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Controlled Growth.

Small isn't always very beautiful

Does your agency feel like it's stuck in a financial hole? Do routine investments in assets like vehicles, real estate and software seem insurmountably large? Do you find yourselves deferring or trying to get around major spending decisions that you know you should be making?

These symptoms are usually hard to miss because they're based on undeniable realities. Moreover, when they persist over a long period of time they almost always suggest that a fundamental economic imbalance exists.

This kind of problem is a failure to achieve economic size. In simple terms, it means that an agency is not large enough to provide the services it seeks to provide.

Rise of service providers

One of the most enduring characteristics of many nonprofit agencies is their fierce orientation to the local community. A second is their small size. The two traits came together during the past 30 years as governments everywhere turned to nonprofit organizations to provide health and social services that otherwise might have been provided by government entities themselves.

The result is that in most parts of the country there is a fairly widespread network of locally oriented 'nonprofit health and social service providers (even hospitals, for all their size, have a strong local identity).

Organizations that years ago might have been single advocacy groups or small experimental agencies have now been asked to become fairly large service production engines. Whether they produce therapist visits, children's psychological assessments or special education classes is immaterial for our purposes. Their job is to produce a large volume of reliable services.

In a production environment, achieving and maintaining economic size is essential for survival. A large part of economic size is covering the fixed costs associated with producing the services. Costs are said to be fixed if they must be incurred irrespective of the volume of services.

For instance, a school must have classrooms whether it educates one student or a thousand, and the rent or mortgage payments are not going to change at either volume. Staff is also' largely a fixed cost at least for several months at a time if not longer: teachers are added for each new classroom, not for each new student.

Fixed costs tie up capital. Rents must be paid in advance, and mortgages generally require a down payment. The dollars that go toward fixed costs are not available to pay for other things, like supplies or administrative costs or adding new staff. So one aspect of fixed costs is that they take up a relatively larger percentage of small agencies' budgets.

Drivers of fixed costs

The increased demands on service providing organizations in the past two decades are well documented and are steadily growing. Just to stay in existence many non profits now need things like computer systems, good human resource management, and a professional marketing or fundraising effort. Each one of these demands drives up fixed costs and therefore raises the minimum economic size of doing business. To refuse to assume the responsibilities is not an option.

Locally-oriented service providers often equate community responsiveness with being small, and a small service area often proves unable to provide enough business to support the rising economic size for that type of agency

The first trade-off that agencies facing a rising economic size typically make is to reduce quality. Unable or unwilling to make the necessary investments, they accept subtle deterioration in service quality: invoices get mailed rather than transferred electronically, buildings don't get needed paint jobs, the copier breaks and doesn't get fixed for two weeks, less qualified staff get hired, etc.

Soon the really big compromises start occurring. The break-even years turn into years of small deficits, then into a string of years with larger deficits. Meeting payroll suddenly seems more of a chore than it's ever been. There's a general feeling of tension in the air, and whispers of financial stress. More ominously, people leave faster than they can be replaced, and the organization seems to have lost its reputation as a good place to work. Board members aren't interested in serving or they find other things to do.

Many agencies misinterpret these signs of being economically undersized and instead blame a variety of other factors. Often it's the executive director who gets the blame -- a situation likely to produce a string of executive directors. Financial managers can get their share of blame too, as do stingy funding sources, changes in regulations, and just plain bad luck.

In this weakened state, the undersized organization is highly susceptible, to genuine bad luck. Floods, cracked foundations, lost data from computer crashes, a lawsuit, a series of unfavorable articles in the local newspaper -- these are common disasters that healthy agencies can survive but that can crush economically undersized organizations.

Fixing it

The best answer to most management problems is to identify them before they become serious, and the problem of being economically undersized is much more correctable if it's recognized early in the process of decline. Since the economic size problem is driven so much by uncontrollable fixed costs, monitoring the agency's fixed cost percentage each year is a good way of setting up early warnings.

To monitor your fixed cost percentage, separate your expenses into those that are either fixed irrespective of the volume of services or that vary with the volume of services. Your agency's Form 990 is a good place to find a workable list of expenses (part II), Calculate the percentage of total expenses represented by fixed costs over the past three years. If the fixed cost percentage increases more than about 2 percent from year 1 to year 3, it's probably a sign of being economically undersized.

What then? The answer is easy, the execution is not. The answer is to grow the agency to a larger size. Of course, this is not an easy task when one is struggling with an undersized organization in the first place. As a first step, determine what is driving most of your increase in fixed costs. Chances are it will be one of the following: a tight labor market (staff demand more pay and are hard to get); a credentialed labor force; new technology requirements; increased regulatory burdens; or real estate costs. By understanding what is driving the costs, you may be able to correct it.

Most likely the answer will involve achieving some sort of growth. The key is to grow at a rate faster than the growth in your fixed costs, or else the problem will only worsen. Since this is not always possible, the other logical approach is to reduce your fixed costs through some sort of collaboration.

This is why some agencies are joining together to reduce certain administrative costs such as technology. For maximum economic benefit, however, a merger is the only reliable collaborative way to achieve economic size.

The idea of merging with another organization is still foreign to some, and for others it raises fears of too large agencies unresponsive to community needs. While we may or may not know what "too large" means, we do know what "too small" means. It's all in the economics.

Thomas A. McLaughlin is a nonprofit management consultant with BDO Seidman, LLP in Boston. He is the author of the newly published "Trade Secrets for Nonprofit Managers" and of "Nonprofit Mergers and Alliances: A Strategic Planning Guide" (both from John Wiley & Sons).
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Article Details
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Title Annotation:management techniques non-profit organiztions
Author:McLaughlin, Thomas A.
Publication:The Non-profit Times
Article Type:Brief Article
Geographic Code:1USA
Date:Mar 1, 2001
Previous Article:Letters to the Editor.
Next Article:Intermediate Sanctions.

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