The Role of the Philanthropist: Evidence-Based Theories of Change, Round II

[This continues Sean Stannard-Stockton's and my conversation about theories of change. Sean wrote a guest post on this blog, arguing that donors should be primarily concerned with funding great nonprofit organizations rather than crafting theories of change for social programs. I replied. And Sean has now responded on his Tactical Philanthropy blog. Here's an excerpt from his response. I'll plan to respond later in the week.]

In "Donors as Investors not Entrepreneurs," Sean writes:

For-profit firms are generally built by entrepreneurs and funded by investors. Most investors are "passive" in that they provide capital, but do not influence the day to day operations of the firm. Some investors, especially large, early stage investors such as venture capitalist, do exert influence over how the firm is run. However, at the end of the day, the business plan is crafted and adapted by the entrepreneurs, not the investors...

Sure nonprofits should have sound business plans that address both operations as well as a Theory of Change for why their programs will affect social impact. While neither nonprofits nor their funders should expect the level of evidence found in science, I do think that nonprofits should base their plans on evidence that they will likely work and accumulate evidence along the way that things are working (or not). My point is the designing of programs and researching of validity should be the domain of nonprofits. The focus of donors should be reviewing nonprofits and selecting those that appear to offer the best opportunity for impact. This is not how foundations behave today.

...Many foundations are practicing philanthropy with their emphasis in the wrong place. Foundations should be spending most of their time researching nonprofits and then figuring out the best way to fund the ones they chose, rather than spending their time designing programs and then finding which nonprofits they can contract with to execute their plans. ...

So yes, evidence of social impact is important. Yes, any public benefit activity should be executed according to a plan and progress towards goals should be tracked. But I refute Paul's assertion that philanthropists are the ones charged with designing a theory of change. Instead, I think their role should be in funding the best nonprofits. It is no wonder that we've been so slow to develop social capital markets if the major funders are more interested in designing programs than in providing capital to build great nonprofits.

In my model, donors would have their own beliefs and expertise around what sorts of programs work. But they would be "synthesizing generalists" in the words of philanthropy advisors Lowell Weiss ... A synthesizing generalist, which is an apt description of most great for-profit investors, does not have the domain expertise to create social impact business models. But they do have the ability to evaluate nonprofit firms across a variety of areas and select the ones who are most likely to have a theory of change that works and the ability to execute their plan. ...

Comments

[Bongo2000]

In a perfect world, each nonprofit would have a theory of change written on its sleeve, and would make data available about its efficacy. In this utopia, funders would be able to select nonprofits based on both how much they agree with the theory of change and past results. In practice, few nonprofits articulate a specific theory of change or have meaningful measures of their impact.
Specifically:
1. Funders *can't* distinguish between good and bad organizations by result, and since there's no smorgasbord of well-documented theories of change in competition, funders can’t sit back and passively select organizations that adopt theories they agree with.
2. Foundations *should* have a deep interest in the impact of their investments, but when they don’t have metrics, it’s hard to argue that they *act* as if they actually do have such an abiding interest. I’m talking about actions, not state of mind. Without hard data (such as profit or loss), delusional thinking is easier to maintain.
3. Liquidity may not be the best concept here. Lack of compatible measures, and the enormous amount of time / effort to come up to speed to monitor a multitude of nonprofits (outside of one’s own portfolio of grantees) mean that funders are unlikely to understand nonprofit universe in detail similar to what investors have with respect to the investment universe.

[Bongo2000]

Analogies between the financial and nonprofit sectors only go so far.

Stannard-Stockton observes that “most investors are ‘passive’ in that they provide capital, but do not influence the day to day operations of the firm,” in support of the idea that funders should leave grantees to their own devices.

This ignores the fact that financial markets indirectly select strategies by allocating more capital at higher valuations to companies investors judge to have superior strategies.

This is impossible in the not for profit sector for numerous reasons--I’ll focus on three:

First, analysts can compare companies’ results using well-established metrics (revenue per subscriber, free cash flows from operations, tons per annum of production), while non-profits have yet to establish common benchmarks that accurately portray their efficacy.

Second, portfolio investors have a much more concentrated self-interest in the (measured) success of their portfolio investments. This leads to companies being responsive to the market views the effectiveness of business strategies. Companies viewed by analysts as having adopted effective strategies (and being able to implement them successfully) garner relatively more capital at higher valuations. Similar forces are mainly absent from the non-profit world.

Third, the market for foundation-funded non-profits is vastly less liquid than financial markets, rendering the little information available to insiders inactionable by most of the funding universe.

These factors serve to push the onus to do more of the basic thinking about strategy and measurement of outcomes up to the grant making level.

[TacticalPhilanthropy]

Excellent counter argument! I probably confused my message when I wrote about passive investing. I'm arguing mainly that strategies for creating social impact programs should be designed at the nonprofit level and funders should provide capital to the best organizations. That does not mean that funders should just back off and let nonprofits do what they want. Any smart investor cares deeply about the strategies that their portfolio investments make, but they don't tend to tell them what to do. They just walk away (and take their money with them) if they lose confidence in the investee's decisions.

Regarding your three areas:

1. The lack of well established metrics should not mean that smart funders cannot distinguish between good and bad nonprofits. Plus, even with the well established metrics in the for-profit space, it is certainly not easy to pick good investments!

2. I would think that foundations should have a deep interest in the success of their investments. It may be that the profit incentive is stronger than the desire to do good (I think it is complex), but if you argue that only a profit incentive can direct donations well then we might as well write off philanthropy.

3. I think this is wrong. Liquidity refers to the ability make transactions on demand. Anyone can write a check to a nonprofit at any time, so liquidity is not an issue.