For organizational resilience and impact, focus on business model not overhead
Originally posted on Medium.com on October 21, 2020.
It has always been a source of angst for ambitious not-for-profit organizations: how to ensure that the organization can sustain- and scale up impact while also building resilience to weather financial or other shocks. Often the focus is on increasing core or unrestricted funding and covering general operating costs through grant overhead.
The COVID-19 pandemic and national responses to it have exacerbated this challenge and, in doing so, have brought into stark relief important structural problems within the not-for-profit sector. What have been perennial issues for many not-for-profits — sustaining impact, financial resilience — are now existential ones.
In recent years, even prior to the pandemic, governments, private foundations and other donors have openly recognized the need to cover a greater portion of not-for-profit organizations’ general operating costs through grant funding. That in itself is a good thing. However, I do not believe this approach, on its own, will lead to long-term resilience of ambitious not-for-profits, nor will it enable them to effectively scale impact.
What will ensure more resilience and the ability to scale up not-for-profit organizations is the pursuit of new and creative business models that fit with their missions and activities.
In this article, I draw on my and colleagues’ experiences of growing Conflict Dynamics International, a 16-year young not-for-profit working to prevent and resolve violent conflict and to alleviate human suffering arising from conflicts.
1. Common not-for-profit business model
A common business model for not-for-profit organizations is that the organization secures contributions from donors to fund its charitable work. This funding support can be for the core operations of the organization or it can be for particular programs or projects. In either case, it can be restricted or it can be unrestricted in terms of intended use. Let’s call this the Contribution-based Business Model.
With this business model, not-for-profit organizations must fund their non-program expenses through a combination of: (i) contributions for general operating support; (ii) restricted core funding; and/or (iii) institutional overhead applied to program direct costs.
In Conflict Dynamics’ experience, the institutional overhead on grants from non-United States governmental sources has been in the range of 7 to 13 percent (see below). Many private foundations allow for institutional overhead in this range also, while a few allow higher (e.g. MacArthur Foundation, up to 29 percent). In our area of practice, for organizations receiving funding from US Government sources, the Negotiated Indirect Cost Rate Agreement (NICRA) can cover overhead, as I understand it, up to 22 percent.
From the not-for-profit’s perspective, the core value exchange through the Contribution-based Business Model goes something like this: “we (not-for-profit) will deliver social impact; you (donor) will provide funding and other resources to support the activities towards that impact.”
Conflict Dynamics Brainstorm in East Africa Branch Office
2. Challenges with this business model
In our 16 years of working in some of the most challenging conflict situations in the world, we have learned that the Contribution-based Business Model is not sufficient to scale the impact of our organization and to ensure resilience. Perhaps it is better suited to not-for-profit organizations working in less volatile situations, or those that deliver predictable program services, or have reached a higher level of annual revenue.
The types of shocks we have to insulate ourselves from are generally funding shocks. Of course, the COVID-19 pandemic is a unique, seismic shock. We have been able to adapt our program activities and at the same time we have been seeing the funding shock which has resulted from the pandemic. Conflict Dynamics is fortunate to have many wonderful supporting partners, however even in normal times we have on occasion experienced U-turns on donor pledges, long delays in disbursing funds, and non-renewal of grants when the political situation changes unexpectedly (at source or country of implementation!) etc.
Back to the Contribution-based Business Model; I see a number of challenges:
In recent years, many governmental donors in particular have been reducing the percentage and scope of coverage of allowable institutional overhead on grants. For the types of grants we secure for our work, the following donors allow these overhead percentages: Sweden Ministry for Foreign Affairs — 13 percent; Switzerland Federal Department of Foreign Affairs (FDFA) — 10 to 13 percent; United Kingdom Foreign, Commonwealth and Development Office — 10 percent; European Union (EU) — 8 percent; Netherlands Ministry for Foreign Affairs — 7 percent etc.
Many institutional donors have pulled back on the amount of general operating support and other core funding they are providing to not-for-profit organizations, preferring instead to fund projects. A colleague recently referred to this as the ‘projectization’ of funding. This has direct tangible impacts on the ability of the organization to grow its infrastructure, as well as impacts in terms of staff retention, professional development opportunities, staff morale etc.
When organizations are funding their core operations through heavy reliance on program-related overhead, the organization becomes vulnerable if its programs do not continue or face funding gaps. If experienced program staff and institutional memory are lost, this places additional demands on the organization.
Whether for core- or program-specific funding, this business model requires the organization to proactively pursue new grants on a near continuous basis to ensure sustained revenue. The transaction costs for securing a large number of smaller individual contributions are very high, and so that generally requires that the organization first reach a certain level of revenue and capacity.
