When nonprofits evaluate their potential to engage in a social enterprise, getting to “no” is not a wrong answer; in fact, deciding not to begin a social enterprise may be more important than getting to yes. The decision of whether or not to launch any social enterprise at all should be the first and overarching concern for any nonprofit thinking of starting its first business enterprise. At a minimum, a new business requires a long-term commitment, a significant financial investment and a willingness to learn to manage effectively in a world driven primarily by market forces. In some cases, the differences between the existing program-driven nonprofit and the new social enterprise are so great that the organization creates a separate management team or spins off the venture into a separate entity. Once a nonprofit makes the decision to create a social enterprise, practitioners emphasize the importance of a serious assessment stage prior to committing to a specific business. Three key elements of this Vision stage are: the enunciation of clear criteria by which a decision will be made, the analysis of information gathered, and the securing of stakeholder buy-in based upon the facts and analysis.
Clear decision-making criteria
It is essential to have a clear set of criteria on which to base the decision of whether to enter a new business. Nonprofits primarily consider criteria associated with their mission, the proposed business’ financial viability, and the fit with their own organization. Social entrepreneurs typically begin by screening each proposed business by its ability to further their social mission: creating needed jobs for their target population. They base their assessments on different combinations of factors such as:
- The labor intensity of the business (the more labor intensive the better for creating entry level jobs)
- Total jobs created for the investment required
- The ability to create “quality jobs”
- The attractiveness of the jobs to the target workforce
- The ability to impart the skills required for a follow-on permanent position
- The attainability of follow-on jobs
- The ease of creating a good “first job environment” for the target workforce
A practitioner may employ one or more of the above factors as an initial screen of business ideas. At the same time, practitioners have clear criteria for evaluating the economics of the businesses they are considering. Although definitions of viability vary widely, each organization examines some aspect of the venture’s financial viability and likely returns. For example, some organizations only look seriously at businesses they believe will cover 100% of their costs. Others are willing to engage in ventures that cover all of the typical costs of doing business but require subsidies for additional program and training costs. Still others consider only businesses that have the potential to generate profits back to the parent nonprofit.
Even when the parent organization already operates social enterprises, it is useful to have standards by which to assess each proposed business’ fit with the nonprofit. Different types of businesses place different demands on human, financial, and infrastructure resources. Similarly, expansions into new locations or related businesses may have organizational ramifications that need to be considered beforehand. For example, a new business location may make it difficult for client employees to access complementary social services offered by the parent nonprofit, creating the need for additional program staff. Or, reaching a new type of customer may require hiring someone whose experience would require a salary far higher than the existing pay scale.
The following list captures some of the major questions current social enterprise leaders ask when investigating the fit of an additional business.
Timing: Does the organization have sufficient resources (human and financial) to devote the significant effort necessary to start up a new business and make it succeed at this point in time? Can the organization (management, board, staff) focus its attention on a new enterprise right now or does this energy need to focus on other programs, other businesses, fundraising, strategic planning etc.?
Leadership: Who will be the social entrepreneur that leads this new business? What role will current senior management play? How can this role be managed given other commitments?
Internal knowledge/expertise needed: What specific skills are needed to start and to run this business? What level of industry, functional and management experience does the venture need to have? How could those needs and the industry standards for compensation and structure fit with the organization’s human resource strategy?
Capital required: How much investment will be required up-front and over the next five years? How much of that capital can the organization invest or realistically obtain from third parties? How will that investment affect other organizational priorities?
Financial risk for the rest of the organization: How much cash would the parent organization need to contribute to the enterprise up-front and over the next five years? Could the nonprofit survive the loss of its total investment and the requirement to pay off accumulated debt? What structures could be put in place to minimize financial exposure (rent vs. buy property, slow expansion, low initial inventory levels, etc.) without jeopardizing the business?
Board readiness for this type of business: How well does the current board understand this business? What specific expertise could individual board members contribute? How does the business fit with the board’s risk profile?
Existence of an established model to follow: Is there any evidence that this business could be successful with the target population? Is it reasonable to believe that a nonprofit has any advantages that would enable it to reach profitability in this business?
According to practitioners who have gone through the process of deciding to start a social enterprise, getting the information to make a good decision requires investigating and analyzing the facts more rigorously than many of them realized when they went through the decision process the first time. Social entrepreneurs often mention a common pitfall of “not really understanding what we were getting into” when they started their first business. When considering later businesses, these same organizations had learned they needed to dig much deeper in order to understand the likely social outcomes, financial resources required, and key levers of profitability before making a commitment.
Social enterprises should carefully examine at least three factors that will affect a proposed business’ capacity to achieve its social goals. First, the nonprofit should consider the potential job opportunity from the perspective of the targeted employee. Then, the organization must research the business sufficiently to understand whether it can support the proposed employment scenario without subsidies or losses. Finally, the decision makers must ensure they have a viable strategy for both attracting the intended employees to the business and helping them reach any longer term goals that are part of the organization’s social mission.
Unlike most businesses, the employees described in a social enterprise’s mission statement are its ultimate clients. The social enterprise must investigate whether the intended beneficiaries of additional employment opportunities would actually value this opportunity. Would members of the target population want to work in the proposed business? What would be the benefits of working for the new business instead of working for existing businesses, enrolling in other programs or other alternatives? How would the proposed positions contribute to employees’ overall objectives, such as escaping poverty, finding a career or providing better for their children? The best way to gather this information is from the source, talking with both individuals from the targeted group and talking in-depth with providers of services.
