At a recent conference in San Jose sponsored by the White House's Millennium Council and INDEPENDENT SECTOR, Harry Saal, president of Cultural Initiatives Silicon Valley, complained that nonprofits were being squeezed out by rising local costs attributed to the expansion of high tech industry. In particular, Mr. Saal cited rising costs of rental space and salaries for talented workers. (See The Chronicle of Philanthropy, October 5, 2000). The issue of rising costs of specific inputs to the operations of a nonprofit is by no means confined to Silicon Valley, however. It arises in any downtown area whose economy is booming and in affluent suburban areas as well. The problem for nonprofits is that they have very limited resources with which to cope with these changes in market conditions. What can they do to maintain themselves and continue to serve their communities? Here, I would like to suggest five categories of coping strategy that nonprofit leaders may explore when certain inputs to their operations rise steeply in price. Each category allows the nonprofit to explore a different way to improve efficiency or effectiveness in order to maintain its mission in the context of a more stringent economic environment. These five strategic categories are based on several different economic concepts: productive efficiency, factor substitution, economies and diseconomies of scale, and demand:
1. Use Existing Resources More Efficiently: The first thing a nonprofit can ask itself is, given its current ways of doing things, whether some of its resources can be used more efficiently so that some savings in costs can be achieved. Economists call this improving productive efficiency. For example, perhaps the organization isn't using its floor space very wisely and could manage with less space if things were rearranged. Perhaps some extra or unused space could be shared with another organization which could pay to offset some of the cost. Or perhaps the staff would be more productive if their work assignments were rearranged in some way. In this case, staff size might be comfortably reduced. While such sources of inefficiency are the first place to look, I am making no claim that they are a major source of savings in nonprofits nor do I advocate that this strategy include reductions in the quality of work life. Rather, the point is to try to identify ways to work better, not harder.
2. Change the Mix of Inputs. A further step is to explore substitutions between the costly input and other inputs that could help compensate for its use in the production of the organization's services. Economists call this factor substitution. For example, the organization can ask whether computer technology can be used to substitute for physical space by storing records electronically and destroying paper records or moving them to a remote location. Alternatively, one can ask whether space can be saved by allowing staff to telecommute rather than work regularly in an office. Relatedly, one can ask if transportation and communication technology can be used to substitute centrally located (expensive) space for (cheaper) space at a remote location. On the staff side, one can ask whether there are areas where volunteer labor can be substituted for paid staff. The factor substitution strategy asks whether there are adjustments the nonprofit can make in its production process by changing the combination of input resources used, so that lower costs can result without serious losses (perhaps even gains) of effectiveness.
3. Operate on a Larger or More Comprehensive Scale. This strategy raises the question of whether the organization could become more efficient by expanding or by combining its operations with other organizations in certain ways so as to exploit what economists call economies of scale and scope. This strategy promises savings by spreading the fixed costs of infrastructure over greater levels of production or output activity. For example, could two or more nonprofits that share office functions such as receptionists, xeroxing, telephone service, libraries, etc. operate more efficiently than if they functioned separately at smaller scales? Would two or more performing arts organizations benefit from sharing performance space, ticketing, or marketing of their shows? Are there other ways that agency operations can be combined to achieve savings without losing effectiveness? Possibilities under this strategy range from cooperative agreements or contracts among completely autonomous organizations, to formal partnership agreements, to corporate consolidations or mergers. The latter strategies are normally longer term propositions that may be difficult to achieve quickly in reaction to sudden increases in the cost of certain inputs. The trick here is to explore specific areas where the scale and scope of operations may be expanded through combinations of mutual benefit. When all is said and done, however, a nonprofit may not be able to fully cope with the rising cost of certain factors of production by savings achieved through one of the three forgoing efficiency enhancing strategies. This leaves two further alternatives: raise more money or cut back on operations.
4. Exploit Supporters' and Beneficiaries' willingness to Pay. Funders and consumers can be made aware of changing cost conditions and consulted on their willingness to pay for maintaining the character of current operations. For example, if a central location affects the quality of an organization's services, funders can be asked to increase their allocations to cover increases in rent, and consumers can be polled to see if they prefer an increase in fees versus the option of driving to a more remote location. If corporate sponsors value their association with local charities they can be asked for their willingness to share some of their own space or their own staff with them, as a way of maintaining proximity and offsetting the rising costs of these particular inputs. Government funders too can be made aware of cost increases of specific critical inputs and asked to offset them through changes in payment rates or special allocations. The overall point here is that maintaining the use of certain inputs whose costs are rising, may critically affect the quality of services, and resource providers may be willing to shoulder some of those increases rather than suffer a quality deterioration. Economists would see this as responding to the demand for services at particular levels of quality and price. Of course, it is always possible to seek new sources of income unrelated to the specific factor whose cost is rising. For example, nonprofits might invest in a new venture designed to produce net profits, or seek increases in general membership, contribution or grant revenues, in order to compensate for shortfalls caused by rising costs. However, if such opportunities are available they are logically pursued whether or not the nonprofit is facing a rising cost situation.
5. Retrenchment. Finally, the possibility does exist for nonprofits to reduce the scale of their operations in order to cope with rising costs of certain inputs. This strategy may work for two reasons. First, the current scale of operations may be inefficiently large - economists would say that diseconomies of scale can occur in some cases. For example, the unit cost of producing day care may rise for groups above a certain size because of variable costs that increase with scale such as supervision or security. Cutting back, while eliminating services for some children, could achieve savings, permitting the organization to remain solvent under existing fee schedules and rising costs of certain inputs. Second, the organization may have certain fixed sources of revenue, such as grants or annual contributions, that would not change substantially if services are cut back. If these are revenues are stable, cutting back could eliminate costs without commensurate losses in revenue, again permitting the maintenance of solvency. In summary, retrenchment works where cutting back - at the margin in economists' lingo - reduces costs more than revenues. Retrenchment or downsizing may not be an attractive option for nonprofits that wish to maintain their presence in the community, though sometimes it is necessary to consider.
Rising costs of particular inputs are nothing new to the nonprofit sector. In the 1980s, for example, many nonprofits had to curtail programs because of rising premiums for liability insurance. Following a retrenchment strategy, some YMCAs and YWCAs closed their pools. Overall, however, nonprofits have a number of different ways to cope with the rising costs of insurance, space, talented staff or other specific inputs to their operations. A systematic examination of these options ensures that all possibilities will considered in these difficult situations now prompted by a booming economy. Note: Thanks to Roni Posner, Herrington Bryce, Mary Ann Waikart, Brenda Zimmerman and Peter Shiras for their comments and suggestions on the first draft of this column.