Fee (Earned) Income

It comes as a surprise to many that fee income is the dominant source of revenue for reporting charitable nonprofits in the United States, given the traditional association between charities and gifts. However, the United States is not alone in this pattern; many other countries' third sectors are dependent primarily on fee income (Salamon, Sokolowski, and Associates, 2004). Nor does this pattern hold for all nonprofit subsectors, as previously noted. Still, fee income is sufficiently dominant as to warrant its examination for most operating nonprofit organizations in the course of their resource development and planning deliberations. The issue of fees breaks down into several parts. For any given service offered by a nonprofit, one can ask whether a price should be charged at all. If the answer is positive, then the question becomes how to appropriately design the price structure. The latter question is contingent on the nature of the service itself. If the service entails public as well as private benefits, then the price will need to reflect that, perhaps only partially covering the cost of the service in order to ensure that an efficient level of externalities or distributional benefits are produced. However, if the service produces fully private benefits, and is perhaps even intended solely for financial support rather than mission impact, then prices should be designed to maximize net revenue.

Given a salience of private benefits, the issue of whether to charge a fee involves several considerations (Oster, Gray, and Weinberg, 2004). First, implementing a fee for a previously free service will entail investment in what economists call “transactions costs”—a new cost of doing business. An historically free museum will need to build and staff ticket booths, implement a system to collect, track, and reconcile these new revenues, and implement fraud prevention measures, or contract with an outside firm that knows how to do these things. Thus, the nonprofit needs to determine if the additional net fee revenue would offset the additional transactions costs associated with putting in place a fee system.

In addition, the museum may have to overcome cultural resistance from a community or donor base that feels entitled to free access or believes that open access is historically mandated or required by the original benefactors. Cooper Union, a New York City college that provided free tuition for students since 1902, is a prime example of this cultural resistance. In 2012, the college announced that it would begin charging tuition to graduate students and that in 2014, undergraduate students would begin paying tuition (Mytelka, 2012; Vilensky, 2015). Although Cooper Union stated it had to charge tuition to prevent financial insolvency, there were outcries against the college's decision. A group of individuals comprised by students, graduates, and a professor of Cooper Union sued the board of directors to stop tuition charges and, in 2015, the New York Attorney General began investigating Cooper Union's past financial decisions to understand the school's decision to charge tuition (Vilensky, 2015). The resistance to the tuition charges stems in part from disagreements over the founder's original goals and whether he intended for all students to attend tuition-free (Harris, 2015).

The question of how fees will affect the ability of the nonprofit to accomplish its mission is, of course, central to the decision. In the case of a museum, one has to ask whether the fee system would reduce usage by those people the organization is intended to serve. This is partly a matter of how the fee system is implemented. For example, sliding scales or special periods of time when access is made free (for example, free Wednesdays at the museum) can allow fee revenues to be collected without seriously impinging on mission impact. In fact, properly designed fees can sometimes increase mission impact. In particular, aside from providing more revenue, fees can create constructive incentives. In the case of Cooper Union, tuition charges are meant to prevent financial insolvency by generating funds from students who are able to pay while the neediest students are still eligible for scholarships. In other cases, a fee can add a dignity factor that may make it more likely for targeted populations to participate. For example, a free transport service for elderly residents to travel to their senior center might be viewed as “charity,” whereas a nominal fee might preserve self-respect and increase usage.

Once a decision to implement a fee is reached, there are a variety of considerations that go into determining the fee structure. Much stems from the goals of the service involved. If the service is purely a commercial venture intended to generate maximum profit for the organization, which can then be devoted to support mainline mission-related services, then prices should be set for that purpose. If, however, the service addresses a mission-related social purpose, the fees must be gauged to what targeted recipients are willing to pay for the private benefits they receive. Here is where sliding scales and other approaches can be helpful. In such cases, the goal is not full cost recovery or the generation of net financial surpluses but rather some level of off-setting revenues that can help pay for the service, or extend its volume or reach, in combination with other forms of support.

