In 2006, a report sponsored by two of Chicago’s largest social service funders, the Chicago Community Trust and the United Way of Metropolitan Chicago, warned a coalition of 22 of the city’s oldest and financially strongest human service agencies and community nonprofits that they faced the prospect of decreasing revenues and rising service demands. To better use existing resources, the report advised the coalition—the Chicago Alliance for Collaborative Effort (CACE)—to develop a plan to maximize efficiencies or prepare for financial hardship.
The consulting firm McKinsey & Company volunteered to study best practices and to develop a plan for generating large savings. A team spent six months analyzing the spending patterns of larger CACE members, such as ChildServ, Casa Central, and the Chicago chapters of the YMCA, Catholic Charities, and the Salvation Army. In the fall of 2007, McKinsey reported that health and human service organizations throughout the Chicago area spent $750 million on purchased goods and support functions, which amounted to nearly 25 percent of their $3 billion operating budgets. McKinsey estimated that as much as $100 million could be saved annually through a shared service platform that consolidated overlapping support functions, such as finance, accounting, information technologies, human resources, and purchasing.
McKinsey also recommended that CACE lead this enterprise by creating a stand-alone entity governed by a board of agency CEOs and Chicago-area business leaders. The effort would be funded, in large part, by the participating agencies themselves with startup financing provided by Chicago foundations. Estimated annual savings for CACE members alone could be large—in the range of $27 million to $35 million.
Consolidating back-office operations and creating shared service platforms are not new to the nonprofit sector. Hospitals, universities and colleges, home health care agencies, and other nonprofits have a long history of leveraging pooled resources to buy goods and services. Larger nonprofits like Goodwill Industries and the American Red Cross, for example, established shared service operations through their own federations and networks. The United Way of Metropolitan Chicago consolidated the back-office functions of more than 50 suburban affiliates into one in 2003, producing $3 million in annual savings.
But no one had undertaken a venture of the size and scope as suggested in the McKinsey study for Chicago. Shortly after the report was issued, the Back Office Collaborative (BOC) was formed by eight members of CACE as a cooperative—a for-profit business owned and operated by its founders for their mutual benefit. Ownership was equal and profit sharing was built on leveraging and scaling. But the structure meant that conflicts between members could slow or even thwart the collaboration’s development. And like any business enterprise, it faced the possibility of high risks and large rewards.
Initiatives like BOC raise larger questions about how efficient the nonprofit sector should be—and, in turn, how efficient individual nonprofits can be without compromising their identity and mission. Traditionally, a nonprofit became concerned about efficiency when it made a major financial decision (such as leasing or buying a building), when dire financial conditions required hard choices, and when economies of scale came into play, such as expanding programs, sites, or collaborations with other organizations. Even in those cases, mission was the principle against which these efficiency issues often were decided. Beyond such choices, discussions about efficiency were rare.
But over the past decade, a new level of debate about efficiency in the nonprofit sector has arisen, due to a heightened awareness that societal problems are expanding much faster than the available resources to deal with them. This discovery has generated a major rethinking of how to restructure the nonprofit sector, resulting in two schools of thought on how to increase efficiency. The first believes that donor reform and better information unlock efficiency throughout the sector. Market competition, the theory goes, would cleanse the nonprofit world of inefficiency by diverting money away from inefficient nonprofits (which donors would avoid), and steering it toward the more efficient ones (which donors would reward with more funding). (See “The Rise of Social Capital Market Intermediaries” for an example of this school of thought.)
The second school of thought, which is most relevant to this article, seeks to transform rather than eliminate inefficient organizations. In the much cited May 2003 Harvard Business Review article “The Nonprofit Sector’s $100 Billion Opportunity,” former US Senator Bill Bradley and his McKinsey colleagues pointed out new opportunities to release billions of dollars by changing “the operating practices and notions of stewardship that currently govern the sector.” In examining the finances, practices, and management of thousands of large nonprofits, they found vast opportunities to save more than $100 billion annually. One part of the savings, $55 billion, could be gained by changing how donors fund nonprofits and distribute their holdings. The larger part of the savings, $62 billion, could be gained from program and service cost reductions and reduced administrative costs, such as shared services and back-office consolidations.
