There is a calculation (in addition to the cost of fundraising which I’ve discussed before) that I would love more nonprofits to do. And that is to calculate the opportunity costs of a decision.
An opportunity cost is the value (money, time, resources) of the next best option when you make a choice between two options. Understanding the opportunity costs of decisions is particularly important when resources are scarce, as is the case in the nonprofit sector.
And it is the topic of today’s installment in the ongoing Financing Not Fundraising blog series.
In calculating the opportunity costs, you are consciously analyzing two or more options and quantifying the value of the next best option when you choose one option over the others. So, for example, when you are choosing between two new jobs you’ve been offered, you recognize that in choosing one position you are giving up the value (or salary) of the other position. It seems so simple, yet in the nonprofit world it becomes much more complex.
Because the nonprofit sector is under capitalized, money is king. A driving motivation in many nonprofits is to preserve money, or go after money, at all costs. So the concept of opportunity costs is often ignored in favor of economic costs. But if we truly want to put every last nonprofit resource to its highest and best use, we must understand opportunity costs.
Opportunity costs are calculated like this:
Opportunity Costs of Option #1 = The long-term benefits of option #2 – the long term benefits of option #1
If the opportunity costs for a particular choice are positive, you have not chosen the best (most valuable) option.
Let me give you a couple of examples of how opportunity costs can be calculated in the nonprofit world.
Fundraising vs. Friend-Raising Event
This decision came up for one of my clients the other day. They were going to host an event at a board member’s house with 25 potential major donors. They were hesitant to use the event just as a group cultivation of major donors, so they were grappling with the idea of asking attendees to make a $100 donation while at the event (a total of $2,500 in revenue). That would have been a huge mistake because of opportunity costs. If cultivated correctly over the coming year, the attendees all had the capacity to give much larger donations, probably an average of $5,000 per attendee (a total of $125,000 in revenue). But if those attendees were forced to make a $100 donation, they would be done with their giving to that organization for the year.
The opportunity cost of the fundraising event would be:
$125,000 (value of the friend-raiser) – $2,500 (the value of the fundraiser) = $122,500
In other words, in deciding to hold a fundraising event, instead of a friend-raising event, the nonprofit is giving up $122,500 in value.
Needless to say, they decided to make the event purely a friend-raiser, with no fundraising ask. However, it goes without saying that they now need to be sure to do effective follow up cultivation and eventually solicitation with every attendee to the friend-raiser.
Grantwriter vs. Development Director
If a nonprofit leader is deciding whether to spend $45,000 to hire a grant writer or $75,000 to hire a development director they might opt to hire the grantwriter because that is the cheaper option, and in the world of nonprofits, cheaper is always better. But in hiring a grantwriter, the nonprofit would save $30,000 in regular costs (the difference in salary between a development director and grantwriter), but lose many times that amount in long-term benefits. The difference in revenue brought in under the development director, someone who could increase the overall financial engine of the organization, could be in the hundreds of thousands and many times the value of the grantwriter, who would only be able to increase foundation and/or government funding.
So the opportunity cost of hiring a grantwriter would be:
$250,000 (estimated annual increase to overall giving with a development director) – $30,000 (additional cost of the development director salary) – $100,000 (estimated annual increase to foundation giving with a grantwriter) = $120,000
In choosing the “cheaper” grantwriter, the nonprofit is losing $120,000 in value.
I would love to see more nonprofits calculate the opportunity costs of all decisions they make. Indeed, because nonprofits are so constrained for resources they should be even more cognizant of opportunity costs and ensure that every last resource is put to its highest and best use.
If you want to learn more about moving from a fundraising to a financing approach at your nonprofit, check out our on-demand library of Financing Not Fundraising webinars, guides and e-books.
Photo Credit: Krzysztof Poltorak