In formulating an organization’s financial strategy, we spend a lot of time on the primary expense line: staffing. For many nonprofits, the remaining expenses account for just 20-30% of the budget, and our discussions often focus on revenues. That makes sense, but did you know there’s another big cost to running a nonprofit, one that gets comparatively little airtime?
It’s called opportunity cost. My dictionary defines this as “the loss of potential gain from other alternatives when one alternative is chosen.” It’s a big part of microeconomics, and very real. Businesses use this concept in cost-benefit analysis all the time. But nonprofits rarely do. Why is that?
Think of opportunity cost this way: Every time you invest human resources (primarily staff time) in something, you are making the decision NOT to do a long list of other things. Therefore, you won’t get the benefits of doing any of those other things. If one of those other things could have produced more good for your organization, the opportunity cost may exceed the value of what you did decide to do. When that happens there’s a negative impact on your organization. It’s as if you invested money in a stock that later tanks.
In some cases you only realize you bought the wrong stock well after the fact, and it may be that you couldn’t have known – decisions often carry some risk and often you need to go with what you’ve got. This comes with the territory of being a decision-maker. But, what if there had been information that was available that might have cautioned you against buying the stock, yet you didn’t seek it out? That feels different.
I’m guilty, at times, of making decisions too quickly. With many things to do on a typical day, I want to cross tasks off the list, and once in a while I either go too fast or stick with the status quo too long, both in order to save time. (Example: waiting until last week to ditch my lousy internet service provider, something I should have done years ago.) I occasionally stop to wonder, would I have been better off had I done more analysis or challenged my comfort zone?
Since the answer is often hypothetical and vague, it may not feel worth dwelling on. What is worth time and energy is the runway to decision-making. How can we make opportunity costs tangible?
Businesses use the concept of return on investment, and directly compare options. That’s a tangible way to look at opportunity costs. Public Interest Management Group routinely incorporates this approach into strategic and business planning.
One key is to realize that time really is money. (You experience this every time you see a debit on your bank statement for a payroll withdrawal.) The value of staff time is clear. It’s the fully-loaded cost of people involved in a task. Volunteer time, as limited and essential resource, also has a real value, which can be estimated in various ways.
Here’s an example common to the nonprofit world: Organizations conduct fundraising events. Inevitably, the events are deemed “a big success.” What’s the measure of success? Often, it’s gross income or gross income minus direct expenses. Both of those metrics are wrong and tell us nothing about the financial success of the event. A better measure would be net income, incorporating the value of all labor used to plan and carry out the event. I rarely see that metric used, perhaps because it would often show that events lose money (or make very little), and that’s deflating to the people who worked so hard. So, there’s a tendency to cherry pick numbers that tell a more uplifting story, even when it’s inaccurate. (It’s also fairly common when faced with poor performance numbers, that groups change the narrative to focus on the enthusiasm of the participants as the “measure” of success; but enthusiasm doesn’t pay the bills!)
You may be gathering that I’m not the biggest fan of fundraising events. Their true net income often turns out to be negative (though there are exceptions). But that’s not the worst of it… The net income metric doesn’t account for the opportunity cost: what could we have done with all the time and effort we put into planning and running money-losing fundraisers? Several other fundraising methods historically (and generally) show better returns on investment than events. To truly know whether a fundraiser is a good idea we need to estimate the financial impact of alternate paths. There are ample ways to make estimates. Is this the best way to raise money, given our scarce resources and options? That’s the key question here.
I’ve been in board meetings where members challenge the idea of fundraising events as a productive technique. That’s encouraging (unless you’re an event planner). But here’s a topic I almost never see on the table: the costs and benefits: nonprofit board and committee meetings. How much time (and therefore money) goes into planning and running meetings? (It’s a lot, but woudln’t it be interesting to see a figure?) What are the benefits of this investment of resources? For boards that meet monthly, how do estimates compare for every-other month or quarterly schedules? Importantly, what could the organization do with all that time saved by reducing meetings, or making them shorter? And what would those benefits be? It’s a little messy, but we can address these questions analytically. First we have to ask the question, then we need to apply estimates. The subject almost seems forbidden. It shouldn’t be.
Going back to my original question, why is it that nonprofits, as a group, tend to downplay (or even ignore) opportunity cost in making strategic or operational tradeoffs? Much of it is organizational culture, which itself lives off the radar.
Public Interest Management Group’s applied research shows that there are common elements of successful nonprofit cultures, one of which is disciplined decision-making. Nonprofits that do this well tend to be more successful than those that do not. The concept of opportunity cost, as well as a conscious effort to build this type of culture, are great pieces to build into a strategic or business planning process. These elements can distinguish a powerful plan from a forgettable one.
Sometimes, as the crew of The Titanic reported when they got to New York, what’s hidden can be more important than what’s above the surface.