As appealing as this vision is in theory, many nonprofit leaders have found it difficult to transform their organizations’ practices and collaborate successfully. It would be convenient to attribute these difficulties solely to organizational inertia and outdated worldviews. A closer look, however, reveals legitimate concerns about the implications of the collective push for efficiency and about cost-cutting initiatives. Not all efficiencyboosting initiatives automatically help organizations’ quest for “more mission.” In fact, some initiatives can even hurt the mission. The deep organizational transformation required to substantially and sustainably enhance efficiency often involves tough choices and tradeoffs that can profoundly affect an organization’s future, its relationships with employees, volunteers, and clients, and its identity and standing within its local community.
This case study explores how a group of Chicago funders, donors, consultants, service providers, and other stakeholders grappled with many of these concerns as they came together to undertake a unique experiment in administrative efficiency.
From the start, BOC’s strongest advocate was Stephen Cole, president and CEO of Chicago’s YMCA. Before joining the YMCA in 2001, Cole spent 33 years in the private sector, where he oversaw the development of Cash Station, also known as the ATM interbank network, for the First National Bank of Chicago (now part of JPMorgan Chase). Cash Station enabled cardholders from participating banks to access the same ATM machines to conduct transactions, providing huge economies of scale for both consumers and banks.
Using a Chicago Community Trust grant to CACE in 2007 to develop the BOC concept, Cole began preaching the benefits of collective action and leveraging human service agency assets. He advocated a cooperative business model over a traditional 501(c) (3) charity, because he wanted CACE members to embrace what he called a “for-profit mentality,” where they would be members for governance and owners for reaping benefits. Cole recalled that Cash Station developed a large brand awareness, which made banks want to join. If BOC worked in Chicago, Cole thought, it could be rolled out elsewhere. “I thought that we could leverage this model to go national.”
Notwithstanding Cole’s aggressive salesmanship of BOC, only eight of CACE’s 22 member organizations joined as founding members of BOC in 2008. Among the critical questions that prospective members weighed were whether or how the collaborative furthered their organization’s mission, and the costs and benefits of participation. Clarence Wood, president and CEO of Jane Addams Hull House Association, the nonprofit founded by Jane Addams in 1889, was one leader who decided not to join BOC. “The new agency would have access to our bank accounts, which presented too much of a risk and potential legal liability,” said Wood.
Still, there were enough organizations willing to join the startup to make it viable. The founding eight, with annual budgets ranging from $11 million to $85 million, agreed to provide 0.13 percent of their annual budgets to finance BOC over a three-year period. Stiff financial penalties would be invoked for early withdrawal. “All CACE members received the McKinsey report, and the all-in and hard-to-get-out arrangement scared off a few,” said Dan Valliere, executive director of Chicago Commons, a 116-year-old neighborhood-based social service provider that was one of the first to join BOC.
McKinsey projected that roughly $1.5 million would to be needed to finance BOC over the first two years. The eight founders provided $300,000; the Chicago Community Trust gave $300,000, consisting of a $100,000 grant and a $200,000 no interest loan; the United Way of Metropolitan Chicago matched the trust’s $200,000 loan; and $100,000 was contributed by other foundations. This meant that BOC was initially capitalized at $900,000 ($300,000 for each of three years). BOC’s future sustainability would depend largely on the fees it would generate from the shared service platform and its individual products. As the table “How BOC Generates Fee Income” below illustrates, a BOC member with a $5 million annual budget would pay an annual fee to BOC of about $6,000, and save (after the fee) about $31,000 a year.
Initial decisions about how BOC was structured proved critical. BOC would be completely independent of CACE. It would build its own platform and eventually sell services to others under the nonprofit cooperative arrangement developed by the board. BOC would begin with a target for generating savings from strategic sourcing of products and services, and next move into opportunities for integrating back-office support functions that included accounting, finance, information technologies, and human resources. Because of Cole’s strong role in getting BOC off the ground, members asked him to serve as the organization’s first chair. In January 2009 BOC hired Kevin Carty, a former UBS investment banker, as its first CEO.