Finally, it is worth addressing the option of “membership” fees or dues in connection with overall fee revenue alternatives (Steinberg, 2007). One conception of membership dues is that they are a form of “package pricing” under which it may be more effective to charge consumers for several services under a single price than to charge them separately for each component service. For example, memberships in YMCAs are more efficient than charging clients separately for the weight room, the swimming pool, and towels. Savings accrue in the form of convenience and lower transaction costs. In addition, package pricing can help advance the mission of the organization by inducing clients to use included services that they might not otherwise use if they had to pay separately. Thus, clients of the Y are more likely to use the diet counseling service if it is included in the membership price, thus advancing the Y's mission to improve personal health.

Overall, the key to determining whether fee revenue should be a component of a nonprofit's revenue mix is to assess whether there is a strong component of private benefit to an identifiable beneficiary group to whom prices can be feasibly and effectively charged. For a variety of reasons, many nonprofits produce services for which there is a strong private benefit component. One reason is that they are capable of offering certain commercial products at a profit because of some competitive advantage, the revenues from which can support the charitable mission. Universities are good at offering public lecture programs and arboreta are well suited to provide attractive facilities for private weddings and bar mitzvahs. Moreover, nonprofits' mainline missions often justifiably entail private goods and benefits because of their competitive advantage in producing sensitive services, such as child day care or elderly care, in which consumers can comfortably place their trust. In such cases, it is entirely sensible for nonprofits to pursue fee income as an important component of their revenue portfolios.

Gift Income Contributed by Individuals

When nonprofits offer services that entail a significant component of public or redistributional goods or externalities, it makes sense to look for other sources to supplement fee revenues. This is because the benefits associated with these goods are such that beneficiaries can enjoy them without paying for them. For example, it is difficult to charge people in a community for the benefits of lower contagion risk associated with inoculating their neighbors' children. Similarly, the benefits of cleaner air, lower crime, or more informed citizens that may result from the programs of particular nonprofit organizations accrue collectively to various groups of beneficiaries whose individual members would be difficult to identify or charge. As a result, substantial “free riding” occurs when people are asked to pay voluntarily.

Nonetheless, people do contribute voluntarily to nonprofits for services they care about. The challenge to nonprofits is to find ways to overcome free riding as much as possible so that beneficiary and donor groups come as close to contributing levels commensurate with the benefits they receive. Those benefits, related to the reasons that people do give, are several-fold. Research shows that people are both altruistic and self-serving in their giving behavior, that is, they value both public and private benefits from giving (Vesterlund, 2006). To the extent that donors care directly about the level of output a nonprofit provides, they are being altruistic, giving simply to ensure that those services are provided in sufficient quantity. Donors also receive personal satisfaction from the act of giving itself, sometimes called “warm glow.” In this case, donors give irrespective of the nonprofit's level of service in amounts that reflect their personal satisfaction (Andreoni, 1990).

In order for nonprofits to be effective in raising charitable contributions from individual donors, they must build strategies based on these diverse motivations. They can appeal to altruism by measuring, describing, and communicating the level, quantity, and effectiveness of the services they perform, and they can appeal to warm glow by communicating the virtue of their work, the good reputation of the organization, the good feelings associated with giving, and by recognizing donors' particular contributions. Long ago, Mancur Olson (1965) identified several distinct strategies for overcoming free riding in the case of public goods. One of these strategies, which he called “selective incentives,” would appeal to the warm glow and other selfish motives of donor and beneficiaries by tying private rewards (special gifts, naming rights, membership privileges, and so on) to gift giving. Another strategy, social pressure, would exploit the power of small groups and public exposure to encourage, perhaps intimidate, donors and beneficiaries to give their fair share. Such strategies are common in church congregations and on boards of directors of prestigious or well-respected nonprofit institutions. The social network effect associated with online giving and crowdfunding, when fans of organizations on social networking sites encourage each other to give (Saxton and Wang, 2014), is also an example of social pressure.

