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Jan 21, 2011

Nonprofits to Face Tough Choices

I just finished my January column for Columbus Business First. It talks about the tough choices that may confront nonprofits as states take steps to reduce or eliminate their extraordinary operating deficits.

The matter goes far beyond the issue of what cuts nonprofits may face. Many nonprofits are losing money on the grants and contracts they already have with the government. The likely cuts will be lower reimbursements rates. They possibly may face more costly reporting demands as well. Many nonprofits are already tapped out and their ability to survive a year of even larger operating losses is low.

Here is the problem with current government grants and contracts:

Most nonprofits run very tight budgets and governments have benefited from their parsimony. Nonprofits also have low personnel costs, from their generally lower salaries and benefits and from their use of volunteers to further lower the cost of labor. While nonprofits could have benefited from using this low cost structure to strengthen themselves financially, governments have insisted on capturing most of these savings.

But governments have unfairly sought additional savings, which have limited nonprofits’ options to accommodate further reductions in government payments. First, state and especially local governments have been chronic late payers who do not pay interest or late fees to their nonprofit service providers. Lucky nonprofits have absorbed this burden with lines of credit that brought them additional interest costs, but many nonprofits without access to credit have had to respond with layoffs and salary and benefit reductions. Second, governments at all levels have refused to pay the full cost of providing the services they request. They generally impose maximum overhead rates that are unrealistically low, exclude certain reasonable costs from reimbursement, and enforce onerous reporting requirements without any compensation for the additional cost of compliance.

Governmental demands for further savings will leave nonprofits with only three choices:

Their first choice is to increase fundraising. While many nonprofits will try, the reality is that fundraising has never exceeded about one-fourth of total U.S. nonprofit revenues since the early 1980s. While there is undoubtedly great variation across individual nonprofits, the ability of the entire sector to replace a significant percentage of governmental funding with a higher percentage of fundraising is doubtful. The fundraising challenges nonprofits already face make this solution even less helpful.

The second choice is for nonprofits to increase the prices and fees charged for other services they provide and to transfer those additional proceeds to governmental services. This has been the business model for successful nonprofits. Nationally nonprofits have thrived by basing most of their income on earned revenues and using those revenues to internally subsidize important community needs that cannot be provided profitably. The practicality of doing this varies by the type of nonprofit and the incomes of their clientele and patrons. It is likely the human services nonprofits have the poorest clients and the most limited scope for increasing earned income.

The third choice is to cancel or scale back the government contracts or grants that lose nonprofits the most money. This will be difficult for nonprofits because they are accustomed to providing critical services at a loss. What is different this time is that many will reach the limit of the losses they can absorb because they have already drawn down their financial resources in order to survive the recent economic recession. There is also a limit to the number or amount of profitable services they can provide without abandoning their IRS-mandated mission to primarily serve community needs that are not profitable.

The key question nonprofits must confront in the coming months is whether each government grant or contract they have is a high enough mission that they would provide the service anyway or whether the service is something they are providing only because there is a grant available or the government has issued a request for proposals. If the answer is the latter, then dropping the government contract or grant may be the proper response.

What would governments do if nonprofits were forced to refuse government contracts and grants? Can nonprofits play hardball? Would it be counterproductive? For nonprofits to ignore their more difficult options may lead to failures that could reduce service even further. At a minimum the conversation with state officials needs to be about the affordability of providing services on behalf of the government. Nonprofits need to stop being grateful for receiving grants and contracts that confront them with losses. After all, a nonprofit that loses money on everything it does is a bankrupt nonprofit that ceases to provide any services.