The Paradox of Profit: The Difference Between For-Profit and Non-Profit Organizations
For-profit and non-profit entities share a similar trait in that both can report revenues exceeding costs over a particular time interval, a phenomenon that is also observed when governments run surpluses. In this sense, each of these institutions earns “profits” in the conventional sense of monetary income exceeding expenditures. However, a closer examination of their organizational structures and objectives reveals important differences between for-profit and non-profit enterprises. The distinction centers around the concept of owner’s equity and the differing goals these entities pursue.
Public for-profit organizations have their operations grounded in the principle of equity maximization. Every investment decision, strategic initiative, and operational move aims to enhance the company’s value on some level, at least in theory. While quarterly earnings are undoubtedly a focus, accruing more assets than liabilities, and increasing this difference over time at an exponential rate, is the more important goal. While there are a variety of ways to assess the worth of a company, the value of a firm ultimately lies in its equity base. For good reason then, management of public for-profit firms focus on maximizing the return to this equity capital, while private for-profit firms typically have similar aims (though the goal may be less explicit and there is more room for other goals to take priority).
By comparison, non-profits operate in an environment typically devoid of equity. They work in a cycle of raising funds and then deploying them. The absence of equity means there’s no organizational value that accumulates over time other than perhaps in terms of brand. Thus, when a non-profit generates a surplus, that surplus typically gets channeled toward some aspect of the non-profit’s mission or toward employee compensation.
A subset of non-profits, those with endowments, stand out as similar in some respects to for-profit ventures. However, the goal of growing an endowment and the goal of pursuing the mission of the non-profit are typically dealt with independently. Regardless, retained earnings, invested in an endowment, can build organizational “capital” as invested assets finance other productive sectors and grow in value.
Raising money is also an important role of non-profits. Moreover, just as employees working for a for-profit company are rewarded with salary increases and bonuses, so too are non-profit employees. This means that financial incentives apply in the non-profit space, perhaps just as strongly as with for-profits. By extension, both for-profit and non-profit workers are open to the temptations of “greed.”
Problematically, non-profits typically lack of as clear an objective as “shareholder value maximization.” To offer a few examples, the United Nations’ goal is to maintain international peace and security, while the World Wildlife Fund’s mission is to conserve nature and reduce threats to biodiversity. Having less objective measures of success and less clear ways of identifying the non-profit’s marginal impact exposes non-profits to risks such as mission creep and the misuse of donor funds. The perpetual need to raise money can also result in a deviation from core objectives.
This does not make non-profit activity not worth pursuing. It does make them less efficient in general. Non-profits’ job is typically harder, their influence less easy to measure, and their opportunities to make a positive difference usually rarer, compared to their for-profit counterparts.
Due to these difficulties, the aspiration of many non-profit workers and government employees should be to effectuate a significant change or implement a critical policy that more than justifies one’s entire tenure or career from a social value perspective. Non-profit employee pay and activities often constitute social waste over any particular short-term interval, but this need not be the case over the long haul.
For example, a single government employee having an innovative idea on a billion-dollar regulation could produce benefits that far outweigh the cumulative lifetime salary of that official. Marginal shifts like these, when affecting large magnitudes, may be the primary way individuals in the non-profit sector have a positive impact.
Revenue generation and expenditures, budget management, and salary and bonus disbursements, are all shared activities across the for-profit and non-profit spaces. Thus, non-profits are incentivized by price signals and guided by them to an extent just as for-profits are. But the end destinations are different. For-profits aim to create value by growing a company’s equity base or distributing profits to be reinvested elsewhere. Non-profits typically don’t grow equity as such. Their value is intrinsically tied to their mission and the broader societal impact they achieve. Without a doubt, many non-profit ventures are worthwhile, but they face distinct challenges compared to for-profits, both with respect to achieving their goals as well as maintaining dedication to their missions.
James Broughel is a Senior Fellow at the Competitive Enterprise Institute with a focus on innovation and dynamism.