The fixed overhead on program grants induces dependency on this type of funding, because organizations get stuck in a Catch-22 of having to invest significant time in program fundraising, especially when scaling, which takes away from efforts to secure the resources to sustain the core of the organization.
This business model makes it difficult to break through the small- to middle size stage of growth. This is the ‘too small to be big, and too big to be small’ range of US$ 2 to 8 million annual revenue. At US$ 3 to 4 million average annual revenue, Conflict Dynamics is in this range. The reason for this difficulty is that economies of scale only kick in when the organization exceeds approximately US$ 8 to 10 million annual revenue. At US$ 8 million annual program revenue and 10 percent average overhead rate, the overhead amount would be US$ 727,272 / year.
Scaling impact may require upfront investments in new programs or new geographical areas. When there is high reliance on grant-related overhead, there are generally not a lot of funds available to invest in exploring new opportunities.
Ultimately this business model on its own results in constrained and unreliable funding for not-for-profit organizations. That reality, and the consequences for intended impact have been well recognized. Several institutional donors have made commitments to provide more general operating support or restricted core funding, both prior to- and during the pandemic:
The Grand Bargain on humanitarian financing launched in 2016, endorsed by 63 donors and aid organizations (as of September 2020), includes in its commitments that donors will progressively reduce the earmarking of their funds. Conflict Dynamics’ experience of fundraising for its humanitarian action programs is that this commitment is not being fulfilled by the majority of donors. There remains a strong preference for short-term project funding.
In September 2019, five large grant-making foundations in the United States announced their intent to help charities cover essential institutional costs. The foundations are: The Ford Foundation, The William and Flora Hewlett Foundation, The MacArthur Foundation, Open Society Foundations and The David & Lucile Packard Foundation. This included commitments to look at overhead rates and total program costs.
In recent years, individual governmental donors have announced initiatives for increasing coverage of core costs. However, in our experience, these are limited to preferred partners and represent a small component of overall funding.
In June 2020, The Ford Foundation and four other philanthropic giants announced that they would be committing a further combined US$ 1.7 billion for funding to not-for-profit organizations in light of the COVID-19 pandemic and economic injustice. For some of those foundations they will do this through bond issuance.
Much of these commitments and intended actions focus on what donors can do to help non-profits, and they also generally focus on the same business model. Some of the proposed arrangements for donors to help grantees cover overhead costs include: outcome-based funding, all-in-one project pricing etc.
Moreover, some donors are pursuing an approach based on equity philanthropy, whereby loans and investments are made to fund not-for-profit programs. This seems best suited to organizations offering program services that generate predictable revenue streams.
Conflict Dynamics’ experience of donor funding flexibility during the pandemic has been mixed: in general there has been a marked slowdown of decision-making on new funding; one private foundation partner has provided significant grant flexibility in light of the impact of COVID-19; and most governmental donors have not afforded much flexibility in existing grants.
We need a business model to support amazing women working for peace in Somalia
3. A constellation of business models
If the Contribution-based Business Model is not the way to go, then what is?
I believe that for ambitious not-for-profit organizations to build their resilience and scale impact, they need to operate with a variety of business models. This is going further than the obvious strategy of diversifying sources of funding, to diversifying the actual business model itself.
Conflict Dynamics has been exploring an approach based on a ‘constellation’ of five inter-related business models, all oriented towards realizing greater social impact.
Business model 1: Contribution-based I am not suggesting ‘throwing out the baby with the bath water’, so a contribution-based business model will continue to be an important model for not-for-profit organizations. Here, organizations will indeed need to push for more realistic overhead percentages on program funding, longer grant durations, more funding for core expenses etc. For its last three fiscal years, Conflict Dynamics’ grant revenue for programs averaged approximately 98 percent of total revenue … so we have more work to do here.
Business model 2: Monetization The second component of the constellation of business models focuses on monetizing something that the organization already does. This is about extracting added value from the organization’s expertise, analysis, networks etc. For example, Conflict Dynamics has gained a lot of experience in the monitoring and evaluation of peacebuilding programs. The organization can offer monitoring and evaluation services, for a fee, to other organizations.
