Sunday, December 28, 2008

The Business of Charity

You know, sometimes I get a bit tired of columnists who (uncritically) read a book, decide it has the answers to some or all of the world's problems, then pen a column espousing the book's thesis. It's not as bad as stenography of the latest party memo, but generally speaking it's a path to a weak column.

Nicholas Kristof recently read a book by a failed businessman, Dan Pallotta, lamenting how after he raised a ton of money for some wealthy charities he was cast aside. Kristof makes a huge assumption, that the reason Pallotta's company failed was his salary:
But Mr. Pallotta’s company wasn’t a charity, but rather a for-profit company that created charitable events. Critics railed at his $394,500 salary - low for a corporate chief executive, but stratospheric in the aid world - and at the millions of dollars spent on advertising and marketing and other expenses.
Kristof then wrestles, in a peculiar way, with the question of whether higher salaries for the leaders of charities would lead to better or worse results:
I also worry that if aid groups paid executives as lavishly as Citigroup, they would be managed as badly as Citigroup.
Is that the issue? Pallotta worked with the Avon Foundation. Did Kristof call Avon and ask, "Does the person who heads your multi-million dollar charitable trust earn $400,000 or more?" Does he know that the CEO of the Red Cross earns more than $500,000 per year? That the President of the United Way has a salary of about $400,000 in compensation and an expense allowance (plus benefits), but pulled in an additional $800,000 in bonuses in 2007? $1.2 million isn't sufficiently "corporate" compensation? Here's where I'll give Pallotta his due - he was innovative, and shifted the ground for large charitable fundraising events. Have you noticed that the United Way has done anything particularly different or innovative that would justify the huge bonuses "earned" by its president? If so, it has occurred way below my radar.

Sure, it may raise people's hackles that charities are paying their executives astronomical bonuses, but despite some brief negative publicity the United Way hasn't failed. So perhaps we should take a step back, and consider why people give to charity? By spending few minutes on Google, Kristof would have come up with this interesting case study:
When the individual gives money to a charity, no product or service is necessarily provided to them. What the individual purchases is much more ethereal. A contributor to charity receives a sense of reward, self-satisfaction, pride, or deeper purpose from the act of giving. Donors receive the pleasure of altruism as the product of their economic transaction.

The pleasure of altruism is the product supplied by charities. For example, a dollar given to a homeless person on a street corner might buy a small amount of altruistic pleasure, but a million dollar grant to find a cure for AIDS might buy much more. The homeless person and the AIDS cure charity provide different altruistic pleasures. You may not know the homeless man, but you may know someone who has or has died from AIDS. Or perhaps the opposite is true. But such a personal connection is just one example of how a charity creates differentiation among the many suppliers of altruistic pleasure. We most often correlate a charity’s purpose with its worthiness, and therefore with the quantity of altruistic pleasure it can provide.

