15 Sep 2008  Research & Ideas

The Coming Transformation of Social Enterprise

A new generation of business leaders and philanthropists is experimenting with hybrid forms of social enterprises while demanding more transparency and accountability from the organizations they are funding. Harvard Business School professor Kash Rangan discusses what he sees as a sector on the brink of transformation. From the HBS Alumni Bulletin. Key concepts include:

  • Social enterprise as an entity is primarily in the business of creating social value, regardless of whether it's for-profit or nonprofit.
  • Venture philanthropy has to come of age and reorient itself by defining what measures of social return it is looking for.
  • Nonprofits creating for-profit enterprises could pose an unnecessary distraction.
  • There may be some consolidation of nonprofits at the top, but the sector will be more vibrant with many new players and actors helping to facilitate the transformation.

 

Professor Kash Rangan is one of the pioneers of Harvard Business School's Social Enterprise Initiative, now 15 years old. Back in 1993, most people took a "spray and pray" approach to philanthropy—writing checks to charities and hoping something would happen. But Rangan and HBS professor Jim Austin, picked by Dean John McArthur to lead the new initiative, saw the potential for research, curriculum, and career development around the challenges of social enterprises, including both nonprofit and for-profit organizations. Over the ensuing years, the initiative flourished as did the nation's social enterprise organizations.

Today, the United States has more than 1.4 million non-profit organizations, and they account for 5 percent of GDP. Annual contributions have grown faster than the economy for years, and experts predict an avalanche of cash ahead. By 2052, an estimated $6 trillion will flow directly to social enterprise organizations. Concurrently, a new generation of business leaders and philanthropists is experimenting with hybrid forms of social enterprises while demanding more transparency and accountability from the organizations they are funding. In Rangan's view, the sector is poised on the brink of transformation, a topic he enthusiastically expounded upon during a recent interview in his Morgan Hall office.

Roger Thompson: The terms "social enterprise" and "nonprofit" seem to be used interchangeably. Are they synonymous?

Kash Rangan: No. There's an important distinction. Very early in the program we decided that we wouldn't focus purely on nonprofits. We thought it should be about social enterprise, regardless of whether it's for-profit or nonprofit. We defined social enterprise as an entity that's primarily in the business of creating social value. As long as an organization creates significant social value, we don't care how it sustains itself—with internally generated surplus or with donor funds.

Americans give roughly $300 billion a year to nonprofits, yet we really don't know much about what charitable organizations actually accomplish. Why aren't nonprofits more accountable and transparent with all this money?

That's a very big issue in this sector because there is no common measure or framework to assess whether these organizations are accomplishing their mission. Even simple measures are not widely reported, like we got X donations, and we took care of 1,000 children at a cost of $80 a child, which is less than $120 a child spent by comparable organizations. Even that amount of reporting would be very useful, but it is not the norm.

By and large the reporting focuses on the costs of raising money. The lower the better, with the logic being that more money can then go to actual programs. So an organization might report, "We spend 6 percent on fundraising, whereas the industry average is 12 to 14 percent." That's typical, but beyond that, we don't know how the other 94 percent is used. How many people came into the program, and what benefits did they get? And then the even bigger question beyond cost efficiency and effectiveness is, what impact did the organization have? Granted it is very complex to get all the way to that level, but even signposts along the way could be very useful.

Q: Which is harder: raising money, building a successful organization, or achieving real impact?

A: They are all interrelated, but raising money is not the hardest of the three. Getting money is hard, but it is not more difficult than the other two. That's why there are over 1.4 million nonprofits, each with some amount of funding.

Putting the money to good use, building a successful organization, showing that you have a demonstrable impact in achieving your mission, and then scaling the organization are the hardest to accomplish. When you show impact, more money will flow in.

Q: Given how few nonprofits can document impact, would you say these organizations suffer from a leadership deficit?

No, I wouldn't put it that way. Many nonprofit leaders are fantastic, more than is acknowledged. They work hard, and they are very passionate about what they do. So I wouldn't call it a leadership deficit. I think there's an imagination deficit.

"I wouldn't call it a leadership deficit. I think there's an imagination deficit."

Leaders typically ask, "Am I accomplishing my program?" But that is too narrow a view. Nonprofit leaders need to be more visionary. They need to stretch themselves more and worry about mission impact. I believe nonprofit leaders get too bogged down in operational issues, be it fundraising, or managing the board, or program execution. They need to be more strategic.

Q: What role can HBS and other business schools play in helping develop the next generation of social enterprise leaders?

