How a lean cost structure can improve financial sustainability

Like most commercial organizations, non-profit organizations and social enterprises should strive to keep their fixed costs as lean as possible. Those that do this properly will be more likely to survive financial shocks and stresses, and create dynamic and sustainable organizations.

While many of these organizations have already achieved this state, this article targets those social entrepreneurs who believe their organizations have become too expensive to maintain on an ongoing basis, or are about to enter a risky and uncertain financial territory.

This article shares some important lessons I’ve learned from assisting these organizations to develop budgets, build financial models and review their financial structure.

I will emphasize the importance of interrogating one’s business model and financial structure to identify what is essential, what can be outsourced, and how much is required for economies-of-scale to be retained.

What do I mean by “fixed costs”?

I define “fixed costs” as those costs that an organization incurs regardless of how many projects or income streams are currently active. This contrasts with “variable costs” which will increase/decrease depending on levels of activity.

“Fixed cost” will therefore tend to include administrative costs (e.g. rental), marketing costs (e.g. website hosting) and the costs of certain staff (e.g. bookkeeper and CEO). Without these costs, an organization cannot function and is no longer capable of doing its work.

It takes time to properly increase or decrease an organization’s fixed costs. Reducing it too quickly may require retrenchments and legal expenses, create unmanageable disruption and affect the functioning of the organization.

In contrast, increasing fixed costs too quickly, or without adequate planning, may result in bringing the wrong people into the team, disruption to the organization or thoughtless expenditure.

Fixed costs should be kept as low as possible

I believe that non-profit organizations and social enterprises should strive to keep their fixed costs as lean as possible, but not too lean as to undermine their capabilities and prevent them from moving forward strategically.

Achieving this lean state is most challenging for those organizations that have come rely on a single lucrative form of income (e.g. single foreign donor or dividends), especially if they believe it will continue indefinitely.

There are three main advantages to keeping fixed costs as lean as possible:

  • It enables an organization to easily expand during prosperous times, and contract when finances are under pressure. This creates a flexible organization.
  • It means that reserves will last longer during dire financial circumstances. This will give the organization more time to find its feet, reposition itself and secure other income streams. I call this the “sustainability runway”. The longer the “runway”, the more time there is for an organization to “gain speed” and “take off” successfully.
  • It makes it easier for an organization to change its focus and adapt its team and capabilities accordingly.

However, an organization can easily overdo its efforts to become lean, and reduce its fixed costs in a way that undermines itself. There are three main risks of doing this poorly.

  • It could undermine capabilities that the organization must retain “in-house”. For example, an organization might mistakenly outsource key functions that employees should do.
  • The organization may lose economies-of-scale, thereby making its goods or services more expensive to its customers, whether they be donors or beneficiaries.
  • The organization may undermine its ability to market itself and attract new work, and get itself out of its adverse situation.Therefore, organizations should think clearly about how lean they want to be. Being too fat is risky, but then so is being too lean.

How to cultivate a lean state

Reducing an organization’s fixed cost structure does not necessarily mean reducing its overall expenses, unless this is required at the time. Rather it primarily involves the shifting of fixed costs into variable costs.

For example, Senecio, a disability organization in Cape Town, recently shifted from employing therapists to contracting or using volunteer physiotherapists, speech therapists and occupational therapists in its work. This significantly reduced its fixed costs, and offered more flexibility. It had the added benefit of developing much closer relationships with therapists in its area and increased awareness and support for the organization.

I also know of organizations that have outsourced bookkeeping, monitoring and evaluation, social media, logistics and office services.

This lean state can only be achieved by organizations that cultivate a close network of suppliers and partners that can be rapidly contracted should work require it. Though these costs may be more than if they were kept in-house, the flexibility they offer in an unstable world may be worth it.

Several organizations have also used a combination of technology and process optimization to reduce their fixed cost structure. For example, when a social research company I work with revamped its quality systems and shifted over to doing interviews on tablets, its fixed costs were significantly reduced.