Here is where the traditional Neo-classical view of markets begins to fall apart. The charity market is not a perfectly competitive market that balances the supply of worthy causes with the demand for altruistic pleasure because no two worthy causes are the same. While the supply of worthy causes is practically infinite, the market is highly differentiated. One cause may be deemed more worthy by more people, create more altruistic pleasure, and therefore receive more funds than its competitors. Price is not the primary means by which the resource of altruistic pleasure is allocated.
Pallotta's company, Pallotta TeamWorks (PTW), was truly innovative in maximizing the altruistic pleasure felt by participants in its events - and then it dropped the ball. Their innovation was in designing targeted events
tailored to elicit the extreme emotions of altruistic pleasure.... such as biking across a dessert to support AIDS charities or walking 60 miles for three days in the footsteps of breast cancer survivors. The events supported people in doing things that they never achieved before in the name of a worth cause, a desirable vehicle for acquiring altruistic pleasure.
They used sophisticated marketing to communicate to participants "the altruistic pleasures that could be received" through participation in an event. They also provided front-to-back support for participants, to help them succeed first in raising a substantial amount of money required simply to enter the event, and carrying through equipment purchases, training, and support during the event itself.
And at the event, PTW created mobile cities in which the participants ate, slept, and most importantly, intermingled with others inspired to champion the same cause. Through such support PTW was able to keep existing participants involved in future events while continuing to attract new ones. “The organizations that are going to survive and effectively provide services,” says Terje Anderson, executive director of the National Association of People With AIDS, “are going to be the ones that figure out ways to market themselves to new private donors and, at the same time, successfully keep their old donor base”
Although none of these ideas were new, Pallotta's innovation was in bringing them together and creating more efficient fundraising processes. If a charity could afford his services, for a flat fee he would provide them with soup to nuts support for their event - they needed no experience or expertise. The only requirement was that they pay his seven figure event planning fee. And while there were events that were not successful, most of Pallotta's events returned considerably more than his fee.
By 2001, PTW’s ideas, people, and competitive fundraising events were creating real economic growth. PTW’s charities had received more than 3 million donor contributions, equal to more than 1% of the US population (Pallotta TeamWorks 2002, p. 30). But in 2001 PTW’s fundraising numbers began to decline and its participants began dropping out. PTW carefully designed an attractive set of attributes, created a higher value product, and lowered transaction costs for their market by reaching a huge audience. So where did the firm go wrong?
The article suggests that PTW's success depended upon "participants’ approval and excitement over the emotional, engaging way that the firm produced money for charity". Early events returned an average of about 67% of the proceeds to charity, but by 2000 that amount had dropped to about 53%, raising concerns about PTW's management of funds. An alternative theory that, to me, seems more intuitive is that annual events were starting to burn out their participants and their participants' sponsors, and may have started to seem like "the same old thing" rather than a new and cool thing you could do for your charity. But no question, when the money stops rolling in, people start looking at the money trail - and that's where a salary that may have been an irrelevancy a year or two before can suddenly seem excessive. And there is no question that, for example, participation levels for Avon's breast cancer walks were dropping. Low participation makes the high cost of these events seem unwise - for the 2002 D.C. AIDSRide, it's reported that 86% of the proceeds went to overhead and expenses.

Pallotta also started to heavily cross-market his own company and, reportedly, other PTW events:
PTW began cross-marketing events for other new events and causes to existing participants using slick brochures, kiosks, and infomercials disguised as safety videos. Event participants “saw Pallotta merchandise, like books by the company’s founder, all along the route” (Winters 2002). T-shirts, sweatshirts, and other collateral were hawked to participants, all trumpeting the PTW brand, not the cause. A former PTW employee and event participant complained that the AIDSRide events “became a Pallotta TeamWorks event, and they stopped even talking about AIDS” (Freiberg 2002). To event participants the PTW brand smacked of commercialism and obstructed their access to the real product, the pleasure of altruism.
(PTW reportedly denies cross-promoting other events at its 3-day events.) This opened the door to criticism and skepticism of PTW and its integrity, ultimately causing its flagship partners to fire PTW. There are a couple of lessons here that Pallotta and Kristof seem to have missed:
Participants didn’t care that PTW was the brand producing the altruistic pleasure. They cared about the means of how it was produced and the quality of that product. As Peter Drucker reminds us, quality “is not what the supplier puts in. It is what the customer gets out and is willing to pay for”
In other words, Pallotta stopped producing the product his customers wanted. And in that respect, PTW was like any other business - if you can't sell the customer what she wants, you'll fail.

The case study goes on to describe some of the economics of scale produced by Pallotta's massive events, and how some charities managed to generate millions of dollars in donations (despite marketing costs approaching 60% of revenues) while more "cost-efficient" traditional fund-raising might have only raised a fraction of that amount. This brings me back to Kristof's piece, in which he observes, "It’s notable that leaders of Oxfam and Save the Children have publicly endorsed the book". No, it's not particularly notable, at least when you get past the notion that Pallotta's innovation was his own salary as opposed to his emphasis on effective marketing and his desire to get away from efficiency as the best measure of charitable success.

