As I was riding my bike through the suburban neighborhoods of Shaker Heights this summer, I came across a very interesting economic enterprise. It was a children’s lemonade stand set up on the front lawn of one of the many attractive houses in this prosperous and socially progressive neighborhood. But this was a special lemonade stand - it was unattended, with a pitcher and glasses laid out for pouring and a sign that said, “Free”. There was another sign too, attached to a jar with money in it that was labeled “Tips”. Clearly, some enterprising children, perhaps with their parents’ guidance, were trying a new twist on a conventional venture - increasing the productivity of a lemonade stand by reducing its labor input!
The lemonade stand started me thinking: Why should such a venture work and what might it have to do with nonprofit organizations? Two thoughts came to mind. First, the whole enterprise was built on trust. In nonprofits, for example, donors must trust that recipient organizations will not misuse their gifts. In the case of our lemonade stand, trust seemed to work in two directions - the producers clearly trusted their neighbors to pay for the drinks and not walk away with the kitty. And the consumers trusted that the product was wholesome and untainted, despite the absence of labeling and government oversight. It was assumed that consumers would understand that this was the venture of neighborhood kids having fun and trying to learn about business, and as such, was deserving of their patronage and fair treatment. Consumers and producers were presumably all part of the same community. Just as in a nonprofit day care center governed by parents or a community museum that features local artists, the line between consumers and producers was not sharply drawn.
But the analogy goes further than this.
How would consumers of the lemonade determine how much to contribute to the tip jar? One way would be to make a mental comparison with market value. How much would it cost to purchase a glass of lemonade at a local restaurant or fast food establishment? If the lemonade entrepreneurs wanted their customers to use this standard, they might have posted a “suggested contribution” which they determined to be profitable and competitive (like some “free” museums or historical buildings do). But they didn’t do that. Perhaps they had something else in mind. Perhaps they wanted to tap into the deeper well of their neighbors’ support for their activity. Perhaps they intended to engage in what economists call “voluntary price discrimination”. By marketing their product in a manner that depended on their neighbors’ sympathies with the social character of the enterprise, perhaps our clever child-entrepreneurs vested it with more than the going market value for lemonade…
In a seminal article in the Yale Law Review in 1980, Professor Henry Hansmann recognized that for some kinds of nonprofit organizations, particularly those in the arts or higher education, the same individuals who use and pay for the services are the ones who are likely to be voluntary donors as well. It is as if these patrons are saying, “we didn’t pay enough to reflect the overall value we received from the institution, so here’s a gift to supplement our payment”. One could ask in these circumstances, why not just charge patrons more, rather than rely on voluntary supplemental contributions? The answer, Hansmann pointed out, is that there is no reliable way of knowing in advance how much a given individual actually values the service, and moreover, there is often no practical way of devising a pricing policy to discriminate between those who are willing to pay more and those who are not.
But voluntary price discrimination may do the trick. Give patrons the opportunity of supplementing regular prices or dues with additional contributions of their own determination. Of course, there will be a “free rider” problem under such a policy - many consumers will tend to underestimate the value they receive and some will avoid any such contribution, but overall this strategy may be the best alternative in many circumstances.
An example of this application came up in a site visit that a team of experts from the National Center on Nonprofit Enterprise made recently to a social service organization in Washington, DC, which ran a very high quality pre-school program for the community. The school was an important element of the agency’s financial structure and its mission, and it sought ways to make it more profitable. The clientele for the school ranged widely from low- income families to very prosperous families who were drawn to the school both by the quality of its program and the diversity of its student body. While a sliding scale by income certainly could be devised to account for both the need to subsidize low-income clients and the ability of higher income clients to pay more, such a scale could not do the whole job. If the upper end of the scale was constrained by competitive market prices and the lower end required substantial subvention that was not sufficiently supported by external grants or contributions, the agency might not make a profit or break even. However, putting less emphasis on differentials in the formal price schedule, and more on voluntary willingness of higher income parents to support the school and its social objectives, might actually be a more lucrative and productive strategy. By keeping formal prices at relatively low levels, and sliding scale differentials modest, well-to-do parents might be tempted to pay more in total than they would otherwise.
Nonprofits have a special advantage in engaging in voluntary price discrimination because they engender the trust that contributed funds will be used to advance the organization’s social objectives, and not line anyone’s pockets. For-profit firms have a much harder time exploiting this strategy. While “tips” are indeed a part of a for-profit sector practice, in restaurants and even now in over-the-counter coffee shops, it is generally understood there that these tips are reserved for the servers, not contributions to the organization (even if tips allow a business to pay their employees less!). But the unmanned lemonade stand in Shaker Heights seemed to transcend the business sector’s practice of tipping, reflecting a wider connotation of contributing to the social good of the neighborhood. For nonprofits whose customers can also be their donors, this lemonade stand’s voluntary contribution strategy sets an interesting example. I wonder if the kids who set up that stand had any sense of how profound their approach might be. I hope they go into nonprofit management. We could use more folks who make lemons into lemonade.
Thanks to Research Advisory Council members Alan Andreasen, Mel Gray, Regina Herzlinger and Herrington Bryce for their comments and suggestions on an earlier draft.