Oct-Dec 2015

Ex-post Funding: Innovating Non-profit Organisations

The authors study an emerging/innovative model in the Non-profit Organisations (NPO) marketplace, wherein the NPO raises donations/funds for a development project post its implementation, thus allowing it to reduce the information asymmetry prevalent in such marketplaces and potentially raise larger donations.

Non-profit Organisations (NPO), differ from forprofit businesses in two important ways. First, the NPO status does not permit distribution of surplus cash flows as dividends or pay-outs to the shareholders (or units) that establish control and finance the NPO. Second, most NPOs raise funds for operations through donations from various entities and use these funds to achieve social goals, where the social goals typically involve the provision of a public good that simultaneously benefits many individuals. In spite of these differences, the non-profit sector contributes significantly to the global economic activity. A recent study based on financial data available from 40 countries, estimates the operating expenditure of the non-profi t sector to be approximately $2.2 trillion and the sector employs almost six percent of the economically active populations in these countries [Salamon, 2010]. Typically, donors who contribute to the NPO’s cause include government agencies, philanthropic institutions, and individual donors. It is noteworthy that voluntary contributions, via individual donors, constitute about 14 percent of the total funds raised by the NPOs and represent a significant amount in absolute terms [Vesterlund, 2006]. A common reason cited for such voluntary contributions is that individual donors derive personal “utility” from the mere act of contributing for a good cause. While it may be true that donors make voluntary contributions because of this “warm glow” effect [Andreoni, 1990], it is also well understood that many donors also care about the “impact” of their donation [Duncan, 2004]. That is, despite the lack of a profi t motive, and not being consumers of the public good provided, donors care about the total benefit provided by the NPO to the end beneficiary population. In other words, such impact donors worry about the NPO’s ability to use their contributions to provide maximum possible benefit (the amount of public good created) that is, they care about the NPO’s operational efficiency.

Information Asymmetry in NPO Marketplace

However, there are significant impediments to achieving this. Unlike for-profit marketplaces, a key challenge for NPO marketplaces is the lack of robust and timely fl ow of accurate information, leading to signifi cant information asymmetry (or opacity) between donors and NPOs [The William and Flora Hewlett Foundation and McKinsey & Company, 2008]. This information asymmetry is two-sided. The donors care about the NPO’s output and its operational efficiency because it affects their net utility gained from donating. On the other hand, the NPO is concerned about the willingness of donors to give because it directly impacts the NPO’s ability to raise sufficient funds to execute the project. In the traditional mode of NPO operations, wherein the NPO raises almost all funds prior to implementation of a social-development project, the donors bear most of the risk because of such information asymmetry places and potentially raise larger donations. [Hobbes, 2014]. Particularly, the donors donate without observing the NPO’s operational efficiency or the resulting social utility being delivered. To reduce such donor risk, intermediaries such as Charity Navigator and Give India have emerged to help bridge the information gap. These intermediaries facilitate connecting donors with NPOs [Brown and Kalegaonkar, 2002, The William and Flora Hewlett Foundation and McKinsey & Company, 2008] and act as rating agencies (exchanges) with a focus on rating the NPO’s efficiency in using funds, accountability and transparency, and financial sustainability. This allows the donors to make a more informed choice. However, some studies have shown that key information needs of donors regarding effectiveness of the NPO are still not met adequately [Hope Consulting, 2011]. For example, consider an early-stage NPO. Typically, the ratings provided by the intermediaries are based on self-reported information of the NPO as well as performance of the NPO on past projects. While an early-stage NPO may have some initial funds from past contributions, or the promoters’ contributions, the initial funds may not be sufficient for the NPO to undertake a complete project. Thus, it needs additional donor contributions before it has enough funds to complete the project. However, not having enough completed projects, intermediaries (and donors) are unable to rate the NPO, which in turn hampers the NPO’s ability to raise contributions.

The non-profi t sector contributes signifiantly to the global economic activity. A recent study based on fi nancial data available from 40 countries, estimates the operating expenditure of the non-profi t sector to be approximately $2.2 trillion and the sector employs almost six percent of the economically active populations in these countries.

To partially address some of these challenges, NPOs are beginning to innovate their fund raising strategies in the marketplace. In a relatively new market-based approach, which we call as the “ex-post funding” approach, a NPO uses its initial funds, even if insufficient to meet the total cost of the project, to implement early phases of the project. The results from, and costs incurred for, these finished phases are documented and “result-certificates” are issued against the observable outcomes. Having created these result-certificates, the NPO then invites donors to purchase these certificates post implementation.

Such an approach makes the NPO’s operations more transparent to the donors and allows the donors to evaluate the quality of the NPO as well as the output of the given project. Basically, it allows the NPO to credibly signal its operational efficiency through the output delivered. The funds raised from selling the result-certificates are used to recover the original funds and implement future phases of the project. For example, United Care Development Services (UCDS), a NPO based in Hyderabad, uses an “expost funding” approach to raise contributions from donors. Other examples include Splash, a NPO that aims to provide clean drinking water to children, and maintains a monitoring and evaluation platform called “Proving It” where donors can track the progress of each project before making their donations.