Business model 3: Unrelated business income In certain circumstances, tax exempt not-for-profit organizations can generate revenue from unrelated business income. In the United States the Internal Revenue Service has stringent criteria for what constitutes unrelated business income, as this can be liable for tax. There are exemptions. One area of interest is in rental income. During Fiscal Year 2018–2019 Conflict Dynamics had total office lease expenses of US$ 109,429, of which US$ 26,782 was covered from institutional overhead. With an approximate average overhead rate of 10 percent on program grants, Conflict Dynamics had to bring in roughly US$ 294,600 in program grants just to cover this one expense. Ownership of a larger office property could eliminate rental expenses, as well as generate income through subleasing of office space.
I realize the pandemic is not an ideal time to get into commercial real estate, however, looking to the future there will be opportunities to offer other not-for-profits co-working spaces in certain locations.
Business model 4: Investments The fourth business model focuses on investment income. Organizations can approach donors to make an initial short-term investment, for the purposes of kick starting an endowment. With a 1-year investment of US$ 100 million and a conservative return, the organization could realize revenue of say US$ 7 million for that year. That would provide the initial funding for an endowment for the organization which would in turn provide roughly US$ 490,000 of unrestricted revenue per year. For a US$ 5 million per year organization this would represent nearly 10 percent of total revenue.
This level of investment is not implausible; recently the MacArthur Foundation has chosen an approach in one of its program areas of making a single very large investment over 3 years. The ‘100&Change’ initiative made an award to Sesame Workshop and International Rescue Committee in the amount of US$ 100 million.
Business model 5: For-profit feeder Not-for-profit organizations can set up separate for-profit ventures, with a view to the profit from the venture feeding into the not-for-profit entity. Many large corporations have charitable foundations, and the approach here is to do the same in reverse. This requires that a profitable business model can be designed and executed.
This business model also affords the opportunity to seek equity investment. Also certain forms of corporate entity, such as Public Benefit Corporations (B Corp), can (in the US) generally receive Program Related Investments (PRIs) from private foundations.
These components are building blocks and can be combined together in different configurations depending on the needs and capacities of the organization. They are not mutually exclusive. In other sectors, governments and foundations facilitate reduced-risk ‘sandboxes’ to experiment with business/regulatory models. Perhaps it is a good time to test these business model components and others in a sandbox environment.
4. Where does this leave us?
When I visited the Palais des Nations — the seat of the United Nations Office in Geneva — in late 2019, I was surprised to see the direct effects of the cash flow crisis which the UN has been enduring. As one minor example, some elevator banks were intentionally closed to save money, and some meeting rooms were out of use. The lesson is that when it comes to vulnerability of business model, size matters only so much.
Covering more core costs through increased unrestricted funding and overhead may be necessary, but it will not be sufficient to ensure greater resilience and to enable not-for-profit organizations to scale impact. That will require diverse and overlapping business models. The COVID-19 pandemic surely provides the added impetus for moving to new models.
In this article, I have laid out five components of a constellation of business models. Ambitious not-for-profits such as Conflict Dynamics will benefit greatly from support to diversify their business models, moving beyond conversations on overhead rates.
About the Author: Gerard Mc Hugh is Founder and President of Conflict Dynamics International.
 In this article, the term ‘general operating support’ relates to unrestricted funding for the operations of the organization. The term ‘core funding’ refers to funding which is for the core of the organization and which can be restricted or unrestricted.  For more information on the Grand Bargain see: https://interagencystandingcommittee.org/about-the-grand-bargain [Accessed 12 October 2020]  Maria Di Mento, “Five CEOs of Wealthy Foundations Pledge to Do More to Help Charities Pay Overhead,” The Chronicle of Philantrophy 4 September 2019. Available at: https://www.philanthropy.com/article/5-CEOs-of-Big-Foundations/247063 [Accessed 12 October 2020]  James B. Stewart and Nicholas Kulish. “Leading Foundations Pledge to Give More, Hoping to Upend Philanthropy.” The New York Times, 10 June 2020. https://www.nytimes.com/2020/06/10/business/ford-foundation-bonds-coronavirus.html# [Accessed 12 October 2020]  These are some of the approaches identified in the work of The Bridgespan Group’s ‘Pay What it Takes’ initiative. See: https://www.bridgespan.org/insights/library/pay-what-it-takes/pay-what-it-takes-philanthropy [Accessed 12 October 2020]. See also: Jeri Eckhart-Queenan, Michael Etzel, & Sridhar Prasad, “Pay-What-It-Takes Philanthropy,” Stanford Social Innovation Review Vol. 14 №3 (Summer 2016).
 United States Dept. of the Treasury Internal Revenue Service (IRS), Tax on Unrelated Income of Tax Exempt Organizations, IRS Publication 598 (February 2019). Available at: https://www.irs.gov/pub/irs-pdf/p598.pdf [Accessed 12 October 2020]
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