In sum, there are several steps nonprofit managers and development officers can take in order to enhance individual giving as much as possible. These include identifying those groups of beneficiaries and potential donors who care about the collective (public and redistributional) benefits the organization is producing, understanding and appealing to the motivations of these groups, and devising strategies to overcome the tendency to free ride on the contributions of others. Just as fee revenue has its transactions costs, development efforts to secure contributions involve fundraising costs. A sensible way for a nonprofit to view its fundraising program is to conceive of it as a profit-making business whose purpose is to maximize net revenues. Like any business, this entails some investment in the form of fundraising expenses to identify and communicate with current and potential donors. An important question is how much a nonprofit should spend on its fundraising operation. Viewed as a profit-maximizing business, an economist would say: continue to invest until the last dollar of expense produces at least a dollar in raised revenue (Young and Steinberg, 1995). Spending any less would forfeit potential additional net contributed revenue; spending any more would entail spending some (marginal) dollars for less than a dollar in return.

As simple as the above rule is, nonprofits commonly violate it because of certain commonly accepted practices. One such practice is to set an arbitrary fundraising goal and spend whatever it takes to reach that goal. Obviously, if that goal is not carefully calibrated, it can cause the nonprofit to over- or under-spend on fundraising, perhaps even spend more on fundraising than the goal itself. Another practice is to adhere to specified ratios of fundraising expenses to total expenses (sometimes identified as “good practice” by watchdog agencies such as Charity Navigator or the Wise Giving Alliance) or, worse, to attempt to minimize average fundraising cost within some range of revenue generation. The problem here is that the point of maximum net revenue generation does not necessarily correspond to the point at which specified ratio standards are met. Indeed, the level of optimal fundraising expense will vary widely with the circumstances (for example, field of service, age, size, location) of the nonprofit in question. Thus, nonprofit managers need to use careful judgment and basic economic principles to determine how much they can raise in the form of individual charitable contributions, rather than strictly adhere to arbitrarily specified goals or ratios.

Institutional Giving

According to Giving USA, 80 percent of charitable giving comes from individuals, yet the remaining 20 percent from foundations and corporations can be very important to nonprofit organizations. Although there are more than one hundred thousand foundations in the United States, and many additional corporate giving programs not formalized as separate foundations, the largest of these institutional philanthropies are the most visible, focused, and assertive in their giving. Thus, they are the natural targets for nonprofits seeking charitable support. However, institutional givers are not entirely similar to individual donors, although there are some common attributes. In particular, the many small foundations (including family foundations) and some larger ones are essentially the institutional personifications of their benefactors, who have found it to be efficient to channel their giving through the foundation structure. Moreover, much of the funding by community foundations takes place through “donor-advised funds” that essentially manifest the giving preferences of their individual donors. The same observation applies even more strongly to giving by the charitable funds administered by securities firms such as Fidelity or Schwab.

One variety of institutional philanthropy takes the form of foundations that can be viewed essentially as nonprofit organizations with their own articulated missions, but which have chosen to pursue those missions by making grants. In some sense, these are nonprofits that simply outsource the implementation of their missions through operating nonprofit grantees. As a consequence, nonprofits seeking support from such philanthropies need to propose projects and programs that promulgate those missions, one hopes without distorting their own missions. Many institutional funders, however, have broad missions and programs that may accommodate a wide variety of nonprofit proposals. Nonetheless, there are again serious transactions costs associated with searching for appropriate potential institutional funders, cultivating relationships with program officers, staff consultants, or board members and engaging in the procedures, negotiations, and implementation and evaluation processes required by those funders. These costs vary widely from funder to funder.

Given the relatively small role that institutional philanthropy plays in the overall financing of nonprofit organizations in the United States (20 percent of the approximately 13 percent of nonprofit funding that is accounted for by charitable giving, or 2.6 percent of the total), it is not surprising that institutional funders prefer to make strategic grants rather than be relied upon as sources of ongoing operational support. Thus, foundation grants tend to be time limited and focused on particular project initiatives and contingent on an overall plan for the nonprofit to sustain the initiative over the longer run from other sources. There are many exceptions to this pattern, of course, and foundations have been criticized for failing to provide ongoing infrastructure support for nonprofits. One variant that addresses some of this criticism is an approach called “venture philanthropy” under which institutional funders make intensive and ongoing investments in selected nonprofit organizations, and then maintain intensive oversight and support of those organizations, at least until it is clear that they can make it effectively on their own or are judged to have failed.

