In a recent post I surveyed different types of funding models, including nonprofit models such as universities or private foundations, and for-profit models such as startups. Although we need both models, I believe that for-profit models are underrated today. In what follows I will explain some fundamental advantages of the for-profit model.
To understand these advantages and why they are essential, we have to understand the incentives and feedback loops that exist within the for-profit and nonprofit worlds. One framework I use to think about this is a concept I call organizational metabolism.
An organization, like a biological organism, has a metabolism: a core set of processes that keep it alive. These processes provide the resources it needs to act, to grow, and to sustain itself. For an organism, the basic resource is energy, whether from food, sunlight or chemicals. For an organization, the basic resource is money, for payroll and other expenses. Just as an animal must eat, an organization must collect revenue, or die.
Understanding an entity’s metabolism is fundamental to understanding its role within an ecosystem of competing entities and the selective pressures it is under. An entity with a successful metabolism survives and grows; one that fails in its metabolism is eliminated. Over time, through natural selection, an ecosystem becomes dominated by the entities with successful metabolism. Different entities can have different designs and make different choices, but the laws of nature decide which of them thrive.
Metabolism can be represented as a set of feedback loops. Here is the metabolism of a for-profit business:
The main loop is on the right: a business sells a product or service to its customers for a profit. To give birth to a business, investors can put in capital, which must produce a return; this is the loop on the left. Call the right-hand loop the “product loop” and the left-hand the “return loop”.
A business must be profitable over the long term to survive—but any business that makes a profit can survive. Similarly, a business must credibly promise a return to receive investment, and an investor must make a return over the long term to continue investing—but any promising investment can receive capital, and any successful investor can stay in business. And over time, resources accrue to the most scalable and profitable companies, and to the most successful investors.
In contrast, here is the metabolism of a nonprofit organization, such as a charity or foundation:
A nonprofit also typically provides a product to certain beneficiaries, whether clean water for poor rural areas, or a non-rival good such as research for the world at large. Note however that this product loop is not its core metabolic loop. As we will see, the nonprofit product loop is weak, and sometimes broken.
The loop that sustains a nonprofit is its return loop. Donors provide the organization with its revenue. What do they get in exchange? What does the organization have to provide to sustain or grow its revenue?
In theory, donors give because they support the organization’s mission: they want to sustain its product loop. In the best case, the product loop is closed with evidence of value delivered, from data and statistics to testimonials and case studies. This is provided to the donors to close the return loop: objective demonstration of success at the organization’s mission leads to more and larger donations.
Not all donors, however, are this discerning, thoughtful, or well-motivated. A charitable donation is often an emotional choice, fueled by moral sentiment. Donors may not demand, or even care for, evidence of success; they may be more persuaded by pictures and stories that tug at the heartstrings, or by the charisma of the executive director. Or they may be driven by motives less honorable than generosity, such as prestige, status, a public image. In short, donors may care less about doing good than about feeling good or looking good.
To the extent that donations are not driven by proof of effectiveness, the product loop is broken: it is no longer a loop, and it does not matter to the organization’s metabolism. The organization may still provide a valuable service, but if so, this is incidental to its survival, an epiphenomenon. The organization is now in a loop of providing a feeling or a social image to its donors, and as long as it can do that, it can survive indefinitely whether or not it does any good for the world.
It’s possible for a pathology like this to exist in a for-profit business—the nutritional supplements industry is probably an example—but it’s restricted to a subset of products for which it is difficult to make rational buying decisions. And even a supplements company would quickly go out of business if it failed to physically deliver its product into the hands of customers—yet this kind of failure is routine in the nonprofit world, where disaster-relief donations are often discarded and international aid ends up in the pockets of warlords.
Nonprofits can of course be effective and efficient, and some are more so than many businesses—but this happens more by the grace of an executive with courage and integrity, or the rare strategic donor, than by inherent selective pressures.
