McKinsey Study Shows Stunning Lapse in Logic

In this month’s issue of Harvard Business Review, Bill Bradley, the former New Jersey senator, and two of his colleagues at McKinsey & Company claim that simply by improving their management practices, nonprofit organizations could generate $100-billion to serve society. Were it not for the damage likely to be caused by the sensationalism of the article, it might simply be dismissed as theater of the absurd.

The authors’ assertion that nonprofit groups have the power to free up enough money “to give every high school graduate in the country a $40,000 scholarship” will hurt charities when they turn to the public for support. It also is likely to fuel an investigatory zeal among members of Congress who seem eager to seize on stories of abuses in the nonprofit world to turn attention away from their own bumbling of the public interest.

It is not surprising that employees of a management-consulting firm see the complex dynamics confronting nonprofit organizations and philanthropic foundations principally as management problems. Nor should it be shocking that they seek technocratic solutions to a profound social and political dilemma. While there is some truth and value in their analyses, McKinsey clearly is serving its own business interests rather than those of the nonprofit world or the public.

Mr. Bradley and his colleagues analyze the nonprofit world with a market mentality; they are not thinking critically about its roles and functions in our democracy. They look at the production of charities’ services as if they were consumer commodities. They discount the fact that often nonprofit groups have clients (individuals, neighborhoods, localities, and even causes) with complicated problems that are expensive and difficult to solve, and which often need to be dealt with concurrently in many different ways. Further, they ignore advocacy groups addressing the environment, family health, minorities and the disenfranchised, and a universe of other issues important to various segments of the public.

A careful analysis shows the flaws that run throughout the article:

Program costs. On its biggest- ticket item and in perhaps its most simple-minded argument, the McKinsey article claims that nonprofit groups could pump out $55-billion by reducing program costs. They come to that conclusion by equating “program efficiency” with the cost per client in affiliates of the same national organizations and among organizations with a similar mission. “Poorest” and “star” performers are judged not by the results of their programs, but by program costs.

This notion of nonprofit groups as equivalent to commercial entities, as service manufacturers whose efficiency is measured exclusively by cost per customer or sale, fails to recognize differences between the market and the social arena. Nonprofit services are not mass-production items. The “products” of different organizations, even those in the same network, are appropriately different in context, characteristic, quality, and cost so that they can respond to the needs of clients who often have significantly different problems and concerns.

As an extension of their illogic, the authors dismiss the possibility that any organization with a budget of less than $500,000 (more than 70 percent of nonprofit groups) can become sufficiently more efficient, and they therefore advocate mergers, asset sharing, and various collaborations. Those are not bad ideas on the surface, but other researchers have shown such amalgamation into larger entities has very real costs to the involved charities, the cities and towns they serve, and society as a whole.

Fund raising. The McKinsey authors suggest that charities could save about $25-billion a year if they would better manage their appeals to individuals, businesses, and foundations. They contend that nonprofit groups are inefficient for “soliciting large volumes of tiny contributions” and competing with one another for a “finite pool” of donor dollars. Displaying a stunning absence of common sense, they contrast nonprofit groups’ fund-raising efficiency with that of businesses raising funds in capital markets.

As a way to be more efficient, the authors propose that charities give more emphasis to online fund raising. That will undoubtedly reduce the costs of solicitations, but McKinsey does not make clear how online appeals reduce the problem of lots of tiny donations nor do they recognize that not all causes and all potential donors are equally well served through the same types of solicitation media.

While donations made via the Internet are often more substantial than those made in response to a direct-mail appeal or telephone pitch, very few major gifts are made online. Further, some charities believe online appeals quite likely will diminish opportunities for educating donors, building relationships, and increasing the involvement of donors.

McKinsey also suggests that more big donors be encouraged to centralize their money in professionally managed donor-advised funds rather than in smaller foundations. They do not even think about what that would mean ultimately for erosion in diversity of interest, knowledge of locality, and responsive expertise more likely to come through a larger number of donors.

