When I am meeting with the leadership of a potential nonprofit client, one of the first questions I ask is what is their target for their mix of earned-versus-contributed revenue. This question is typically greeted with blank stares. In the beginning, I thought it was how I was asking the question. I have discovered, instead, that it is simply something most nonprofits don’t consider.
Earned revenue is a tricky concept in the world of nonprofits. Most nonprofits have some form of earned revenue, but they also tend to be scared to talk about it. The reason for that is that, unlike our for-profit colleagues, the Internal Revenue Service has a host of regulations governing how we can make money. The majority – not all – of a nonprofit’s revenue sources have to align with the organization’s mission if they want to retain their 501(c)(3) status. This type of revenue is classified as “related income.” Revenue not tied directly back to the mission falls into the unrelated income category, and the IRS has rather vague limits on the percentages of unrelated income a nonprofit may have.
For the purposes of this discussion, we will only focus on related business income. (To learn more about unrelated business income see https://www.irs.gov/charities-non-profits/unrelated-business-income-tax.)
Sources of related business income have to directly relate to a nonprofit’s mission, so it is helpful to be clear (and sometimes broad) in your mission statement about your sources of related earned income. Ticket sales in arts organizations, copays in medical nonprofits, and certain fees in social service organizations are all acceptable forms of revenue.
For some nonprofits, the concept of attempting to maximize earned revenue feels “unclean” to them. After all, we get into nonprofit because we, ourselves, are philanthropic by nature. In a perfect world, our products or services would be offered to the public for free, and donors would foot the bill.
When last I checked, we do not live in a perfect world. More importantly, I have found a truism: “people do not perceive value in that which they receive for free.” Instead, valence is only achieved when there is some cost for the beneficiary.
The goal of revenue management in nonprofit is not to wring every dollar we can out of our patrons, patients, or clients. Instead, it is to ensure that people pay appropriate amounts based on their capabilities to pay. More importantly, good revenue management practices start with thinking broadly about other, related ways we can earn money to offset the costs of serving those patrons, patients, or clients.
Nonprofit revenue management starts with thinking about our sources of related revenue. Speaking broadly, our sources fall into a few categories:
- Consulting or training other nonprofits on our core competencies;
- Government contracts to provide services to target populations;
- Licensing our proprietary technology, programs, or practices to other nonprofits or for-profits;
- Selling products or services related to our mission;
- Renting out space in our facilities; or
- Creating enterprises – including, possibly, for-profit subsidiaries – that provide a related product or service and upstreaming their revenue to support the mission.
As I have mentioned before, earned revenue management is the process of matching the right product to the right customer at the right time for the right price. It’s a balancing act of demand, inventory or capacity, and price. In order to achieve that balance, the starting point is gathering data.
If your organization already sells a product or service, do you have detailed sales reports? If not, start generating them. You cannot determine demand or price without first understanding what you sell when. I generally tell organizations that you need a minimum of two years’ sales data before you can begin implementing revenue management practices.
Sales reports need to report “units” of goods and services sold and at what price. You will use this data to calculate the profitability of what you are selling and the yield. The profitability is determined by subtracting the cost of the good or service sold (COGS) from the sales. If the number is negative, you need to either raise the price or stop selling that good or service. It’s not helping you.
Assuming it is profitable, you will next calculate yield. Yield is calculated by dividing the total sales by the total units sold for a given period. The goal of revenue management is to increase revenue by increasing yield. Once you start watching these three numbers: total sales, total goods sold and total yield, you should begin to see patterns emerge over time. This lets us infer when there is demand for our product and manage the price and yield of the product to match that demand.
This is the basic principle of revenue management.
There are more complex concepts that help us improve revenue performance. These include market segmentation of your customers or clients and understanding their price sensitivity. These principles and concepts are too complex and industry-specific for this column, but Our Fundraising Search can help you better understand your sources of earned revenue and how to optimize them to better fund your mission.
Next time, I plan to discuss the role of revenue management principles to improve fundraising.