The Importance of Earned Income in Your Funding Model

In the recent SSIR article, “Finding Your Funding Model,” authors Kim, Perreault, and Foster laid out a thoughtful, well-structured, and practical framework for nonprofit leaders to systematically define the right funding model for their organizations. But surprisingly, they left out a major funding component in their discussion: They focused exclusively on contributions/donations and government programs as funding options, and totally ignored private-source earned income.

In fact, privately derived earned income is the single largest source of revenue for the entire nonprofit sector. According to the Center on Nonprofits and Philanthropy, private-sourced fees for goods and services made up more than 45 percent of total nonprofit sector revenue in 2010.

Specifically, there are major segments of the nonprofit world where earned income dominates the funding picture. Just think of:

• Hospitals and primary care facilities. For example, the Cleveland Clinic gets more than 70 percent of its annual revenue from private-source program fees, mainly patient services.
• Private colleges and universities, particularly smaller ones. Haverford College (Philadelphia PA) and Juniata College (Huntingdon PA) both get more than 70 percent of revenue from private-source earned income, principally tuition and fees.
• Private nonprofit retirement communities. Kendal-Crosslands in Kennett Square, Pa., and Bay Village in Sarasota, Fla., routinely get more than 95 percent of their revenue from private earned income sources, mainly resident payments.

And there are other sectors where earned income may not dominate, but where it is still a large—sometimes the majority—source of funds. Just think of:

• Arts, culture, and humanities organizations. The Philadelphia Museum of Art gets about 12 percent of its funding as private-source earned income, while both NPR and Shakespeare and Company (Lenox, Mass.) derive about 55 percent of revenue from that source.
• Housing. Habitat for Humanity’s local organizations routinely get 20 to 50 percent of their funding as earned income, as does Common Ground of New York City.

All of that said, for an organization that doesn’t have a significant earned income stream, it may seem daunting to establish one. However, the steps that the authors of “Finding Your Funding Model” shared (understand your current state, benchmark peers, weigh costs and benefits, and develop a plan) provide an excellent roadmap to get you started. While they wrote to help organizations create an income model that “typically revolves around a single type of funding…which constitutes the majority of the organization’s revenue”, I believe their basic framework can work just as well to establish a new revenue stream, even if it is just a supporting player.

If you’re looking to start or renew an earned income strategy, a useful metric is what we call the Private-sourced Earned Income (PEI) index. The PEI index is simply the ratio of the organization’s total, privately derived earned income to its total cash revenue:

PEI Index = Private-sourced Earned income/Total Cash Revenue

Two interesting organizations to compare around earned income are Guidestar and the Wikimedia Foundation (which operates Wikipedia). Both provide information and insights to the public, but differ significantly in the role earned income plays in their funding mix. Wikimedia has a core value that “knowledge should be free” and depends on voluntary gifts from many small donors for support (see the Wikimedia Strategic Plan) with earned income being a small fraction of total revenue. Guidestar, on the other hand, is committed to long-term sustainability through earned revenue (primarily from the sale of products and services) so that while 98 percent of its visitors use the site for free, subscriptions and licensing fees from the remaining 2 percent accounted for about two-thirds of total revenue in 2008.

The PEI indexes of these organizations reflect this difference in approach. Guidestar’s is relatively high (0.67 for 2009) and the goal (according to board member Feather Houstoun) is to continue to grow it until earned income fully supports core operations (with gifts and grants supporting infrastructure and innovation.) Meanwhile, the Wikimedia Foundation has a PEI index of only about 0.03 (see 2011-2012 annual plan). And even though its PEI index is expected to grow (forecast to be 0.05 for 2011-12), it will almost certainly always be small compared to the equivalent Small Donation Revenue (SDR) index, which is about 0.79 for 2010-11 and forecast to grow to 0.85 for 2011-12.

In conclusion, while earned income currently may not play a big role in your funding picture today, it’s well worth exploring. The pot of money out there and the potential for enhancing financial sustainability are too substantial to ignore. And if it’s a good fit with your overall mission and strategy, then there are models and metrics to help your organization make it work.

Read more stories by Richard Tait.