A second thing to note about these diagrams is that every part of a business’s loops can be measured. On the right, the business can measure costs, sales, and profit; on the left, capital, dividends, and return on investment. From fundamental measures such as these are derived a sophisticated system of financial metrics, and an entire discipline to manage them: accounting.
Financial metrics have a bad reputation; they are the implements of corporate “greed” and are blamed for everything from sweatshops to pollution to securities fraud. A myopic focus on financial metrics can indeed lead to long-term destructive behavior. But used properly, finance is a powerful tool to promote efficiency and effectiveness. It can identify waste, optimize portfolios, and justify long-term investment. Crucially, it can manage risk.
Precise, quantitative risk management is especially important in the allocation of resources to early-stage projects. Along the efficient frontier, risk is correlated with potential reward. A mechanism is needed to provide the investor with a higher rate of return in exchange for funding riskier projects. In debt, this is done with interest rates; in equity, by the mechanism of valuations: higher risk is reflected in lower stock prices. Particularly in the world of venture capital, this means there is a disproportionate reward for being right early—for being the first backer of a promising project at its inception, when risk is highest.
The result is that investors are actively incentivized to embrace contrarian theses: they win biggest when they bet on something that the rest of the world would not, once success is proven over time. I know of no such mechanism or incentive in the nonprofit world, where the incentive for donors is if anything the opposite: to seek out safe, consensus causes, especially to the extent that the donor’s motivation is prestige or social approval.
The weaknesses of the money metabolism come from two key requirements that the nonprofit metabolism does not have. First, you must capture part of the value you create. Second, you must generate a return within the time horizon of investors (about a decade in venture capital). As a result, there is often pressure to fund specific, visible goals rather than completely undirected exploration.
Conversely, the strength of the nonprofit model is its lack of these limitations. It is probably a better way to support, for example, basic research, which tends to explore uncharted territory to generate open, often unpatentable knowledge that leads to economic value only on the timescale of a generation or more. (There are also reasons to believe that nonprofits are better suited for a variety of areas from performing arts to nursing care.)
However, when it is possible, I see great advantages to the for-profit model:
Revenue is as scalable and reliable as demand itself. When your market grows, your revenue grows; as long as your unit economics work out, you can scale supply to meet demand. In a nonprofit, if your market grows, only your expenses grow. Your revenue is at best loosely tied to demand. A charity that donates clean water to poor rural Africans may or may not find enough rich Westerners to pay the bill, but a business that figures out how to sell water to them at a profit will serve as many customers as are willing and able to pay. Again, this is not to say that such a charity should not exist, but simply to point out that it has inherent limitations to scale.
For-profits have the incentives and the metrics to drive effectiveness and efficiency. A charitable donor may not think strategically about how many meals, mosquito nets, or doses of a vaccine can be delivered for their million-dollar donation. Indeed, to the extent they are motivated not by doing good but by feeling good or looking good, they are likely to measure themselves not on the results but on the amount of money they gave, or the portion of their wealth that represents—thus making the fundamental mistake of substituting metrics that measure input for those that measure output. In contrast, a business is constantly driven to serve more customers at lower cost, to expand into new markets and new product lines, to reduce waste, to cancel or overhaul failing programs. (Notable exceptions include many effective altruist organizations, such as Open Philanthropy—notable in part because the strategic thinking they evidence is so rare.)
For-profit investors are more likely to fund high-risk, high-reward experiments. The incentive for investors to seek contrarian theses at the individual level leads to a diversified global portfolio of bets at the ecosystem level. The mechanism of equity, in particular, allows investors to be rewarded proportional to risk, which allows each investor to build a successful portfolio even when many of their bets fail. Given how many crazy-looking, risky experiments turned into breakthrough innovations that transformed the world, a mechanism that funds them when they are overlooked by others is extremely valuable.
These advantages are so great that I submit a bold principle:
Anything that can be for-profit, should be.