Similarly, they urge foundations to distribute larger, even multimillion-dollar, grants. They give no thought to the fact that doing so would lead to a further concentration of wealth in fewer and fewer nonprofit organizations or to the implications of such a result. The top 5 percent of charities already account for about 80 percent of total nonprofit revenue and assets; the bottom 80 percent for about 5 percent.

Administrative spending. Becoming more modest in their ambition, the authors suggest that $7 billion could be saved by trimming nonprofits’ administrative costs. Here, again, performance is assessed only by cost comparison. It can be improved, the article argues, by sharing back-office functions among local organizations and undertaking other management efficiencies (perhaps with the help of McKinsey’s management consultants).

Effectiveness. The article also argues that both individual organizations and the nonprofit world as a whole would produce “the equivalent of $20-billion per year” if it “increased the social benefit it delivered by a mere 1 percent (however that might be measured).” To force charities to become more effective, McKinsey suggests that donors support only those organizations “with a proven record of success” to “squeeze out” the others, to “bring ‘market forces’ to bear” on charities.

Once again, McKinsey inappropriately applies commercial logic and fails to understand or appreciate the full dimensions of the nonprofit world and what we, as a society, expect from it.

The authors are unmindful that such criteria for donors will discourage them from supporting vanguard charities that risk failure and experiment with new program approaches.

Organizations that work for long-term change instead of short-term deliverables would find it nearly impossible to raise the money they need. Fewer donors would be willing to finance new groups if they had to worry about proven track records, and if that happens, who will pay attention to emerging needs and causes? The difficulty of financing new groups would inevitably narrow the diversity of the nonprofit world and reduce its responsiveness to society’s needs.

Endowments and reserves. The McKinsey report says that nonprofit organizations and foundations could generate an additional $30 billion a year by increasing the share of reserves and endowments they spend each year. Their argument is about “net present value.” To oversimplify, that means that if you spend more to solve a problem today, it will save money later. That is true, but McKinsey should have paid some attention to where nonprofit organizations and foundations spend their money rather than the amount spent today or tomorrow.

The sad truth is that charitable dollars are overwhelmingly directed to providing services to meet immediate, often pressing, needs, to remedy problems but not to solve them. Much too little attention and too few resources are spent on efforts to seek fundamental change.

If the nonprofit world’s money and energy were directed to fighting the ill-informed and mean-spirited public-policy making that prevails today, if malfunctioning governmental institutions — including the democratic process itself — were the focus of structural-change efforts, the “net present value” argument might hold. Simply heeding McKinsey’s call to provide more services to more people at the head of the line right now does not mean we are doing anything to change things for the future. Others will still have to line up behind them later today, tomorrow, and into all the days ahead, given what our government is now doing.

Certainly, it is important to question the wisdom of present-day investments, to debate how much foundations should distribute each year and the extent to which nonprofit groups should build and preserve endowments. The nonprofit world needs countercyclical supporters, those who pitch in more when others bail out. But to suggest that nonprofit groups are hoarding resources is ridiculous. Compared with government and business, nonprofit endowments can yield little.

The principal problems of nonprofit groups today are the problems of how our society is being governed.

Our nation is in the midst of an unprecedented and draconian retreat of government from the provision of public services, from social responsibility. No matter what level of management efficiency and cost-savings the nonprofit world might achieve, it cannot possibly compensate and shoulder the intensifying shift of “social burdens” that even McKinsey notes. Public services are being slashed at the national, state, and local levels, sacrificed to tax cuts that so horrifically favor the wealthy.

All of this is beginning to give greed a bad name, and failing to recognize or acknowledge it renders the McKinsey effort less than helpful. Perhaps the McKinsey consultants are so embedded in a culture of corporate excess and political complicity that they cannot see the different realities known to the nonprofit world. Yet, even with all of the wisdom and talent that Senator Bradley and his colleagues might have been able to muster, and even with all of the sacrifice, talent, and commitment of charities’ employees and volunteers, we will not alleviate the damage now being done to nonprofit organizations and to our nation — that is, not until adequate attention and resources are directed to the real issues of the day.

Mark Rosenman works in Washington as a distinguished public-service professor at Union Institute & University, whose main campus is in Cincinnati.