Implementing the project in phases and raising funds against finished phases also allows the NPO to raise donations in smaller amounts, through multiple rounds of fund raising, from a large donor base with many repeat donors. Raising small contributions over multiple rounds typically leads to a higher amount of overall funds raised [Vesterlund, 2006]. Another relevant example is that of Educate Girls, a Dasra portfolio organisation, which is funding a programme to educate girls in Rajasthan using an ex-post funding approach. In their case, existing donors fund the initial operations. Once the project achieves results, the buyers (donors) of these results pay (donate to) Educate Girls, thereby providing new funds for the organisation to expand its services [AVPN, 2013]. The buyers of the results (i.e., new donors) focus only on outcomes achieved and the organisation has more flexibility in the usage of funds raised.

While the ex-post funding model can potentially allow an effi cient NPO to credibly showcase its efficiency to the donor community and increase contributions, at the same time it also exposes the NPO to financial risks. Specially, if the donor contributions, post implementation, are not sufficient to cover the funds spent, then the NPO may face a shortage of funds which can hamper its ability to implement future projects. Essentially, unlike the traditional approach, the financial risk shifts more towards the NPO. Consequently, this new approach raises interesting questions for the NPO: which funding approach to choose, i.e., the traditional approach or the ex-post approach; and when? One can think of a scenario where different NPOs choose different approaches and the choice itself acts as an indicator of the NPO’s operational efficiency. In a recent theoretical piece of work [Devalkar and Sohoni, 2015], we analysed this key trade-off faced by donors and resource-constrained NPOs, who care about the benefits provided to a target population. The donors are uncertain about the NPO’s effi ciency in using these donations effectively and the NPOs are uncertain about the donors’ willingness to donate. Modelling the NPO and donor as expected utility maximisers, whose utilities are increasing the benefit provided by the project, we compare the performance of the traditional form of fund raising with the emerging practice of seeking ex-post funding. We demonstrate that the ex-post funding approach gives higher expected donor utility and higher expected benefit when the NPO is reasonably certain about the donor’s willingness to donate. However, in markets with higher uncertainty about the donor’s willingness to give, the ex-post funding approach results in higher expected benefits only if the NPO’s disutility from a shortfall in funds (difference between funds spent and donor contribution) is sufficiently small. While the ex-post funding approach enables the NPO to signal its efficiency credibly, our analysis shows that even a very efficient NPO might sometimes, particularly when there is significant uncertainty regarding the donor communities’ willingness to give, prefer to adopt the traditional approach, which also results in lesser donor contributions being raised.

In the new market-based approach, which we call “Ex-Post Funding”, result certificates issued against observable outcomes are offered to donors for purchase. Such an approach makes the NPO operations more transparent to donors and allows them to evaluate the NPO and the output of the project.

Additionally, our finding also has some broader implications for policy planners. For example, if the NPO’s disutility burden from a shortfall is reduced, through systematic policy interventions (for example, charging nominal interest on bank loans), the expost model may ensure higher benefits to the target population. Moreover, both donors and NPOs could be better off by the reduction in information asymmetry in the marketplace due to the wider adoption of the ex-post funding approach. There are other operational considerations that might also be equally relevant. For example, does the choice of funding approach depend on the risk profile and/or other characteristics of the social-development project? Sometimes public goods are of the “threshold” type where a minimum fixed cost, in addition to operating costs during implementation, needs to be incurred before any implementation can begin and output delivered [Andreoni,1998, Devalkar et al., 2014].

The ex-post funding approach is one form of signalling operational efficiency. There are other market-based mechanisms such as “Development Impact Bonds (DIBs),” that are emerging in the NPO marketplace to improve efficiency and transparency. For example, UBS Optimus Foundation and the Children’s Investment Fund Foundation (CIFF), have launched a DIB pilot project to improve educational outcomes in Rajasthan, India [Perakis, 2014, Vaishnav, 2014]. This is a three-year pilot project aimed at addressing the challenges of high dropout rates, and poor quality of education for the girls in the state. UBS Optimus Foundation raised an upfront investment from UBS clients wanting to make investments with a social impact. These funds will be used, by a nongovernmental organisation (Educate Girls, mentioned earlier), to implement the project and outcomes will be measured rigorously. If the outcomes are up to the mark then CIFF, the outcome payer, will reimburse the investors with additional returns depending on the rate of success. A non-profit intermediary, Instiglio, will monitor the project and measure the outcomes achieved. Similarly, there is a conscious move by the Department for International Development (DFID), of the United Kingdom Government, towards making funding tied to achieving results. The idea is to use instruments such as Social Impact Bonds (SIB), that reward philanthropists and impact investors who take on financial risk to fund NPOs that undertake programmes to help poor and vulnerable people. They are rewarded for the risk if the programme succeeds and meets performance goals [Bond for International Development, 2014, Department for International Development, 2014, McKinsey & Company, 2012].

In conclusion, even today, NPO marketplaces continue to be operationally inefficient and innovation in business models and funding approaches is nascent. There is a definite need to accelerate operational innovation in these marketplaces. Overall, the nonprofit marketplace provides several opportunities for entrepreneurs, practitioners and policy makers and operations researchers to enhance our understanding about how to improve operational efficiency and innovate accordingly.


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