Oxfam and Save the Children spend a lot of money on marketing. At the same time, their charitable ratings depend upon their keeping their administrative and fundraising expenses low as compared to the money they apply to their programs. A multi-million dollar investment in marketing might bring in tens of millions of dollars in new donations - but could drag down their efficiency ratings and turn off or scare away another set of potential donors. Charity ratings sites often list, right along with the charity you're evaluating, a series of similar charities - it's easy to find one with a better efficiency rating, and to direct your money to that charity instead. A big part of Pallotta's failure might be attributed to the rating standards of the Better Business Bureau:
The BBB had issued more stringent guidelines, which became effective in 2003. Prior to 2003, CBBB standards limited fund-raising expenses to 50% of related donations (Heaney 2003). The Avon 3-Days historically averaged fund-raising costs close to 40% of total donations through 2001 (PTW 2001), complying with watchdog group guidelines. In 2003, the NCIB and the CBBB merged, forming the BBB Wise Giving Alliance. A new standard required fund-raising expenses to be no more than 35% of “related contributions” (BBB 2006a). This meant that Avon Foundation’s historic average level of performance would no longer be good enough to comply. Another standard called for program spending to exceed 65% of total expenses.

The trend of the Avon events’ fund-raising ratio going into 2003 was not good. In 2001, in part because of disruption caused by the September 11 attacks, the fund-raising ratio had risen from 36% in 2000 to 43%. The 2002 event season had some unusual costs related to the shut-down of PTW in August (Avon 2002), and the fund-raising ratio rose to 49% of related donations. Program spending as a percent of total expenses was only 41%, far below the 65% level specified by the BBB.
Yet it appears that part of that warm, altruistic feeling many people get from making donations arises from the knowledge that only a small part of their contribution will go to administrative costs and marketing. While this is a bit different than the environment for a traditional business, within the world of charitable giving it's something that's not likely to change. The lesson that Oxfam and Save the Children might draw from Pallotta's experience is that by providing a good altruistic experience you can push marketing and administration costs past the 30% level, but as they approach 50% you can expect the backlash to begin. As Pallotta can no doubt attest, that can turn into a microscopic examination of everything you do by the people who feel that you took advantage of your altriusm. Seemingly overnight, you can go from being seen as a helpful symbiote to being perceived as a destructive parasite.

Meanwhile, six years after his business failed, other than marketing himself, what's Pallotta offering to the rest of the world?

Kristof concludes with a couple of stories about how capitalist enterprises can return social utility. This, apparently, surprises him. He describes how a consulting firm helped Rwanda improve its public image in the United States, and significantly increase the price of Rwandan coffee and tea. He also describes how a Nigerian businessman is making money installing pay toilets - he rents, leases and sells port-a-potties. I'm not sure why this would surprise anybody - or why Kristof would see the return of social utility as the province of a charity as opposed to a business. I get my electrical, phone and gas service from profit-making utility companies - I get great benefit from those services, but none of the providers are charities. Furthermore, if there's money to be made and free market forces will result in the spread of a good in a manner equivalent to or better than that which could be achieved by a charity, the charity should invest its efforts and resources elsewhere.


  1. Aaron,

    You've written a thoughtful analysis here but you have a lot of facts wrong - too many for me to go into here. If you would, buy the book and read the case study. Just a few things you have wrong:

    We did not deny cross-promoting events. We were proud of it;

    Money did not stop coming in - gross and net revenues grew each year. Breast cancer 3-Day nets from 1998 - 2002 were, respectively, $4m, $16m, $45m, $51m, $77m - huge growth - on a net basis!

    Reason we went out of business - avon backed out of the 3-days, we lined up another partner, avon announced their own new events, new partner backed out. we sued avon for breach of contract and prevailed - an independent arbitrator ruled that they had "appropriated" the 3-day concept and that the breach was the direct cause of the loss of the opportunity for a contract with the other charity.

    we were trying many new event concepts and many new cities, e.g. weekend to end poverty, out-of-the-darkness suicide prevention event, kids-march, we had just consolidated all operations and marketing - we were innovating like crazy - reason the average went down was because it includes all of the experimentation, not all of which works, and drags down the overall operational average.

    e-mail me after you read the case study and we'll talk more -

  2. I am working based upon published accounts of your events. I don't personally care whether or not you cross-promoted your events; however, as that was raised as a criticism of your organization, I thought it fair to include your reported response to that criticism. Thank you for clearing up that the complaints were valid; but that actually makes the criticism of your organization seem more valid - the perception that you were more interested in self-promotion than in promoting the causes of the charities that retained you. For example:

    It also didn't help that on many of last year's rides, Pallotta heavily cross-marketed his new 2002 events. For many veteran participants (and even new ones like me--I did the Northeast AIDSRide before I started reporting this story), it seemed a bit much. After the mandatory safety video, participants had to sit through ad after ad hyping upcoming fundraisers. Kiosks set up at the campsites each night distributed slick PTW brochures. A general store hawked Pallotta's book (a memoir called When Your Moment Comes), plus cameras, sweatshirts, and T-shirts emblazoned with the PTW logo, and most of the proceeds went to his coffers. "It was excessive," says Gwenn Baldwin, executive director of the L.A. Gay & Lesbian Center. "The marketing of other PTW events during last year's California AIDSRide diminished the focus on HIV and AIDS."