An important distinction should be made between funding by private independent foundations or public charities, such as community foundations on the one hand, and corporate philanthropy on the other. Internal corporate giving programs and many separately incorporated corporate foundations that maintain close ties to the mother corporation must be understood within the overall context of corporate strategy. Corporations can derive many benefits from their relationships with nonprofits and charitable causes, and most corporations have these in mind as they engage in charitable giving. Such benefits include improved public and community relations, enhanced employee morale, greater effectiveness in marketing their products and services, opportunities to cultivate new markets among nonprofit stakeholders, obtaining access to expertise and knowledge that the nonprofit may harbor, and tax benefits. These are the kinds of “exchange” benefits corporations can derive for themselves by supporting nonprofits.

The trick to securing corporate support is to find a corporate relationship with the right “strategic fit” wherein the needs of the nonprofit and those of the corporation are both met (that is, a mutually satisfactory exchange of benefits can be arranged). Nonprofits may receive monetary and valuable in-kind support, including, for example, valuable public exposure through a corporation's marketing program, in exchange for some combination of the above-mentioned benefits to the corporation. In this negotiation, the nonprofit needs to think about what exchange benefits are of value to the corporation and to pitch its proposals accordingly. There is risk in this exchange, of course, if the negotiated arrangements damage the reputation of the nonprofit or somehow undermine its mission. For example, nonprofits must be wary of endorsing corporate products that may be harmful or fail to best serve their stakeholders. Thus, the American Cancer Society or the American Lung Association can be comfortable associating themselves with manufacturers of tobacco patches, but they would err by endorsing a particular brand because other brands may ultimately prove to be superior. In fact, SmithKline Beecham Consumer Healthcare, which licensed the American Cancer Society's name and logo for smoking cessation products in 1996, eventually settled with twelve state attorneys general in 1998 due to the misrepresentation that the nonprofit endorsed the products (Daw, 2006). Although there were no financial consequences for the American Cancer Society, this example suggests the possibility of negative reputational impacts from corporate support.

In summary, support from institutional philanthropy requires awareness of the needs and goals of the funders. In the cases of independent and community foundations, the issues are likely to be compatibility with the charitable missions of those institutions and planning for long-term sustainability once the initial grants are expended. For corporate funding, the objective is to find the appropriate strategic partnership that serves the purposes (provides the exchange benefits) to both parties in the transaction.

Government Funding

Approximately one-third of nonprofit funding derives from government in the form of contracts and grants of various kinds. Like charitable giving, the rationale for government funding derives from the public or redistributional nature of some of the goods and services delivered by nonprofit organizations. In particular, a third strategy for overcoming the free rider problem in providing collective goods is for the government to apply coercion through taxation. For goods and services that entail widespread public benefits or widely supported redistributional goals, there may be a political consensus for government to support these services through legislation. Ultimately, government may choose either to deliver these services itself or to outsource them to private delivery agents, commonly nonprofit organizations. This is the American system of “third-party government” described by Salamon (1987), which permits government to exploit efficiencies and diversity in private provision while assuring adequate resource support. Chapter Twenty of this volume addresses the issues of government contracting in great depth.

From the nonprofit viewpoint, seeking government funding is appropriate for support of programs and services for which there are widespread public benefits and existing or potential statutory programs available for funding. This is largely the case in areas such as human services, education, health care, and environmental conservation, but less so for expressive activities such as the arts or religion, where there is less consensus.

