Before the 2008 financial crisis public sector funding for the third sector (grants and contracts) had become so prevalent that many charities and social enterprises had, frankly, become overly reliant on funding from local and central government. In some cases they had become totally reliant on public funding with often a very high proportion of that being in one or two large grants or contracts. It’s not surprising that a large number of charities and social enterprises I have worked with want to develop income diversification strategies. This article reflects briefly on a few of the common issues I have encountered.
My first observation is that there were broadly two responses amongst charities to the effects of financial crisis; I call them early responders and the hopeful waiters.
The early responders recognised it was not going to be a short-lived downturn and either had sufficient reserves, or secured funding to invest in changes to enable them not only to weather the storm but, in many cases, to thrive and grow. They invested in various changes including: fundraising capacity; rationalising the back office; marketing and communications; reshaping business/delivery models; staff retraining/restructuring; and impact assessment capability.
The hopeful waiters cut a few costs here and there but otherwise continued as they were, subsidising recurrent deficits from reserves and hoping the downturn would be short enough that they could replenish reserves from future surpluses. Many of these are now in dire straits and many have closed.
An important lesson for the future, therefore, is to keep your finger on the pulse of what is happening and respond early to threats. Better still; turn threats into opportunities by investing in positive change.
Knee jerk reactions
Having said that early response to threats is important, I have seen far too many knee jerk reactions to attempt to diversify income. Often this involves jumping on the latest band-wagon, whether it is setting up a trading arm, seeking social investment or some other approach. Of course, these approaches can and do work for many, but I would counsel to take a little time to make sure the approach is right for your organisation before potentially wasting time and money on fruitless ventures.
Trading (or earned income) can be a good way to develop a sustainable income stream but there are issues to consider before rushing to set up a trading arm, including:
is there a big enough market for your services/products;
will customers pay enough for you to make a surplus to contribute to core costs;
can you differentiate yourself from your competitors to secure market share;
do you need a trading subsidiary anyway (i.e. are you proposing primary purpose trading that can be undertaken through the charity itself); and
do you have available (or can you secure) sufficient funds to forward fund the trading (e.g. marketing, sales, after sales support etc)?
Before starting any trading, it is important to do some research, get expert advice where needed (e.g. governance) and ensure you have the right people to make it a success.
A few years ago this widely misunderstood term was seen as a magic bullet for replacing lost statutory sector funding. Well it wasn’t and isn’t. Social investment is basically an umbrella term for a variety of loan products targeted at the third sector, sometimes (but far from always) backed by Government payment by results contracts. There is no doubt these can work really well but the key feature of most social investments is that the investment needs to be repaid so you must be generating an income stream to make the repayments (e.g. from trading, fundraising or Government payments for results).
The other feature of many social investment products is that the due diligence lenders require can be onerous. This is not necessarily a bad thing; many organisations have found the rigour to be reassuring and a stimulus for positive change in the way they do things. However, it can be, a significant draw on capacity, so you need to be sure you have that capacity available.
All, that said, in the right circumstances social investment can be a very powerful tool (e.g. for start-up funding) and Government and other funders continue to encourage it.
Alternative grant sources
There is no doubt that many charities have turned successfully to grant making trusts, the Lottery and the corporate sector for funding. However, with diminished resources and much more competition this is by no means an obvious funding source for all charities. It can take time and capacity to build relationships to ensure success rate and you need strong evidence of need and impact; it is not simply a case of dashing off a few applications. Getting the capacity, expertise (e.g. research, needs analysis, bid writing and impact assessment etc) and systems in place to maximise your chances of success is vital. With corporate funders it is also essential to be clear about what is in it for them and to be specific about what kind of support you are seeking (cash or in-kind).
Full cost recovery
A critical issue with is to ensure that, at least in the medium term, your income sources are sufficient to cover your core costs. In general this will mean that marginal cost funding (i.e. funding that only covers the direct costs of the activity itself) will not be sustainable and this should only be done after careful consideration of the implications. Therefore, pricing for traded services, bids for grants or contracts etc needs to ensure that each funding stream makes its fair contribution to overheads/core costs.
For trading, this can be challenging because generally it is only possible to charge “what the market will bear” i.e. what customers will pay. So a careful assessment of the costs of developing, selling and delivering each service/product is important to ensure that income not only covers direct costs but contributes to core costs. The key is to ensure that costs are understood and controlled and to have the courage to stop offering products/services that aren’t viable on a full-cost recovery basis.
For grants and contracts, most larger funders now understand there will be a management fee or similar within the costing of a bid to contribute to core costs. How much they will tolerate very much varies. When bidding for contracts, there will often be price competition so a judgement call is required on the overall price. Some funders now use more sophisticated ways of treating overheads in their applications forms, which can be helpful but can also be very difficult to judge do if your future income is uncertain.
Overall, my message is that charities and social enterprises need to understand their full cost base in detail and ensure that across all income there is sufficient contribution to cover core costs, otherwise you will never have the capacity to run your basic core functions, let alone to innovate and grow, and in extremis your organisation may no longer be viable and will close. Managers sometimes need the courage to decline (or not bid for) funding that doesn’t support core costs for the sake of long term sustainability.
Sustainable income diversification
Income diversification is, in my view, essential for all charities and social enterprises to have a long term sustainable future but this shouldn’t mean accepting any funding that comes along or following the latest funding fad. Options should be considered carefully to ensure that they help and not hinder the mission and viability of the organisation. Expert advice or new skills will often be essential to maximise the chances of success.
In the end, no organisation can be “fireproof” when it comes to the impacts of the wider economy. Those that survive and thrive, are almost always those that have their finger on the pulse and plan prudently when times are good to ensure they can respond quickly to threats and turn them into opportunities. The best time to diversify income is when your organisation is relatively financially secure rather than as a fire fighting measure when times are tough, but whenever you do it, do it in a thoughtful and planned way.