Nonprofit organizations should be formed only as a last resort to fill in the gaps where for-profits cannot work.
If a given need cannot be served profitably, then finding ways to make profit possible in that area is even better than serving the need with nonprofit organizations.
Institutions and mechanisms that create opportunities for profit—such as property rights, including intellectual property rights—create enormous value for a society.
Conversely, when profit is prohibited in or drained from an industry, it represents an enormous destruction of value.
As an example, a challenging area of pharmaceutical development is repurposing drugs: discovering that a known drug (which may be off-patent) works for a disease it was not previously known to work for. Patents for this type of use can be difficult to obtain and enforce; better market protection for repurposed drugs would make it more profitable to discover these uses, and pharmaceutical investment would follow.
Conventional thinking says that money is a corrupting influence. We hear calls to get money out of politics, out of health care, out of everything. I believe the opposite.
Money illuminates what is murky. It aligns interests. It keeps people honest. Money is, in fact, one of the greatest forces for social good. Instead of getting money out, we should find ways to bring money and profit into as many areas as possible.
I agree that revenue is a key part of the organizational feedback loop that non-profits do not have, and it's often a problem. However, for-profits have a tendency to turn toward revenue. To the extent that we care about what an organization does for society, we should care about organizational drift caused by chasing revenue. I believe it's an open question whether lack of revenue feedback in non-profits or organizational drift cause by revenue alignment in for-profits is currently a bigger problem in society.
I also think you may be underestimating the type and scope of programmatic evaluation that non-profits do. This is an extremely rich area, the goal of which is to ensure that operations are correctly aligned to the desired outcome. One well-developed part of this is non-financial metrics, for example. "Money coming in" is a very convenient metric with which to measure your success, but it is far from the only plausible feedback signal. If "clicks" are the false god of the attention economy, then revenue is the false god of the financial economy -- in both cases easy to measure, sometimes aligned to value and sometimes not.
Well said. And this middle ground is exactly what I am worried about losing as companies add more AI to their operations -- human managers can and do make many subtle choices that trade profit against other values, but naive algorithmic profit maximization will not. This is why my research is on metrics that may help align commercial AI to pro-social outcomes.
Naive algorithmic anything-optimization will not make those subtle trade-offs. Metric maximization run on humans is already a major failure point of large businesses, and the best an AI that uses metrics can do is draw awareness to the fact that the metrics that don't start out bad become bad over time.
We could look at donors' public materials, for example evaluation requirements listed in grant applications. We could examine the programs of conferences or workshops on philanthropy and see how often this topic is discussed. We could investigate the reports and research literature on this topic. But I don't know how to define enough concern.
Thank you for writing this! I've been harping on something along this axis for a long time to anyone who will listen to me. Now I have something to link them to, which explains this much better than I ever did :)
I agree at a high level, but details matter. Specifically, I'm unsure about the "can" in this recommendation, and I'm a little unsure of the audience for this advice.
Nonprofits are generally formed for topics/services where for-profit services aren't sufficiently (in the minds of the organizers and donors) doing it. That implies that in the factual world, it isn't done (enough) for profit. What counterfactuals are in scope for the "can be" done comparison?
For the nonprofits I know well, there's also an important difference in mission. I like your flywheel circles as an illustration - for-profit organizations align the benefits they provide with the money (on both sides of the wheel): customers are the same entities as beneficiaries. Non-profits provide a non-monetary alignment channel - donors are a different kind of beneficiary than the direct target beneficiary.
The very important "can be for-profit" in your advice SEEMS to expand to "if the beneficiaries can effectively use price signals to influence the organization's behavior". Which matches the real-world pretty well: for-profit when the beneficiaries are concentrated and wealthy enough to consume your service, not-for-profit when the beneficiaries are unable/unwilling to pay.
edit: oh, there's also a class of organizations that are non-profit for regulatory or tax reasons, but operationally have fairly normal revenue streams and relatively little dependency on donations. I count those as for-profit for purposes of this discussion.
another edit: why not both? There are LOTS of segments in which for-profit and non-profit organizations both operate, often with a high degree of overlap of overlap.