As with other sources of funds, government support comes with certain risks, challenges, and costs. Substantial transaction costs are often associated with building and maintaining the necessary capacity, skills, and political acumen to navigate governmental systems of funding eligibility and maintaining mandated reporting and evaluation procedures. New governmental policies and changes to existing policies have the potential to significantly impact the funding and operations of nonprofits. For instance, the 2010 Affordable Care Act requires nonprofit hospitals to have explicit financial assistance policies, limit the amounts charged to financially needy patients, determine financial assistance of needy patients before taking collection actions, and to conduct community health needs assessments. If the hospitals do not meet these requirements, they face an excise tax (www.irs.gov). Governments also have a reputation for slow payment of their bills, requiring nonprofits to set aside working capital to manage cash flow.

A number of other, more subtle, risks are also sometimes associated with government funding. For example, given the substantial investment that nonprofits receiving government funding must make in administrative infrastructure and in meeting government service standards, there is the risk that a nonprofit will become heavily professionalized and lose some of its voluntary spirit and indeed become less attractive to volunteers or effective paid workers who lack the formal credentials that government may require. Moreover, government funding may “crowd out” private contributions if donors perceive that the recipient nonprofits no longer require as much in charitable assistance (Andreoni and Payne, 2003). There is also the possibility, however, that government funding, especially if it is properly structured in the form of matching requirements, can induce a “crowd in” of additional private contributions (Okten and Weisbrod, 2000). Finally, substantial dependence on government funding may run the risk of “mission drift” wherein the nonprofit essentially loses its own sense of direction and assumes the role of a government contractor, foregoing its own autonomy and independence (Smith and Lipsky, 1993). One manifestation of this may be increased reluctance of the nonprofit to engage in advocacy work if such activity causes friction with its government benefactors. In addition, dependence on government funding may cause financial problems for nonprofits as a result of government delays in payments and failure to cover full costs of contracts (Boris, de Leon, Roeger, and Nikolova, 2010).

Of course, the foregoing risks are likely to vary with the different forms of government support. The strings are looser on grants than contracts, and payments in the form of vouchers, tax credits, or per capita subsidies attached to service consumers are likely to be even less constraining. These constraints associated with each form of government support may positively or negatively influence program performance (Sandfort, Selden, and Sowa, 2008), so seeking government revenue should be a deliberate decision. In general, it makes sense for nonprofits to seek out government assistance when it provides services with widespread public or redistributional benefits or positive externalities that are supported by government programs, and where fee income and private charitable contributions are unlikely to support efficient levels of service provision.

Investment Income

Income from investments constitutes a category of support for nonprofits somewhat different from other sources because it is not generally directly associated with particular services and benefits. Investment income comes in the form of interest and dividends on nonprofit funds, ranging from interest on operating funds to investment returns on endowments or other restricted funds (Bowman, Keating, and Hager, 2007). As such, funds from investments provide flexibility for nonprofits because they do not generally require appealing to a particular beneficiary group or providing a particular kind of service or benefit. However, this statement requires a number of qualifications. First, the principals or corpuses of investment funds from which returns are derived must come from somewhere.

For example, they may accrue from accumulated operating surpluses derived from fee income and annual charitable contributions. Typically, endowments are put in place through capital gifts by living donors or through bequests. As such, the building of investment income requires appealing to the beneficiaries of these sources of capital, along the lines discussed earlier.

In addition, there are some forms of investment income that are tied more directly to services, benefits, and beneficiaries—namely program-related investments (PRIs). PRIs are generally the domain of grantmaking foundations. They entail loans or other investments of the corpus of foundation funds in activities that have a direct mission impact but that also provide a financial return. For example, a foundation can provide low-interest loans to nonprofits starting up a new commercial venture, say a restaurant, intended to employ inner-city youth. PRIs may also be appealing for larger operating nonprofits. For example, a large children's hospital may wish to loan funds to the local children's museum for a project that educates children and families about nutrition and preventive health practices, on the theory that such an investment contributes both revenue to the hospital and advances its mission of improving children's health. The use of PRIs dates back to the 1960s, but PRIs have increased in popularity since the late 1990s, although less than 1 percent of foundations make PRIs (Osili et al., 2013).