A: I don't think the business schools by themselves are going to solve this problem. Whether it's HBS or any other business school, ultimately I think students come to learn how to be leaders in the business arena. Right now 5 percent of our graduates go to work in the nonprofit sector. To expect 20 to 30 percent is asking too much. Maybe we could pump the percentage up to 7 to 10 percent. But at the end of the day, even counting graduates from other business schools, if you produce 2,000 to 3,000 MBAs a year to work in a sector with more than 1.4 million nonprofits, it's just a drop in the bucket. There are huge salary discrepancies as well.

Ultimately our impact lies beyond directly producing leaders for nonprofits. At least half of our graduates between ten and fifteen years out are quite involved with nonprofits. They might not be directly engaged as leaders, but they sit on boards, provide donations, and serve as volunteers. And they can influence and bring about change. That's where the education we impart at HBS is so important. Our approach to social enterprise has broad appeal to students who may not even go to work directly in the sector. Without it, they would always approach nonprofits as philanthropy. I believe our curriculum conditions our graduates to ask the difficult questions on performance, and even go beyond and recall cases, frameworks, and solution approaches. It is quite a different approach to participating in the sector. In a way they become the catalysts for internal change.

Q: Many alumni get involved with corporate social responsibility (CSR) initiatives. Critics of CSR often cite Milton Friedman, who famously said that "the social responsibility of business is to increase profits." Do you agree?

A: I absolutely think it's too narrow a view. In the decade of the '90s, maximizing shareholder value became a corporate mantra. But the notion that the corporation exists only to maximize shareholder value lasted only a decade. It was a historical anomaly. In almost every other decade business leaders have acknowledged that corporations exist within the larger fabric of society. The School's second dean, Wallace Donham, said that the focus of a business is to make a decent profit decently.

Q: Venture philanthropy, which applies principles of venture investing to social enterprises, has become a hot topic lately. Is venture philanthropy a good idea?

A: The first generation of venture philanthropy had its roots in the success of venture capital. Investors were carried away by the notion of gaining economic returns on their investments, not huge returns but some returns, as a way of forcing an efficient use of their capital. The shining example was microfinance, which provided attractive returns, so why not other forms of social enterprise?

I don't think that's a realistic view of the work of nonprofits in general. If you look at social service organizations working at the cutting edge of where markets have failed, the idea of venture philanthropy clicking is a little hard for me to buy into. Venture philanthropy has to come of age and reorient itself by defining what measures of social return it is looking for. In some instances social and economic returns could be correlated, but in many cases they won't. If you are looking for a social and not an economic return, then loyalty to the program rather than an exit strategy may be a better use of funds. The venture philanthropy community has some translation work to do. Right now venture philanthropy is only a small part of the landscape.

Q: Another hot topic in the nonprofit world is the idea of creating a for-profit business to help underwrite the cost of operations. Is this the way to go to secure a reliable stream of funds?

A: I don't think so. There's a lot of charitable money available. Family foundations now number more than 34,000, an increase of 22 percent between 2001 and 2005. Big foundations have more money in their endowments than they can give away. And there is an intergenerational transfer estimated at $6 trillion over the next fifty years specifically earmarked for social enterprises. None of these sources of money is actually looking for an economic return. They're definitely looking for a social return. That being the case, I don't think that nonprofits should quickly jump at creating for-profit enterprises. In certain segments like health care, and even arts and culture, it might make sense when the for-profit and nonprofit parts are tightly linked by a common purpose or platform. For example, in health care several very successful social entrepreneurs have created a hybrid model where paying clients subsidize the "free" clients. The whole organization, however, is doing only one thing, eye surgery or heart surgery or orthopedic surgery and so on.

But to think that an environmental organization could sustain itself by selling mugs and T-shirts is a bit of a stretch. It is not that hard to put together a for-profit arm, but to have it be a significant contributor to the core mission requires considerable strategic work. It may not be possible for a vast majority of organizations in this space. It could be an unnecessary distraction.

Q: Where do you see social enterprise heading over the next decade?

A: I am an optimist, and I believe we will see refreshing changes in that time frame. The new cadre of donors, the new family foundations, the folks who are involved in venture philanthropy, the new generation of entrepreneurs, and business leaders engaged in corporate social responsibility initiatives all will start attacking social issues in a much more disciplined way. Nonprofits too are very adaptive organizations. I expect to see some common understanding in the sector of what performance means, and how social value creation is measured and reported. From there on it is only a matter of aligning the money with the causes they care about. Perhaps investment intermediaries will emerge to ease the introductions and connections. There may be some consolidation of nonprofits at the top, but the sector will be a lot more vibrant with many new players and actors helping to facilitate the transformation.

Reprinted with permission from the HBS Alumni Bulletin.

About the author

Roger Thompson is editor of the HBS Alumni Bulletin.