As an example, some years ago I had some friends who wanted to create curriculum material, I think aimed at homeschoolers. They were thinking of setting it up as a nonprofit. I counseled them to make it for-profit, because it would force them to find a market and have more impact. They did and told me recently that this made a big difference for them.
But an even bigger lesson here is that we should look for structural barriers to for-profits. This could mean legal changes (e.g., in patent protection); creative new business models that challenge the structure of entire industries; etc.
because it would force them to find a market and have more impact.
If you think nonprofits don't have to find a market (two markets, actually - donors and beneficiaries, which may or may not overlap) and to measure their impact, I suspect you've never worked closely with a serious nonprofit.
When starting out, it's definitely a good idea to be as independent as possible, and that's usually a privately-owned management structure (for-profit, sure, but that designation is a red herring. Startups are profit-irrelevant for the first few releases, and premature outside funding would be as bad a mistake as premature decision to go nonprofit.
After the startup phase, where the founder is a significant part of the labor, the question gets trickier. It depends a lot on your target beneficiary and how much their market power diverges from your mission.
Other than tax implications, what structural barriers do you have in mind which are pushing organizations into non-profit rather than for-profit structures?
I have started nonprofits, and worked closely with others.
I have also seen nonprofits that produce a lot of material that no one reads and that has no impact, but that keep getting donations from donors who aren't paying much attention to impact, or who rationalize away the lack of it.
Examples of structural barriers:
Lack of patent protection, e.g., ability to obtain and enforce patent on repurposed drugs (example I mentioned and linked to in the article)
Regulation: e.g., many health insurance products you might want to create are illegal
Free public alternatives: e.g., it's hard to profit in K–12 education because of public schools, making private school a premium/luxury product for the rich; something like tax credits for private school could alleviate this
Lack of patent protection does not stop a nonprofit from sponsoring research to run a clinical trial for a repurposed drug
Regulation on insurance offerings doesn't stop a nonprofit from paying for people's health care as a charity
Free public schools don't stop a charity from offering an alternative free school
In each case, if a nonprofit wants to offer a product/service, they can do so, but the corresponding opportunities to offer the same product/service on a for-profit basis are prevented by the structural barriers.
Agree that specifics are important here. Some specifically interesting examples to me where non-profit and for-profit models overlap:
A university is set up as a non-profit org, receiving charitable donations from alums and other institutions or individuals. The university's main non-profit activities are education and research. The university also wholly owns a for-profit org (basically, a hedge fund) which is used to manage the university's endowment. edit: actually, an endowment fund also counts as regulatory non-profit if its sole purpose is to fund a non-profit's activity
Mozilla Foundation and Mozilla Corporation. Mozilla Foundation is a non-profit org that also wholly owns the for-profit org Mozilla Corp. Mozilla Foundation's main non-profit activities seem to be internet advocacy and funding other related projects. My impression is that Mozilla Corp. derives most of its income from search engine placement in Firefox, and then Mozilla Foundation is subsequently funded by Mozilla Corp.'s profits. I haven't looked in detail though, so I may be off.
Note that in the above two examples, I've been using the terms "for-profit" and "non-profit" in a primarily regulatory sense, i.e. for-profit = corporation, LP, etc. vs. non-profit = 501(c)(3). In those examples, the terms also seem to map onto their "intentional" sense, but it's unclear what form a general rule might take to disentangle "for-profit" vs "non-profit" in their regulatory vs "intentional" senses.
Technically nonprofit doesn't mean you can't make a profit. It just means you can't distribute that profit, the way a for-profit pays dividends. You have to use any profit for operations.
