Strategic Positioning and the Financing of Nonprofit Organizations: Is Efficiency Rewarded in the Contributions Marketplace?

Beginning of article

Today, the nonprofit sector plays an increasingly important role in the provision of vital services in fields such as health, social services, and education. The size of the nonprofit sector has increased rapidly over the past 60 years from a little more than 12,000 organizations in 1940 to over 1.5 million organizations today (Boris 1999). This sector includes 501(c)(3) public-serving nonprofits that are organized for religious, educational, charitable, and scientific purposes, as well as a host of member-serving nonprofits, such as business leagues, social clubs, and labor associations (Bowen et al. 1994). While the sector has grown quickly, serious questions have arisen in recent years about the funding and management of these organizations, particularly the public-serving nonprofits whose supporters are entitled to a tax deduction for their contributions. In response to contributors' concerns following a series of highly publicized financial scandals at nationally prominent charities, the field of nonprofit management has quietly undergone a period of self-examination aimed at bringing greater financial controls and tighter operations to the sector (Bryson 1995; Kearns 1996; Letts, Ryan, and Grossman 1999; Pappas 1995).(1) Reforms in the way nonprofit organizations operate have been aimed at reassuring the public that contributions are being wisely applied to the core charitable missions of these organizations.

The rapid rise in the number of nonprofits seeking a piece of the limited amount of charitable contributions has increased competition within the sector and made it harder for many of these organizations to achieve long term financial stability. Charitable nonprofits raise funds through two principal means (Hansmann 1980). The first is through the charging of fees for the delivery of services or the creation of commercial ventures designed to generate a stream of earned income. Over the past two decades, these commercial forms of revenue represent a critical source of operating funds that has given nonprofits the ability to launch and sustain initiatives by having clients and consumers pay for part or all of the cost of delivering services (Weisbrod 1999). The second way nonprofits support their operation is through donations and grants. By emphasizing the public-serving nature of their work, many donative nonprofit service providers are able to elicit a stream of contributions that provides critical revenue for operations (Gronbjerg 1993). For organizations that work with disadvantaged populations or that seek to provide a service for free or at a subsidized price, contributed income is often a critical ingredient in their financial strategy. Today, there are few entirely donative or entirely commercial nonprofit organizations. In the face of a tight market for contributions, many nonprofits attempt to alter and diversify their funding bases from a predominant reliance on contributions toward a more balanced approach that includes earned income. All the while, there remains a significant ongoing need for contributed income to fund those activities that are part of the mission of a nonprofit organization but not easily supported by client payments.

Against the backdrop of these financial pressures, we examine the factors that drive charitable contributions to nonprofit organizations. Because nonprofits have received a great deal of advice on how to manage their operations efficiently, we are interested in the question of whether strategic positioning around efficiency, defined as the reporting of a below average administrative to total expense ratio, increases the contributed income that a nonprofit organization is able to raise over time. Beyond the need to build legitimacy and donor confidence, which may underlie the new bottom-line movement in the nonprofit sector, there has been much talk about the growing sophistication of philanthropy as evidenced in the expectation of donors that their contributions be well-spent. This research asks how much reality lies behind this new rhetoric and whether the funders of nonprofit organizations have indeed begun to take more seriously the efficiency of the organizations they support. Thus, while the efficient management of nonprofit organizations may serve a range of purposes, we are interested here in whether it has an impact on an organization's ability to attract public support as measured by contributed income.

The article moves toward an answer in five steps. First, we set the stage by considering the background issues and previous research related to this question. Second, we define the research hypotheses that guided our work. Third, we describe our data and methodology. Fourth, we present our results and analyze the findings. Finally, we conclude with some broader reflections on the question of nonprofit management and accountability.

Background and Literature Review

To date, research on the private funding of the nonprofit sector has tended to focus on donor motivations. Starting with the question of what determines the amount of giving, many studies have looked at the sensitivity of contributions to various changes in the funding environment. The goal of this work has been to explain donor decisions and to do so almost always without taking into consideration the activity of the recipient organizations. Studies of individual charitable contributions have modeled donations as a function of disposable income and the "price" of giving to a nonprofit (Clotfelter 1985) or the "price" of obtaining a dollar of charitable output from a nonprofit (Steinberg 1986; Weisbrod and Dominguez 1986). In the field of corporate contributions, the impact of taxation on giving has also been studied, though the results are more mixed (Navarro 1988). Studies of the giving patterns of private foundations have focused on the multiple roles and responsibilities that frame the strategic decisions that foundations make about how to use their resources (McIlnay 1998). In these and other cases, modeling and theorizing have tended to treat the contributions process from a perspective in which the donor is actively involved in weighing alternatives and the recipient is a passive vessel of benevolence.

Another important line of inquiry is the relationship between other sources of nonprofit revenue and private donations. Specifically, this research addresses whether government grants and contracts "crowd out" charitable contributions (Brooks 2000; Kingma 1989; Okten and Weisbrod 2000; Steinberg 1993). The findings are mixed, however, across various subsectors and geographic regions with some studies finding evidence of a partial "crowd out" effect and other studies finding opposite evidence of a partial "crowd in" effect. Nonetheless, the thrust of this literature has been to evaluate the responsiveness of various revenue streams without explicitly taking into account the actions of the nonprofit itself.

We start with a different set of concerns and assumptions about contributions to the nonprofit sector. Rather than begin with the question of what determines the amount of contributions made by supporters of nonprofit organizations, we draw on a different research tradition; one that starts with the role of information asymmetry (Akerlof 1970) in the market for charitable contributions and moves to the question of what determines the fundraising success of nonprofits (Kelly 1997). Far from being bystanders to the deliberative process of donors, nonprofit organizations are, in fact, actively engaged in courting supporters by signaling the importance of their mission and the efficiency of their operations (Kim 1999). This strategic positioning is a critical part of the giving process since it determines what information reaches donors as they make their decisions on where to direct their funds. The most basic form of positioning is around mission. Nonprofits define themselves around the causes they are established to serve, which they hope the public views as important enough to support through both volunteering and charitable giving. As the public shifts its attention to issues ranging from homelessness to …