    I understand your retort, "How can they complain when we ask them to help those suffering from problems other than AIDS?", but to me that seems tin eared. They can complain because they're there to raise money for a specific cause, and to support a specific cause. They can complain because when they watch what is pitched as a mandatory safety video, they should reasonably be able to expect that it will be focused on safety issues. When somebody raises thousands of dollars before entering into what they believe will be a personally enriching experience to support their preferred charity, you don't want to leave them with the impression that they are in fact a cog in the PTW machine, there to enrich you or your company. Yet it appears your aggressive self- and cross-promotion contributed to that perception.

    In terms of levels of participation, are you asserting that it was not low participation that caused a reported 86% of the proceeds of the 2002 D.C. AIDSRide to go to overhead and expenses? If in fact participation was steady or on the rise, why was the percentage returned to the charity plummeting? The specific numbers I've seen for that ride were $3.6 million collected by riders, with only about $500,000 going to AIDS-related charities - are you stating that's because you were massively increasing your fees to the AIDS charity to subsidize your new event concepts benefiting other charities?

    Beyond that I'm really not interested in a broad "you got facts wrong" accusation. If you can't take the time to point to facts I got wrong, other than as outlined above, I'm satisfied that the remainder of my comments are correct, or are close enough to correct that all you can do is nitpick. Feel free to prove me wrong - you have unlimited space, right here, to do so.

    To the extent that the failure of PTW resulted from your dependence upon a single large client, such that without that client you could not maintain sufficient operating revenues to keep the lights on, that happens a lot in business. (As does the experience of having a former client co-opt your business model, despite the terms of your contract with them.) Losing that type of key contract is a common source of business failure, and businesses with clients comprising 40% or more of their revenue base often struggle between trying to best serve their most important clients or broadening their reach (if possible) to ensure that they can weather the loss of a major client. We can talk more about that, if you like, but it's a pretty basic concept.

    Incidentally, you shouldn't view me as the enemy here, even if I'm critical of some of your business choices. I don't care how much money you pay yourself in the course of running your own successful for-profit business, and if you are presently raking in millions on the book and lecture circuit all the more power to you. I also appreciate the up-front nature of your business model - such that charities knew up-front what your services would cost. I agree with the general argument that "efficiency" as measured by charity rating agencies can get in the way of effective fundraising. I will reiterate, though, that inefficiency (when known) does detract from altruistic pleasure, and that's something a charity must consider when devising a fundraising plan.

  3. Aaron,

    Thanks for the comments - if you have the time, read the book. I think you'd find it interesting given your obvious sophisticated understanding of the issues. Don't mean to be glib but I spent several years writing the book and a few paragraphs of summary here in rebuttal don't do the arguments justice.

  4. ". . . read the bookbut . . . I spent several years writing the book and a few paragraphs of summary here in rebuttal don't do the arguments justice."

    . . . they also don't put any money in your pocket; which I suspect is the greater issue.


  5. I expect that I would find the book interesting, given the time to read it, and I wouldn't be surprised if it includes a lot of valuable suggestions for charities.

    Do you care to offer any hints as to your own next venture? Something that puts your ideas, old and new, back into action?

  6. Hey Aaron,

    Sorry for the month-long delay. Honestly, not really sure what's next. Right now it's about trying to get people to change their thinking on these issues.


    P.S. As for "anonymous" up above, if you think there's a bunch of money in spending four years writing a book about the nonprofit sector I have a bridge I'd like to sell you. And please have the guts to state your name if you're going to defame people.

  7. He did state his name - or at least his initials. Most of the people who follow this blog know who he is.

    Is there a way for us to get the gist of the new way of thinking you propose (that doesn't boil down to "buy and read my book")? ;-)


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