As discussed as follows, investment income can have an important role to play in a nonprofit organization's overall income portfolio by allowing for stable production of goods and services (Fisman and Hubbard, 2003). Investment income can aid risk management and help cover shortfalls due to potential instability of future revenue and costs. In particular, investment income can aid production smoothing when there are large fixed costs (Bowman, 2007). For example, costs associated with maintaining large physical plants or core staff may be difficult to fully finance from other forms of operating income that depend more directly on the level of output that the organization can produce. Frequently, nonprofits restrict use of returns on endowment funds to particular long-term fixed costs, such as building maintenance, student scholarship support, endowed chairs for professorships or curator positions, and so on. Nonprofits may also want to build endowments to assure benefits for future generations or to exploit tax incentives that yield higher investment returns for nonprofits compared to corporations (Hansmann, 1990).

Endowments intended to generate steady streams of operating income also entail some challenges and risks. First, as recent experience has shown, investment revenues, despite their presumed immunity from the day-to-day volatility of service provision, can exhibit substantial instability over time. They also entail transactions costs in the form of competent investment management, and they are subject to the systemic risks associated with downturns in the stock market and the economy at large, as experienced in the Great Recession of 2008–2010. Older and larger nonprofits, as well as private foundations, are more likely to earn higher investment returns compared to other nonprofit organizations, which speaks to the importance of investment management experience and financial know-how (Heutel and Zeckhauser, 2014). Moreover, endowments are often raised for specific projects and facilities that can involve significant additional operating costs. In particular, it is often attractive for donors to contribute endowments for a new building or program facility, or for hiring a prestigious new professorship named in their honor. These projects entail ongoing maintenance and support costs that the donor is often uninterested in covering. Indeed, sometimes donors prefer to give “challenge grants” that require nonprofits to raise additional capital from other donors and also cover the increased operating costs of the new project. For nonprofits, this is a matter of looking gift horses in the mouth. What can appear to be an attractive, prestigious, and generous gift can easily become an albatross that threatens the entire organization. Prudent negotiations with donors of endowment capital require that the ancillary fixed costs associated with capital projects are part of the financing package. The recent Kroc gift to the Salvation Army for the construction of a series of new community centers is an interesting case in point (Strom, 2009). The gift included endowments equal to the cost of construction of each center, intended to generate revenues to cover shortfalls between operating revenues and costs. However, the endowments proved inadequate and required the Salvation Army to raise additional funds.

Volunteer and In-Kind Contributions

A major portion of the income support for nonprofit organizations in the United States comes in the form of nonmonetary or in-kind contributions, most of that in the guise of volunteer labor. It is reasonably estimated that the value of such labor is roughly equal to the value of monetary charitable contributions to nonprofit organizations. The Urban Institute estimates the 2013 value of volunteer labor to be $163 billion, or 10 percent of total nonprofit revenue. Thus, although these forms of income do not normally appear in the financial statements or tax forms of nonprofit organizations, they do constitute significant resources that nonprofits should take into account in developing, managing, and planning their finances.

As with other sources of income, in-kind support entails substantial transactions costs. For material contributions such as art collections, real estate, automobiles, furniture, computers, or perishables such as food or supplies, there are several issues: maintenance and operating costs, compatibility of use in the organization's operations, and liquidity (Gray, 2007). In short, gifts-in-kind are not necessarily net gains to the organization unless their benefits exceed their maintenance or operating costs, or they can be easily used without excessive adjustment or loss of quality in operations, or they can be profitably sold for cash. Still, handled well, gifts-in-kind can be valuable contributions to nonprofit income.