Another example of the power of technology is how FoodForward recently shifted to “virtual foodbanking”. This meant that FoodForward no longer needed to own a fleet of trucks; instead the platform facilitated pickups/deliveries of food between retailers and beneficiary organizations.

Some organizations have chosen the social franchise approach where they license their model and hold onto the intellectual property rather than expand their operational costs. However, this has required an unanticipated amount of work and has not been as easy as anticipated.

Act swiftly and decisively to cut costs when necessary

The biggest problem I’ve observed is when leaders refuse to swiftly and drastically cut or re-assign their costs when circumstances require it. They wait until later and then it becomes too late. They think of their organization’s strategic success in terms of how big it is (e.g. number of staff, turnover) rather than in terms of its brand, relationships, capabilities etc.

The desire to protect jobs can easily result in leaders neglecting their strategic duties to their organization. It’s possible that there they have too much hope that things will improve – too much optimism without sufficient realism to temper it.

Unfortunately, this means that their reserves don’t last long enough – their “runway” is too small for them to gain momentum and successfully take off. Their “airplane” is too heavy. They crash and burn. I have seen this happen too many times. It is very sad.

Therefore, it’s important for non-profit organizations and social enterprises to maintain a lean fixed-cost structure, and then to act decisively and swiftly to reduce costs when required. I once heard the director of a criminal justice organization say something like: “I had to cut deep and swift, rather than cut twice and slow, and in hindsight this was the best decision I could have made”.

What can you do now to prepare your thinking?

Please do yourself a favour. This exercise will only take an hour over a cup of coffee. It is easiest to do this away from the office.

Step 1: Imagine the worst-case financial scenario. This could be a donor dropping your organization, or a key client ending a business contract. Imagine a situation where your organization suddenly loses 50%-75% of its income. Give this scenario a name.

Step 2: Identify the fixed costs that your organization must carry to survive this scenario and keep moving forward, adapt and secure other income streams. They key point here is to remain capable and to make steady progress towards its future.

Step 3: Calculate the costs of executing the downscale to your scenario. This may include retrenchment costs, new technology etc.

Step 4: Identify the factors that will trigger your emergency plan. It may be a report from your bookkeeper or financial manager, or a decision from one of your customers.

Step 5: Identify how much financial reserve your organization needs to cover its fixed costs for a 12-month period, and the costs of downscaling to this state.

Step 6: Imagine how you could start shifting some of your fixed costs into variable costs to offer your organization more future flexibility. Perhaps you need to cultivate a closer network of partners and suppliers. Perhaps you’ll need to introduce technology that automates certain functions.

This exercise will help you to prepare your thinking for the future and identify any opportunities to create a more flexible organization.

Conclusion

Non-profit organizations and social enterprise tend to operate in difficult financial circumstances. This requires that social entrepreneurs create organizations with lean fixed-cost structures, and strong and close networks of suppliers and partners.

Not only should organizations strive to build reserves, but leaders should be willing to trigger their emergency scenarios as soon as circumstances require it. Here it is important to act swiftly and decisively, and beware of false hope.

Overall, social entrepreneurs must realize that the success of their organization is not based on its size, turnover or number of staff. These things may fluctuate over the course of an organization’s life. Rather, an organization’s success is based upon things such as its impact, brand, relationships and capabilities.

I’ve worked with several organizations that lost key contracts and needed to rapidly decrease their costs to under 50% of what they were. Those that did successfully and decisively have managed to emerge stronger than before.

This article shares a message of both preparedness and hope. It reminds us to be prepared for our worst-case scenario and develop a fixed cost structure that will enable our organizations to adapt and continue moving forward. On the other hand, it reminds us that organizations must contract/grow, and consolidate/change in order to thrive into the unknown future.

Cultivating strategic clarity.

Back to top of page ↑