on nonprofit capital, not self-sustaining business models, is a big mistake,” he says.
Omidyar makes an important observation: there’s not enough charity and aid money in the world to meet the needs of the poor. I came to a similar realization when I was in China consulting for a social enterprise that wanted to provide P2P scholarships to students in rural regions of China; if you want to help 300 million people in Western China, charity’s not the answer. One of the key differences I use to distinguish between charity/nonprofits and business/for-profits is that charity is designed to transfer value while business is designed to create and capture value. And if we’re trying to provide value to the poor, it seems much easier to create it using the power of business then to transfer it using the power of charity.
2. Charity is (Often) Inefficient
However, philanthropy’s problem isn’t limited to its size, but also its marginal efficacy; philanthropy is inefficient per $ spent because of bureaucratic and allocative inefficiency. One of the reasons there’s all this talk about global social investment exchanges and markets for philanthropy is this failure of philanthropy to allocate its resources efficiently. As William Easterley writes in The White Man’s Burden:
A price that clears the market is like a heating thermostat. When the house gets too cold, the thermostat automatically turns on the heat. If the house gets too warm, the thermostat turns off the heat… The market works in the same way-if there is excess demand, the price goes up; if there is excess supply, the price goes down…
The difficulty of foreign aid agencies is that a bureaucrat is controlling the thermostat to the distant blanket of some poor person, who has little ability to communicate whether she is too hot or too cold. The bureaucratic Planners get little or no feedback from the poor. So the poor foreign aid recipients get some things they never wanted, and don’t get things they urgently need. (168-169)
Like Easterly, I strongly believe that aid is by design an inherently inefficient way of helping the poor because of its lack of accountability to the people who are the primary beneficiaries of aid (what I like to call the Nonprofit Efficiency Impossibility Theorem). Paul Polak, in his excellent book Out of Poverty: What Works When Traditional Approaches Fail, shares the same criticism and argues in favor of market-based solutions to poverty:
In the first twenty years of my work with IDE, development leaders were outraged by my notion that you can and should sell things to poor people at a fair market price instead of giving things to them for nothing. “Business” was a dirty word to development organizations.
“It’s exactly the multinational corporations that use the business approach you advocate who have caused the problem of poverty in the first place,” they would say. “Poor people simply can’t afford to buy the things they need, and they need these things very badly. The only way to make a real difference is to donate these things to them.”
And the development organizations continued to donate mountains of food, free village hand pumps that broke down within a year and were never fixed, and thousands of free tractors that continue to rust under the African sun.
While I see the merits of aid organizations like FORGE (which provides “aid” to refugees in Africa) and Room to Read (which provides educational resources to children in developing countries), where cost recovery really isn’t possible, I’m wary of aid as THE PRIMARY solution to global poverty because of aid’s general lack of accountability.
3. Charity (and Aid) is Often Insulting and Harmful
Andrew Mwenda’s TED talk on how the media should really stop portraying Africa as a continent of hopelessness that needs foreign aid. Enough said. (If you haven’t watched this talk, you really really should).
4. Business (if Successful) Scales
Although I disagree with Yunus’ call for subsidized capital from social investors, a question I’ll explore in much more detail in a later post, I agree with a lot of what Yunus says in his new book Creating a World Without Poverty: Social Business and the Future of Capitalism. In particular, Yunus points out the difference in ability between a business and nonprofit in achieving scale (in fact, one of the first articles on the social entrepreneurship movement back in 2003 by a reporter from ABC News highlights the issue of scale as being ‘the sticking point’ facing the sector). Here’s what Yunus has to say about (social) business, being able to scale more effectively:
Charity too has a significant built-in weakness: It relies on a steady stream of donations by generous individuals, organizations, or government agencies. When these funds fall short, the good works stop. And as almost any director of a nonprofit organization will tell you, there is never enough money to take care of all the needs. Even when the economy is strong and people have full purses, there is a limit to the portion of their income they will donate to charity. And in hard times, when the needs of the unfortunate are greatest, giving slows down. Charity is a form of trickle-down economics; if the trickle stops, so does help for the needy.
A social business is different. Operated in accordance with management principles just like a traditional PMB, a social business aims for full cost recovery, or more, even as it concentrates of creating products or services that provide a social benefit. It pursues this goal by charging a price or fee for the products or services it creates…
The achievement of full cost recovery is a moment worth celebrating. Once a social-objective-driven project overcomes the gravitational force of financial dependence, it is ready for space flight. Such a project is self-sustaining and enjoys the potential for almost unlimited growth and expansion. And as the social business grows, so do the benefits it provides to society.
While the White House’s new Social Innovation Fund might address some of the inequities facing nonprofits in achieving scale, I still think it will be difficult for domestic nonprofits to scale when the federal government is the only viable answer and that international nonprofits will still struggle mightily with the issue. Social businesses on the other hand can sidestep the need for charitable funding entirely.
I believe businesses are generally more efficient than nonprofits, especially when it comes to creating wealth for low-income communities, and that impact investing will be the new giving – mission investing circles anyone? – if philanthropy stops letting function follow form (see Lucy’s excellent post on institutional isomorphism). That’s why I believe a lot of young social entrepreneurs, like Sam Goldman and Peter Frykman, are starting to realize that business solutions and not charity solutions can be more ideal when it comes to maximizing impact (and philanthropy’s impact would be multiplied if it leveraged its capital to fund social impact businesses with true potential).
*While I frame the question of for-profits versus nonprofits by equating nonprofits with charity, I understand that not all nonprofits are engaged in charitable activities; some are engaged in earned income activities as well, making them more similar to the for-profits under question. In a future post, I will expand on my earlier post Reexamining the Case for Social Enterprise, and explain why I and many people I have talked to (especially those in philanthropy and law), are skeptical of not-very-profitable social enterprises and the new L3c form.