I was mostly analyzing nonprofits that don't charge for services. In the case of a nonprofit that charges, and does not rely on external donations, then the “product loop” is much more intact. In that case it's only the investor loop, the “return loop” that is still problematic.
That's really important, and I suspect a big source of confusion about your thesis. If you said "if you can find a price signal, incorporate it into your strategy", even for non-profits, I suspect you'd get a lot less disagreement.
Making the assumtion that people do stuff for money migth be in some places reasonable but it predictably stacks the conclusion in favour of profits. When using such alternative means it migth make sense that they have logic/robustness comparable to that of money. But other forms of influence are known to exist. You could think of religious cults love bombing emotionally invest to later have fervous zealots but no money moves.
One of the arrows in the non-profit diagram is a money arrow and it raises a question could it be drawn with no money arrows whatsoever. If you have an important social issue you might be able to launch a political party.
The being right early deploys a form of argument from lack of imagination. Here is one stance to consider whether it informs the issue: It is more socially rewarding to be early in a winning side of a war. It's enough that there are established sayings like "you want to be on the right side of history". Being late on the "right side" is easier and way less pious. But an issue here is that such "rewards" are more nebolous to measure.
Of course people do things for different motivations. But the people who make money (whether or not that is their motivation) are the ones who get to keep doing their thing. So the ecosystem selects for those who make money.
Some person might earn money in one activity ot be able to lose money in another activity. While typically they are tought as being in a job to get a salary and being a product consumer to lose money to get cookie points there is nothing from stopping somenoe to do less consumering and do self-sacrificial other benefitting work.
And money doesn't select people per se. The main way to get money is to buy it from a store. But if you get your food from a source that doesn't require buying then you do not risk your biological metabolism from being interupted if you can't buy food.
Why does war fall outside of the scope? It is a generally touchy kind of thing so let me try to imagine a more standard example. Following fashion trends early nets you more notoriety and it is hard to be in the leading edge of fashion by being a copycat. For consumer level economics the financial costs of clothes is nearly same whether bough in trending phase or after it being settled style. So people buying different clothes risk being strange but get to be trendsetters if their choices end up as the fashion of the day.
Re war, I just didn't analyze that here. It's worth analyzing how that changes selective pressures, and more generally how government organizations fit into this analysis, but I just didn't cover that.
I think “already is” is correct, except where there are barriers: legal, technological, cultural, etc. Remove the barriers (change the law, invent new technology, etc.) and you could open up opportunities for profit.
Where the world at large pays for research results, those fields are privately funded.
The partnership is to begin immediately with the final terms being agreed in the coming weeks. This will allow for rapid vaccination around the world if the COVID-19 vaccine candidate proves to be effective. The vaccine candidate was developed by the University’s Jenner Institute who began trials in humans last week jointly with the University’s Oxford Vaccine Group.
.... AstraZeneca will work with global partners on the international distribution of the vaccine, particularly working to make it available and accessible for low and medium income countries.
Both partners have agreed to operate on a not-for-profit basis for the duration of the coronavirus pandemic, with only the costs of production and distribution being covered.
I would be more confident in AstraZeneca prioritizing the project if they would look forward to making billions of dollars of profit with the project instead of them seeing it as being about PR.
It also sets very bad incentives for people who invest in pandemic preparedness when they can't make profits on their work. The fact that the big pharma companies didn't predict in advance that being well-prepared to provide a working vaccine for a pandemic like this is a reason why had too little investment into pandemic preparedness in the last years besides.
You incentive people to build products that are useful in potential pandemics by allowing them to make profits when the pandemic happens and the products turn out to be useful.
I would much rather hear AstraZeneca say: "We will invest all profits made into building up factories to provide vaccines for the future and do research on parademic preparedness because we didn't invest enough resources into the area in the last years."
Basing this response just on this exchange and information provide here.
