The inefficient nonprofit marketplace

A friend who’s doing a lot of work to improve giving practices and flows of capital in the nonprofit marketplace asked me the other day: “do you think capital is allocated efficiently in the nonprofit sector?”

“Of course,” is what I was supposed to say, but instead I asked, “Compared to what?”

Here’s another version of these questions, played back with a little more detail:

Question 1: Is there a significant gap between the way capital optimally would be allocated in the nonprofit sector and how it is allocated (where optimal = the best, most high impact ideas / organizations get the most funding; the worst get the least)?”

Answer: Yes.

But before we stop there and dive headlong into the steps we can take to “optimize” how capital is allocated – with better rating systems and more transparency and standards – I’d like us to ask and answer this question too:

Question 2: Is the nonprofit sector any worse than any other sector in how it allocates capital?

Answer:  I haven’t seen any data that helps me answer this question.  So for now, I have to say I don’t know.

Or, more simply:

Might we be a mess? Sure.
Are we any more of a mess than anyone else? Dunno.

For example, let’s compare the nonprofit sector to the mutual fund industry (since both involve individuals and institutions allocating their capital in pretty significant ways).  Mutual fund clients have the clearest incentive to allocate their capital efficiently and to avoid paying for things (like high management fees or stock-picking managers that say they’re going to beat the market) that are proven to be inefficient.  Plus, tons of time and effort has gone in to creating standards and disclosure requirements to protect individual investors and provide them with clear, easy-to-understand information.

And….?  And investors make all sorts of screwy decisions about what to do with their money, pouring billions of dollars into funds that cost 10, 20, 30 times the cheapest and most efficient option.  (And in further proof that we keep on getting halfway to the wall, just three weeks ago the mutual fund industry had another call to action about how disclosure and transparency need to be radically improved.)  In the meantime, high fees persist, people put money into underperforming funds, and investors ignore reams of data that says it’s impossible to beat market returns in the long term, especially with high-fee mutual fund managers.  On average, we buy high and sell low most of the time.

So what about another, simpler point of reference, like, say, just about any consumer product on the market?  Because while mutual fund fees may be obtuse and hard to understand (so arguably a great point of reference for the nonprofit sector), people also routinely spend, say $250 for 1.7 ounce facial moisturizer when its non-comodogenic cousin costs $10.99 for a 20 ounce container (about a 300:1 price difference).

$150/ounce or $0.50/ounce?

The point is not that the nonprofit marketplace doesn’t need better disclosure, more transparency, more accountability – it does. But we need a mental model of what we hope our sector will look like when we’re successful if we’re ever going to get there.  And “better than where we are now” isn’t much of a rallying cry.

Is the model publicly traded companies (with GAAP and ratings agencies…which failed us spectacularly in the latest economic meltdown)?  Is it the mutual fund business?  Consumer credit?   The point is obvious: lots of markets more “advanced” than ours fall short the same ways we do.

Since it’s so hard to find examples of markets that are “working” in the sense that capital is allocated in the “right” way, I would advocate starting by understanding how we’re the same (we’re interacting with consumers who, with limited time and attention, are allocating capital) and how we’re different (nonprofits tend to die slower deaths than their for-profit brethren), and then be clear about what these differences and similarities  mean and, from that, describe the gap we hope to close from where we are to where we hope to be.

In the meantime it feels like there’s a lot of railing about what’s wrong (“it’s not all about overhead ratios!” “Donors just respond to stories and sad pictures instead of digging in and understanding who is most effective!”), and a lot of effort to improve on what we have (by the nonprofits “rating” agencies and work to improve online giving marketplaces) which is all probably productive, but if we don’t know where we’re ultimately trying to go I have trouble seeing how we’re going to get there.

So my closing question is, “What does a highly functioning nonprofit marketplace look like, one filled with real actors who act like real human beings when deciding how to allocate their capital?”  And from that statement, let’s figure out what it will take to get there.

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