BOC bylaws provided for a board of between 10 and 15 members, which met at least quarterly. Initially that included the CEOs of the eight founding agencies, two independent directors from the for-profit sector (Eric Langshur, founder of Rise Health and CarePages, and Mike Murray, the retired CEO of Recycled Greetings), and representatives of the two primary lenders, Chicago Community Trust and United Way of Metropolitan Chicago (but the latter in a nonvoting ex officio capacity). Each board member had one vote, with a majority rule applying to most issues. An operations committee composed of chief financial officers of the eight founders was established with the primary task of vetting the details of shared service initiatives for board consideration. The board also oversaw the hiring and firing of the CEO. In addition to McKinsey, BOC had several pro bono strategic partners, including two law firms and a nonprofit resource development group. These outside resources helped provide best practice information, industry expertise, and access to additional funding.
Almost from the outset, the members disagreed over where BOC was headed and how it would get there. The McKinsey report implied, and Cole openly championed, the idea that the cooperative should be rolled out nationally. Jim Jones, president and CEO of ChildServ, however, thought that BOC’s success would be driven locally, and that other social service agencies would be eager to join once they saw the efficiencies. Chicago Community Trust’s Jim Lewis, the program officer overseeing the foundation’s grants and loans to BOC, cautioned, “You had to fly the plane at Kitty Hawk before you build the 747.”
The BOC founders also differed about where and how savings would occur. Because the McKinsey consultants had based much of the projected savings on the cost structure of the CACE member that was found to have the best or most efficient practice, some assumed that “the best” agency among them would take the lead in a specific functional or service area consolidation. To the extent that jobs would be eliminated after consolidation, other jobs might be added by the agency designated to lead the initiative. Others advocated outsourcing the functions to a third party, which would probably result in an overall reduction of jobs at member agencies.
Another source of discord was the pressure that all CACE members felt to get behind BOC, because all BOC founders were beneficiaries of Chicago Community Trust and the United Way of Metropolitan Chicago. Richard Jones, president and CEO of Metropolitan Family Services, said: “I think at some point we are all going to be mandated to do this. … If you want to qualify for funding, you should participate in a group of this kind.”
The decision to incorporate BOC as a for-profit cooperative rather than a 501(c)(3) charitable organization created an immediate problem. Charitable funders could not make direct loans or grants to BOC, and corporations were not interested in investing. To remedy this, Cole got YMCA board approval for the organization to serve as fiscal agent to receive charitable grants on behalf of BOC and to help manage BOC’s cash until it was able to set up its own systems. But this decision put the Chicago YMCA—then the largest local affiliate in the United States, with 4,000 employees and an $85 million budget—at risk. The YMCA’s finance committee chair questioned the organization’s risk exposure due to BOC, especially when the cooperative already had sufficient scale to leverage its own pooling arrangements. Cole countered that the YMCA should be a path breaker.
BOC leaders continued to clash over various issues, leading to a cascade of turnovers at the top. Cole wanted greater progress and speed. BOC was burning through memberprovided cash as it awaited the Chicago Community Trust loan to be approved. Carty was more cautious, asking that contract agreements bylaws and internal matters be resolved before negotiating with vendors on purchasing—differences of style and speed. In late 2008, less than a year after he was hired, Cole forced Carty’s resignation and lost some trust among colleagues. He, in turn, resigned as head of BOC and was replaced by Jim Jones, who chaired BOC and became temporary CEO from January to June 2009. Then in July, Cole announced his resignation from the YMCA and shortly thereafter the organization pulled out of BOC. Cole’s resignation was not related to the YMCA’s entanglement with BOC, but was due to clashes with his own board chair. The resignation and the loss of the YMCA’s $85 million budget sent shock waves through BOC and Chicago’s social service providers. Cole’s departure “took the advocacy voice out of the boardroom,” said Valliere.
In late July 2009, Langshur recruited Bryan Preston to be president and CEO of BOC. Preston had worked in Washington, D.C., as a health care advocate and in Silicon Valley and Chicago on health-related Internet startups. “I loved that this was a new model—nobody had figured out how to do this yet,” Preston said. Cole’s vision of building BOC beyond Chicago to a national level also had appeal, but Preston recognized that BOC had to work locally before it attempted a national launch.