I'm not sure one can say AZ is not setting up with profits in mind nor is it clear to me their expectations on total profit would be lower they way they are versus the suggestion made about reinvesting profits. How do we go about making that assessment and comparison since I don't think one can simply pick a side and claim victory.
One way of looking at the current, temporary "non-profit" approach could be seen as an investment in a customer base that will be there when the factories are build and provide a good demand volume to support the factory output at levels that provide greater profits. If they seek profits now, but promise to invest in the factories (which they are going to do anyhow) they are both competing for customers today and tomorrow. Trying to establish a loyal customer base now at the start of things doesn't seem like a profit minimizing strategy to me.
My reaction would be that a vaccine should be made for profit; if there are people who can’t afford it there should be a charity to buy the vaccine for them.
Pay careful attention to this formulation. Note the phrase:
there should be
What does that mean, precisely?
When we speak of whether a vaccine should be made for profit or not, we are, implicitly, speaking from the perspective of decision-makers who are in a position to decide whether a vaccine will be made on a for-profit or a non-profit basis. This may be some level of government (which may choose to contract to get a vaccine made, then distribute it to members of the public—or, may elect not to do so, and leave the matter to the vaccine manufacturers to decide), or it may be a corporation (which may manufacture the vaccine and then choose to make it available for free, instead of selling it).
Now, from the standpoint of those decision-makers, what does it mean to say that the vaccine should be for-profit but that “there should be” a charity to buy the vaccine for those who need it? It could only mean one of two things:
We—i.e., by construction, that decision-making organization—having chosen to sell the vaccine for a profit, will now also spin off a charity whose purpose will be to make the vaccine available on a non-profit basis.
We will sell the vaccine at a profit. Perhaps someone else will found a charity which will purchase our vaccine and make it available on a non-profit basis. Or, perhaps not. Either way, we will merely sell it and make a profit.
And note that option #1 is no different from “make the vaccine on a non-profit basis” in the first place, whereas option #2 is simply a shrug—a refusal to accept any responsibility for the problem of people who can’t afford the vaccine.
Either way, you have not answered leggi’s question/challenge, but evaded it.
We already have the situation that normal vaccines are sold for prices to make a profit to developed countries and then sold for lesser prices to organizations that give out the vaccines to the the of the world.
That's the established model that works for giving everybody access and the involved companies a way to pay for the vaccine development.
It doesn't get them to pay for a lot of vaccine factories and as a result we don't have enough vaccine factories at the moment but I would still call the model for-profit.
One other important feedback "loop," or rather a feedback terminal, is an M&A event. The for-profit organization's owners receive a single injection of $ from a new parent organization, and then the for-profit organization (a) continues operating as a separate subsidiary of the parent, or (b) ceases its separate existence, getting liquidated into the parent. (Various outcomes in between can also occur.)
I'm curious whether there is an analog of this sort of M&A "loop" with non-profit organizations. If there is no such analog, then we have two broken feedback loops in non-profits: an indifferent product/sales loop and a nonexistent M&A "loop." How relatively important are the two broken loops in explaining the strengths and weaknesses of for-profit vs non-profit models?
I disagree with your contention that health care should be for profit.
People that are sick or dying and need care are not customers comparing various products. They are humans in need of a service which should not be deprived of them due to their income level.
Also you did not consider public goods, such as fire stations, streets, clean water etc. Some could argue that good health and clean air is a public good.
However, if you want to privatize environmental efforts such as clean air, water and reduced waste then the cost of such things should be placed onto the company. For example, a plastics manufacturer should be charged the amount to recycle all of their plastics. And those making plastics which can't be recycled should be responsible to figure out how to properly dispose of them instead of them being shipped to 3rd-world countries then dumped in the ocean or burned. A coal plant should have to pay for filters so that surrounding communities do not have increased asthma, heart disease and earlier death rates. Basically the capitalist market requires some regulation or they can harm people and the planet.
Then of course there are regulations needed to prevent monopolies, price gouging, etc.