MBAX 6850 Week 1 Nonprofit Sector Overview Post Example

Week 1 Discussion: What Makes an Organization Nonprofit

A Literacy Nonprofit Ended the Year $60,000 in the Black and Is Still a Nonprofit: Defining the Sector by Where Surplus Goes, Not by Whether There Is One

Last year Lakeshore Literacy Alliance, a composite adult literacy nonprofit in northeast Ohio where I volunteer as a tutor and sit on the finance committee, ended its fiscal year with a surplus of about $60,000 on a $4 million budget. Several new board members were uneasy, as if a nonprofit had done something wrong by finishing in the black. I think their unease came from the most common definition of the sector, an organization that does not make a profit, and I want to argue that definition is wrong.

A better definition comes from Hansmann (1980), who argued that what distinguishes a nonprofit is not the absence of surplus but the nondistribution constraint: the organization may earn more than it spends, but it may not distribute that surplus to anyone who controls it, such as directors, officers or members. Lakeshore's $60,000 did not go to anyone. It went into an operating reserve that the board had set at three months of expenses, and next year it will pay for tutor training if a grant falls through. By Hansmann's definition, Lakeshore behaved exactly as a nonprofit should.

Hansmann also explained why the form exists. Many of Lakeshore's donors pay for a service they will never see: an adult they will never meet learns to read with a volunteer tutor. Those donors cannot inspect the quality of what they are buying, a situation Hansmann called contract failure. A for-profit tutoring firm would have an incentive to cut quality, since the buyer could not tell; the nondistribution constraint removes much of that incentive, because no one can pocket the savings. That is why donors give to Lakeshore rather than paying a company to tutor strangers.

So my working definition is an organization barred from distributing its surplus to those who control it. Does that definition fit the organizations you know, or are there cases it misses?

Reply to Keisha

Keisha, your hospital system is a nonprofit and earned a large operating margin last year, which you said made you doubt the label. Under the nondistribution definition, the margin itself is not the problem; the question is where it goes. If it funds new facilities and charity care, the system fits the definition. If executive pay is tied to the margin, that starts to look like distribution in another form. Do you know how your system's executive bonuses are calculated?

Reply to Adrian

Adrian, you raised cooperatives, which return surplus to members. That is a useful edge case, because a cooperative distributes earnings to the people who own it, which is exactly what the nondistribution constraint forbids. Weisbrod (1988) treats cooperatives as a separate category for that reason. So by this definition a cooperative is not a nonprofit, even when its purpose is social. Salamon (1987) adds a reminder that the sector's boundaries also follow government funding, since many nonprofits deliver public services under contract, which is another edge worth testing.

References

Hansmann, H. B. (1980). The role of nonprofit enterprise. Yale Law Journal, 89(5), 835-901. https://doi.org/10.2307/796089

Salamon, L. M. (1987). Of market failure, voluntary failure, and third-party government: Toward a theory of government-nonprofit relations in the modern welfare state. Journal of Voluntary Action Research, 16(1-2), 29-49. https://doi.org/10.1177/089976408701600104

Weisbrod, B. A. (1988). The nonprofit economy. Harvard University Press.