Social enterprise proponents must next plug their social objectives into the analysis of the viability of the proposed business. First, can the targeted employees execute the required tasks with sufficient quality and efficiency to make the business successful? Will it be able to compete head to head with other companies with more advantaged labor pools? Is the nonprofit comfortable with the mix of client vs. non-client employees needed for the business to break-even? How do the organization’s stated objectives of preparing and training employees for more advanced positions balance with a need for experience and efficiency to keep costs down? Positions that are purposely created to be transitional create additional challenges. For example, is it realistic to achieve industry productivity levels with intentionally higher than average turnover?
Employee compensation is the next issue to analyze. Nonprofits tend to think of themselves as relatively low paying but overall “good employers” and believe in concepts like “a living wage” and health insurance. However, these types of benefits may be far above the standard for entry-level employees in the new venture’s industry. Each organization must take a hard look at the norms for pay and benefits in the industry they are entering in order to decide whether they will be happy with the “quality” of the jobs that they will be able to create. It is nearly impossible to be profitable with a labor force that is both lower skilled and higher paid than those of the competitors.
The links that bring target employees into the business, support them in the work environment, and later help them transition to better employment opportunities are less obvious but also integral pieces of analyzing a business’ potential for social impact. The venture should either be able to identify an existing mechanism for recruiting and screening the targeted employee pool or must include these expenses in its cost structure. Engaging in the Field of Dreams strategy of “build it and they will come” just doesn’t work. Similarly, the organization must research the programmatic support needed for disadvantaged employees to succeed in the businesses and determine how it will be delivered and funded. What support mechanisms will be incorporated in the day-to-day operations of the business? What services can be provided by existing third party organizations? How will using those services affect employees’ schedules, etc.? Ventures that strive to help their employees move on to other positions in the private sector also need to analyze the options and costs for job counseling, job development and job coaching. Rarely will employees be able to take that step fully on their own.
Analysis of the financial viability of a social enterprise is typically the single most important and most challenging type of pre-launch analysis. Social enterprise leaders emphasize the need for a clearly defined business strategy, realistic revenue and cost projections and a focused and thorough analysis.
Wise organizations begin by spelling out their “competitive advantage” in the potential business, i.e. “what makes us think that we are more likely to succeed at this business than everyone else who is already there or may enter the industry and will compete with us for customers?” Fundamentally, a business must be able to offer a better “value proposition” than its competitors from the customer’s perspective and must be able to deliver its product or service cost effectively. To succeed, a social enterprise must be able to identify an advantage that competitors will not be able to easily replicate.
In a sound analysis, an organization verifies that the hypothetical competitive advantage really would exist and explores how much that advantage is likely to be worth. For example, nonprofits frequently overestimate the advantage of their social mission on the revenue side. They assume, for instance, that customers will buy their product because of the good done by the organization. In fact, customers usually only consider social mission after they have decided on more important factors such as:
- “How much do I like this product or service?”
- “Is this a good price?”
- “Is this the highest quality I can get for my dollar?”
- “Is this product or service easy for me to purchase?”
Once the organization has outlined its proposed strategy, professionals in the industry can help an organization realistically estimate what its revenues would be if it were operating a comparable for-profit business. It is imperative to check these and any other sales estimates by assessing the underlying assumptions. For example, “we should sell at least $500,000 in year one because that’s what ‘competitor x’ does” may not stand up when you compare ‘competitor x’s’ foot traffic, long-standing reputation and unique product to your proposed business. The most effective projections tend to be “bottom-up”, e.g. “if we sell 30 products per day in the slow season (an average of three products per hour) at an average price of $19.94 and gross margin of 60%…” with a good sensitivity analysis. However, even bottom-up estimates should be reality checked by quick top-down assessments of gross measures like industry sales per square foot, sales per employee, etc. Accurate revenue forecasting will help your organization understand and be able to meet its cash flow, capital, management, staffing and funding needs over the first several years of the business – or make the decision not to enter the business if it cannot meet those needs.
Smart organizations also realistically assess the costs associated with the proposed business. The most common mistakes of social enterprises are to underestimate the senior management time needed to run a venture and the hidden costs associated with working with the target population. Looking at the organizational structures of comparable for-profit businesses can give insight into the management requirements of a new business (keeping in mind that your for-profit counterpart may be an owner/manager who is willing to put extraordinary effort into the business.) Talking with other social enterprises and analyzing the skill set your employees will need can go a long way in predicting the additional costs you will incur because of your work force and even whether your target employees will likely be able to contribute sufficiently to make the business successful.
A rigorous analysis of the potential of a proposed business is a large undertaking that requires time as well as an understanding of business principles. Because many nonprofit and social enterprise managers are already stretched so thin, they often ask third parties to help them assess a potential venture. Third parties can dedicate their efforts to assessing the business, can bring in additional business experience and potentially even industry knowledge and may be more objective than someone inside of the organization. Outside consultants or interns with business back grounds can provide management and board members with significant leverage.
Nonetheless, practitioners should never turn over the process completely to an outside “expert.” The planning and exploration stage is the point at which the social entrepreneur learns how to engage in appropriate business planning. Social enterprises should view the relationship with consultants as an opportunity for “knowledge transfer,” not simply one of “paying for a plan.” Whether done in-house or with consultants, a strong analysis of the financial potential of a venture highlights the key factors for success in the business. Nonprofit managers can then use this information to understand better their own ability to manage the venture and how to allocate their scarce start-up resources in the areas that will be most critical for early success.