IMHO: Four reasons not-for-profit governance is hard

For those with an interest in governance, being on the board of a not-for-profit (NFP) is a good way to be of service to the community. Less altruistically, it is often recommended as a way to gain experience and as a pathway to more difficult commercial governance roles.

However, after some torrid experiences, and observing others struggle after previously successful commercial positions, I began to suspect that NFP governance might actually be more challenging than commercial governance, even after accounting for the difficulties of their respective sectors.

NFPs seem to have inherent structural issues that make them extra challenging. In particular, NFPs lack crucial feedback loops that are a natural feature of commercial operations.

Feedback loops help to ensure that people and organisations are heading in the right direction and allow necessary changes to be identified and adopted. Since they often challenge the status quo, feedback loops work best when they:

• occur naturally (they don’t have to be invented)

• are difficult to ignore.

Compared to commercial organisations there are some obvious feedback loops that are compromised in NFPs. These include not having customers, not having a profit motive or shareholders, and no clear signal that they are unviable and need to wind up.

Feedback loops:

1. Most NFPs do not have customers

Customers provide direct feedback in that they will either buy what a business offers or they will not. If they pay a price, which enables a profit, this is a signal that the customer's needs are being met. If not, the business will need to adjust and offer products and services at prices customers will pay. 

For most NFPs this feedback loop is absent, or at best hazy, as there is generally no clear connection between those paying for, and those receiving, services. Since recipients are often getting something for free or heavily subsidised, they are almost certainly going to accept what is offered. However, they may not have chosen to accept it if they were paying with their own money. Therefore, NFPs find it difficult to tell what value the recipient really places on the product or service.

Important information is lost because the “customer” is passive rather than actively engaged in the “purchasing” decision. Consequently, there is a significant risk of mismatch between resources and needs.

From a NFP governance perspective, being aware of this dynamic and working with it is a huge challenge. Specific efforts are required to mimic the feedback loop that is missing ie client surveys or stakeholder feedback sessions. However, these will seldom be as effective as the feedback from real customers.

2. NFPs have no profit motive

By definition, NFPs do not have an imperative to make a profit, something generally viewed as a positive. However, profits provide a useful feedback loop.

Profits are not only a form of customer feedback (as discussed above) but they also produce a natural “opportunity cost debate”. Directors are constantly faced with at least two competing options: reinvest profits back into the business to make it more valuable or pay out a dividend for shareholders to use elsewhere.

Consequently, the status quo is always under challenge which goes some way to ensure that resources are used effectively as each option is competing with the other.

Since NFPs do not pay dividends, their only option is to reinvest profits back into the organisation. Therefore, this natural opportunity cost debate disappears.

NFP directors are generally well intentioned and want to do "good things". However, they are missing a natural mechanism that continually challenges their decisions and forces them to choose between two or more “good things”. Consequently, there is often a lot of momentum behind maintaining existing programmes, while changing direction and adopting new, more effective, programmes can take a surprisingly long time.

3. Charities have no shareholders

Not being required to pay dividends to shareholders has obvious benefits, but in practice, it also means that NFPs have weak or non-existent accountability structures. In theory, NFPs are accountable to the trust deed and its intentions. However, a trust deed is unlikely to fire someone for poor performance.

At their best, shareholders are incentivised to make sure directors use the resources of the business well. They will be financially impacted if they do not.

Some NFPs have mechanisms which mimic the role of shareholders (ie stakeholder groups, society members, auditors), but without a direct financial stake, this oversight is unlikely to be as rigorous. Without a personal incentive, will these groups actively identify and demand that hard decisions are made when a NFP requires rescuing?

Shareholders do not guarantee success - businesses still fail after all. And this highlights a fourth feedback loop missing in NFPs.

4. NFPs do not end easily

Businesses have a clear signal when they have completely misread their customers' preferences and are no longer relevant — they run out of money and go bankrupt! Although traumatic for those impacted, from a societal level it allows valuable time and resources to be freed up for use in other endeavours that have more chance of success.

Since NFPs have no shareholders to satisfy, and can limp along using volunteer time, they risk remaining in a perpetual zombie status doing little good while taking up valuable time and resources that the community could better use elsewhere.

Closing a non-performing NFP is not a natural or easy decision and generally takes some brave soul to stand up and do the dirty work. Those that do are true governance heroes and should be applauded for their courage rather than vilified. Unfortunately, the latter is often their fate.

Those who still view missing feedback loops as a curiosity of the NFP sector, rather than a critical challenge, may want to consider a strikingly relevant metaphor for how important feedback loops are – the impacts of the disease leprosy. 

Most will be aware that leprosy is associated with physical disfigurement and has resulted in extreme social exclusion and suffering. Until relatively recently it was believed that leprosy itself caused this disfigurement, giving people “bad skin”. However, disfigurement is now known to be a side effect of the leprosy killing nerve endings and removing the ability for a person to feel pain.

Mimicking feedback loops

Pain is a very effective feedback loop. It tells our body if it has been injured, forcing it to protect itself so that healing can occur. Without pain, people unknowingly cause irreparable damage to their bodies, even after they have been cured.

Pain is particularly effective because it happens naturally, demands immediate and focused attention, and can’t be ignored. Attempts have been made to mimic pain by providing artificial warning systems. While better than nothing, because they can be ignored, they are a poor substitute for pain. Damage and disfigurement can only be prevented by constantly monitoring for signs of injury, and actively adopting protective behaviours. This process is automatic when a person feels pain, not so when it is absent.

NFP governance is inherently difficult for a comparable reason. Rather than responding to natural feedback loops that already exist, NFPs have to both mimic signals that are missing and ensure a response even when they don’t “feel any pain”. NFP Governance requires constant and rigorous attention and an extremely proactive attitude to achieving performance. And this needs to happen constantly.

Commercial governance roles are often treated as more prestigious than NFP roles, but the skill and dedication required to achieve success in a NFP should not be underestimated, especially in absence of commercial feedback loops. While NFP board positions are often uncompensated, given what's involved, they may well be more deserving of reward than many of those in the commercial sector.

More radically, rather than seeing NFP governance as a step towards commercial governance, perhaps it should be seen the other way around. 

About the author

Dr Justin Stevenson PhD, BE (Hons), GDipEcon, GDipBusAdmin, MInstD

Justin has a background in engineering, product development,  economics, and finance. He owns a multi-store, retail business along with running a consultancy, Our Social Dividend, aimed at improving the strategic planning and performance of charities and other not-for-profit organisations. 

The views expressed in this article do not reflect the position of the IoD unless explicitly stated.

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