Appropriate contributions of art can add substantially to a museum's mission, contributed real estate in areas where real estate values are rising can become an important part of an organization's asset portfolio or might contribute directly to the mission of an environmental organization wishing to protect a rural area from overdevelopment, and receipt of used cars can provide a source of resale income or economical replacements for cars in a nonprofit's existing fleet. Motivations of individual donors vary from needing to dispose of unwanted but functional items to seeking to preserve cherished collections to receiving tax benefits more or less equivalent to selling items directly. (As to the latter, it is important for nonprofits to be prudent in offering donors a fair market estimate of the value of the gift to avoid the taint of a tax scam.) For corporate gifts, there is the additional motivation for companies to provide visibility to their products, with the possible benefit of expanding future markets. Gifts of pharmaceuticals to health clinics or computers to schools allow manufacturers to expose future paying consumers to their products. In this sense, in-kind income, particularly from corporations, involves the generation of exchange benefits wherein both donor and recipient nonprofit purposes should be well served.

Similar considerations apply to volunteering (Leete, 2006). People volunteer with nonprofit organizations for a variety of reasons, and nonprofits must employ them prudently if volunteering is to be an effective addition to an organization's income. Here again, nonprofits may be viewed as exchanging various benefits to secure the resources that volunteers provide. For volunteers, these benefits may span the range from pure altruism in wanting to advance the charitable work of the organization to various private benefits, including warm glow, experience gained that may prove useful in future paid work, social benefits of interaction with other individuals in the workplace, free or reduced-cost access to the organization's services (such as the opportunity to hear concerts or attend classes), and nonmonetary recognition of a job well done.

The transactions costs associated with volunteering are also multidimensional. Resources must be devoted to managing volunteers, including their recruitment, screening, assignment to tasks, training, monitoring, evaluation, and coordination with other members of the workforce. (See Chapter Twenty-Four of this volume for a substantive discussion of the process of volunteer management.) Preston (2007) makes an interesting distinction between two classes of volunteers—those whose work complements those of paid workers and those whose work can substitute for that of paid workers. In the latter case, volunteers offer a financial savings to the organization and do not require extensive coordination with other (paid) workers. In the former case, volunteers can increase the productivity of paid workers; however, they may also generate extra costs associated with properly coordinating them with the paid work staff. (This can be problematic if volunteer schedules are irregular or unpredictable.) In short, volunteers are not free, and nonprofit managers must ensure that they are accepted and utilized prudently in order for their contributions to represent net additions to the organization's resources.

Mission Effectiveness

The advantage of analyzing benefits and beneficiaries is that it will help nonprofits avoid leaving money on the table from beneficiaries who might provide the resources to allow them to expand to an optimal scale for providing maximum net social benefits. This applies to both the private and public benefits a nonprofit may produce and may finance through alternative mechanisms. In theory a nonprofit should continue to expand as long as the marginal benefits, as reflected in additional revenues from beneficiaries, at least offset additional costs of expansion.

Solvency

As previously noted, some sources of support are more difficult to garner than others. In particular, free-rider effects may preclude a nonprofit from fully exploiting the willingness to pay of beneficiaries of the public benefits it provides. In order to finance those benefits, adjustments may be needed in its finance portfolio, such as the generation of investment revenues or the undertaking of commercial ventures that can compensate for free-rider losses. Essentially, nonprofits are private organizations producing a combination of private and public benefits. As such they must ensure that their financial bottom lines are sound.

One additional factor affecting solvency is the problem of cash flow. If the nonprofit depends on revenues that are episodic in nature, it will need ways to even the flow of income so as to be able to pay its expenses on a regular basis. There are various ways of addressing this issue, including prudent borrowing and building up a working capital fund that can be depleted and replenished as income flows permit. Another approach is to seek alternative sources of income with different time profiles. For example, tuition payments and alumni gifts may flow into a nonprofit school at different times, thus helping smooth the flow of income over the course of a year.

Income Interactions

By pursuing benefit-related income from one source, losses or gains may be incurred in another. This is the so-called “crowding out” or “crowding in” noted above in connection with government funding. Crowding effects may also manifest themselves with other combinations of income, such as fee revenues crowding out charitable contributions (Kingma, 1995). It is also possible for individual sources of fee revenue to cause different crowding effects on each other (Wicker, Breuer, and Hennigs, 2012). This requires awareness on the part of nonprofit managers as they pursue one source of income at the possible expense of another. As such it may limit the degree to which additional sources of income can be productively pursued, or it may require an educational initiative to explain to resource providers why substitutions are undesirable. Alternatively, revenue interactions may provide opportunities for synergy if, for example, donors are encouraged by organizational efforts to increase earned income, or if government programs match income from other sources.