One of the first things Preston did was validate that BOC’s group purchasing initiative—covering office supplies, food, paper products, janitorial services, and the like—actually provided financial benefits. It turns out that it did. BOC members saved an average of 15 to 20 percent on their purchases. The problem was that it did not generate enough fees to sustain BOC’s operations.
To generate more volume Preston decided to offer the group purchasing service to the wider nonprofit community. This was done by amending BOC’s cooperative agreements to provide for a different class of nonvoting members, called affiliates. Affiliates would pay an administrative fee to join, and would not be required to make capital investments like founders. They also would pay a higher fee for shared services.
Preston decided to focus on recruiting midsize agencies with $5 million to $40 million annual budgets. Larger organizations, like the YMCA with its $85 million budget, did not need BOC at this stage. And smaller organizations that had less than $4 million in annual revenues were simply too small to benefit by joining. By the end of 2009 Preston’s efforts had begun to pay off. BOC had 14 members: seven founders and seven affiliates, such as Big Brothers Big Sisters of Metropolitan Chicago and Children’s Home + Aid.
One of the things Preston learned early was that BOC’s majority rule bylaws were not particularly compatible with building trust among members. To succeed, he had to find solutions that worked for all the founding members, not a simple majority. If one member pulled out, as the YMCA did, leverage and economies of scale unraveled quickly. Furthermore, each of the founding agencies had its own unique culture and history, several dating back more than 100 years. Some members did not need their board’s approval to commit their agencies to a BOC initiative, and others did. Some used their boards as buffers to slow down the decision-making process or to extract concessions. Member organizations and their leaders were able to defer, postpone, and delay BOC decisions. Preston had no formal authority to make anyone do anything, so to move BOC forward he had to negotiate between and among organizations. His role was to be a broker and a diplomat, persuading BOC owners to transcend their sometimes divided loyalties to move the collaboration ahead.
THE SECOND HURDLE
BOC’s first collective service was purchasing office supplies and related commodities. Next, according to the McKinsey analysis, finance and accounting support functions should be pooled. Unlike purchasing, which benefited all BOC members without disrupting operations and staffing, functional consolidation would be more controversial and risky. For the finance and accounting support operations, McKinsey’s analysis as well as the research of BOC’s operations committee indicated that outsourcing the work to a third party provided more benefits—expertise, speed to capture savings, and reduced risks—than building such capabilities within the cooperative or through one of its members.
Having studied other groups that collectively purchased goods or services, Preston learned that the greatest risk was that the group would unravel during the last phase of the contract negotiation. To address this, he worked with the chief financial officers of BOC members to develop success criteria for the finance and accounting product, asking members what dollar savings would make the initiative worthwhile. Preston discovered that the threshold for savings was 30 percent. The year 2009 ended with BOC members unanimously adopting success criteria for finance and accounting and health insurance. Members also gave Preston the go-ahead to tap the market for solutions.
In February 2010, BOC’s proposal for finance and accounting services went out to prospective vendors. Twelve firms submitted proposals from which BOC selected two finalists, each of whom promised 40 percent savings—well above the 30 percent threshold. The aggregate savings of 40 percent, however, were not uniformly spread among the seven members; and one agency fell below the 30 percent threshold in the proposal from Outsource Partners International (OPI) and Crowe Horwath, a national public accounting firm. Two members were not ready to commit to the OPI choice and wanted more detail on how the savings applied to their organizations. Rather than push for a simple majority to move ahead with OPI, the BOC board voted to move to a 30-day negotiation period during which Preston worked with lawyers, members, and OPI to create terms that would work for everyone. In the final negotiations, ChildServ found that the economics did not work for them, as savings dropped below the 30 percent threshold. It would not be required to join, nor would it incur a penalty for not participating.
