Nonprofit costs are driven by revenues

This post takes us through health care, college sports, and opera…

One of the first things arts administration students are taught about nonprofit organizations is that by law, and by definition, nonprofits are not to distribute any net earnings to managers or shareholders, but rather any revenues over costs must be applied to the mission-related activities of the organization, either through program spending or through saving it. Nonprofits that spend all of their revenues, in turn, “don’t make any money.”

But it’s not quite so simple. Suppose a nonprofit is in a position to collect significant revenues through ticket sales, sponsorships, donations and other sources. Where does the money go? If it raises the salaries of certain people within the firm, if it is used to expand and embellish the facilities far beyond what is needed to meet the mission of the organization, then in the end, it will look like revenues just covered costs, but no more. The nonprofit “didn’t make any money.” But the “costs” were in fact determined by the revenues – it was the high revenues that drove up salaries and expenditures beyond what they really needed to be. Economists use the term “rent” to describe payments to individuals in excess of what was actually required to get the job done. And successful nonprofits can sometimes generate a lot of rent. The question then isn’t whether the nonprofit “made any money”, but is about who benefited by collecting the rents.

This is brought to mind in the past few weeks in light of the (so far) successful efforts of football players at Northwestern University to start on a path to form a union, and the response from a number of places that, in fact, college football does not actually make any money, except in a handful of Division 1 schools. But that is not so. College football generates a lot of money – see the Times here and here. When someone points out that universities don’t earn much from it, the point being made is that the significant rents generated by college sports do not end up in the universities’ general operating funds. But they end up somewhere. The effort by players is to capture a share of them. And yes, that means those who have previously done much of the rent-collection would lose some of their share. To be clear, I am uncertain about all the pros (heh) and cons of college athlete unionization or compensation. But it is not right to say there is not really any money out there.

The lesson here is not just about college sport – it is also about other nonprofit institutions like orchestras, museums, and hospitals. American health care is extremely expensive, relative to other rich countries (which have comparable, if not better, health outcomes), because the system used in the US to compensate health care providers has few restraints on payments for services (yes, the Canadian ‘single-payer’ system saves money on administrative costs, but the primary way it keeps health costs in check is by limiting compensation to health care providers). There are museum directors who are paid over one million dollars per year, and the reason is that the money is there to be spent, which in turn drives up top salaries.

And as I was working on this blog post, out comes today’s New York Times and its front-page report on the finances of the Metropolitan Opera:

The Met — worried by declining box office income, high labor costs, a growing reliance on donors and heavy spending from its endowment that has left it smaller than it was a decade ago — opened the negotiations recently by asking its unions to accept cuts of roughly 16 percent. The unions, whose contracts are up at the end of July, have balked, urging the company to seek savings elsewhere in a budget that reached $327 million last year. The American Guild of Musical Artists, which represents the chorus and others and is one of the 16 unions at the house, had publicly been warning its members to prepare for a possible lockout next season

The offstage drama that has been playing out has highlighted the difficult economics of opera in the 21st century, which have forced several companies to close or scale back. A spate of recent emails between labor and management, and a review of the opera house’s financial statements have pulled back the curtain a bit on life at the Met, one of the most important opera houses in the world.

Many of the talks will center on work rules that the Met finds too costly. The Met estimated in a recent memo that members of its chorus earned an average of $200,000 last season and called for changes that it said would reduce that figure to around $170,000. The union said that it believed that the changes the Met is proposing would cut deeper than that.

I don’t doubt that chorus members are very talented, and work hard for their salaries. But that $200,000 salary figure is not something that has arisen from a competitive market for chorus singers – it has come about because of the amount that the Met has available to spend. Over the decades it has been able to generate very large amounts of revenue, and those revenues will be captured by those with the bargaining power to do so. The Met is a nonprofit, it ‘doesn’t make any money’, except that it does, and the money goes to those able to stake a claim on it.