Organizational Capacity

The seriousness of transaction-cost issues associated with administering different sources of income may depend on the maturity, size, and sophistication of the particular nonprofit organization. A small or young organization may not be capable of handling more than one type of income source. For example, it may know how to collect donations from individuals through an annual campaign or special event, but may be clueless in applying for a government grant. As organizations grow and mature, they can acquire additional capacities and skills to enable effective administration of multiple sources of income. In general, larger nonprofit organizations tend to have more diversified income portfolios, partly for this reason.

Risk Management

In the management of financial investments, diversification is a key strategy of risk management. So-called unsystematic risk can be reduced for any given level of investment return by diversifying investments whose fluctuations are uncorrelated or weakly correlated over time. The same principle applies to nonprofits, since fee, gift, government, investment, and in-kind income do not vary exactly in tandem over time (that is, they are imperfectly correlated). This can provide a measure of safety for nonprofits that would be at greater risk if they depended on only a single source. In particular, drawing on multiple streams of income can contribute to revenue stability (Mayer, Wang, Egginton, and Flint, 2012). Thus, within the parameters and limitations discussed earlier, it is desirable for nonprofits to diversify their sources of income, both among broad categories of income such as fees versus contributions, and also within categories, for example, by engaging a variety of different donors or corporate sponsors.

There are limits to this strategy, however. First, not all financial risk to nonprofit organizations is unsystematic. The economic downturn of 2008–2010 illustrates that when there is a fundamental deterioration of the overall economy, multiple sources of support can be affected deeply and simultaneously. This has been the case with charitable contributions, government funding and investment income, and to a certain extent earned income as well. However, these sources have not been perfectly correlated so that delays in reductions in foundation funding and other charitable contributions have helped ease the initial shocks to nonprofits. Moreover, the crisis has led to a rise in volunteering and to increases in certain manifestations of fee income, such as tuitions to lower-cost educational institutions as a result of people going back to school or moving from higher- to lower-cost colleges and universities. And although revenue diversification may help stabilize revenue, concentrated income portfolios may allow higher long-term revenue growth (Chikoto and Neely, 2013). The decision to diversify should then be based on stability, growth, and other considerations

For instance, diversification may undermine another source of potential stability for nonprofits—the development of deep relationships with funders. The premise here is that putting most of your eggs in the right basket, such as government social service programs that are unlikely to be diminished (such as Medicare or Medicaid) can be an effective risk management strategy (Grønbjerg, 1993). However, recent experiences with federal, state, and local governments struggling with their budgets raise doubts about the efficacy of this strategy.

In addition to income diversification, nonprofits can manage their financial risk in other ways. For example, developing various types of funds can help provide stability (Bowman, 2007). A reserve fund that socks away six months or a year's worth of operating income in anticipation of a future period of scarcity is a wise precaution assuming it is invested in safe securities. More generally, endowment funds, although they are intended for other purposes, can provide a modicum of stability. Endowments offer a steady source of income unconnected with the success of the nonprofit's program side (and sources of income associated with those programs). However, even a prudent investment strategy may not withstand the kind of market turmoil recently experienced. Even the financial investment wizards at Harvard and Yale experienced 30 to 40 percent losses of endowment value in the recent downturn. Still, endowments provide other safety features as well, including an increased capacity to borrow in hard times, given the asset value that endowments represent. In dire circumstances, it may be assumed that endowments can be invaded to secure debt or cover operating deficits. This is a dangerous practice, however, which has led to the demise, or severely threatened the viability, of once healthy and prestigious institutions such as the New York City Opera (Stewart, 2013)) and the New York Historical Society (Guthrie, 1996).