One of the challenges in creating this new service was that some member agency executives were unfamiliar with outsourcing. Valliere noted that five of the seven BOC founders had no prior experience with outsourcing. “It was clear to me that the outsourcing process would lead to offshoring,” he said. “But that may not have been clear to the others.” At Casa Central, Chicago’s largest and oldest Hispanic social service agency, the pending arrangement was met with resistance from staff and board members because the OPI contract called for staff layoffs. Casa Central has long provided training and employment programs for people in its community; supporting an initiative that moved jobs to India during the height of a recession was too much to bear, even if it resulted in savings. In the end, Casa Central dropped out of the initiative and was required to change its status from a founding member to an affiliate. It also incurred financial penalties for exiting the finance and accounting initiative. With two of the seven members out of the final contract, savings for finance and accounting were significantly reduced.
Meanwhile, BOC’s funders—Chicago Community Trust and the United Way of Metropolitan Chicago—indicated that their future support of the cooperative was contingent on getting the finance and accounting deal done. To make matters worse, BOC was running out of funds. It needed the savings that would accrue from the OPI initiative to remain on track. Yet some of the remaining five agencies were unhappy with the outsourcing option. Although much of the finance work would remain in Chicago, a significant number of jobs would go to India. Preston and member CEOs stressed the positive impact that savings would have on BOC’s mission—nearly $4 million over five years that could be reallocated to program-related activities. After much deliberation, and six months after the process had begun, the five participants cast a final vote. The decision was unanimous: to move ahead and approve the contract with OPI.
Next, the group of five had to decide how much to compensate BOC from the savings initiative. If it were 10 percent, everyone’s net savings would decrease, perhaps threatening the participation threshold. The principals settled on a fee of 5 percent of the savings. The number of actual layoffs expected at the five nonprofits would be 35 full-time employees. Consolidating the finance and accounting functions was a clear winner for BOC, producing an estimated $710,000 in savings in 2011, adding to an estimated $739,000 in savings from joint purchasing of office supplies, food, and shared janitorial and energy expenses. (See “BOC Finances” below for details.)
As of this writing, BOC is on schedule and on budget from the original McKinsey plan. By the end of 2011 it expects to be financially sustainable and plans to repay its $400,000 no-interest loans from the Chicago Community Trust and the United Way of Metropolitan Chicago. Member yearly savings of $1.6 million are expected for 2011, $2.3 million for 2012, and $3.8 million for 2013. (These figures assume that the number of BOC affiliates increases from 21 to 60 over that period.) By almost any measure, BOC’s performance is a success on a scope and scale unprecedented among collaborations of independent human service providers.
Yet some of BOC’s members feel that the efficiencies the organization achieved have come at a considerable cost. Jim Jones said BOC now has a “digestion problem”—to live with the many changes in managing their organizations. Richard Jones believes that although his organization wants to operate more efficiently, it will pay a huge price. “We have a great reputation within the community and as a place to work,” he said. “But we are losing this in the process of becoming more alike—more like corporate America.” Ruefully, Jones noted that he is going to retire at the right time. The decision to outsource accounting and finance has been a painful experience. He, like others, has discovered that the collaboration required participants to give up varying degrees of independence, uniqueness, and aspects of their corporate cultures.
For Preston, the last 18 months have been equally difficult. BOC nearly fell apart twice. He persevered, acknowledging that BOC’s success came about through “developing processes that helped the group navigate forward.” BOC members are on schedule to begin using the finance and accounting platform. New funders have emerged and more affiliates are set to join. Preston has successfully moved the organization to a position where the products are substantial enough to be scalable. The next big hurdle for him and BOC will be to find a common ground on employee health care and human resources. Then the group will tackle how to develop a shared platform for information technologies, completing BOC’s product road map.
Although BOC has succeeded in saving members’ money, it may not fulfill its larger potential. It will not likely be the ATM of the nonprofit sector, as Cole envisioned. And it probably will not go national, as Cole and Preston originally hoped. Indeed, without renewed and passionate advocacy within the organization or further encouragement from the philanthropic community, sufficient incentives may not exist to scale BOC much beyond its current level. Its achievement is pragmatic, not catalytic. As Valliere commented, “We accomplished what we set out to do—to be efficient, save money, and provide more resources to mission.”
Donald Haider is a professor of social enterprise at Northwestern University’s Kellogg School of Management.
Franz Wohlgezogen is a lecturer of management and organizations at Kellogg.