For-Profit vs. Nonprofit Organizations
Written by Leng M. Vizcaino Andres
When looking for the meaning of the term “profit” in the Merriam-Webster Dictionary, it is defined as a valuable return or gain. It also denotes the compensation accruing to entrepreneurs for the assumption of risk in business enterprise as distinguished from wages or rent. It is correct to assume that, on the contrary, when using the term “non-profit”, this is referred to the lack of an interest or purpose in making a profit (Merriam-Webster Online).
In the context of this paper, the economic connotation of the concept of “non-profit” is used as a distinction for some activities driven by other types of interests apart from materialistic ones. Such activities are associated with philanthropic actions carried out through collective efforts, which constitute one of the major sectors of the American society, frequently labeled as the Nonprofit Sector. In contrast, the activities motivated by self-interest in the accumulation of private goods (wealth) is what determines the for-profit nature of the so-called Market Sector. The first sector that functions in society is the government, which regulates the operation of the others (Payton and Moody 2008).
In the same way that the market sector comprises business, firms, and all types of lucrative associations, the nonprofit sector encompasses those organizations and entities with philanthropic and not-for-profit goals. Nonprofit groups may provide one or more public benefits and although they may have different sources of income, what really distinguishes them financially from the market sphere is the non-distribution of excess revenues among members. Any surplus income that a nonprofit organization could have must be used in the fulfillment of its mission (Anheier 2014; Smith, Stebbins and Dover 2006).
For many centuries, benevolence has driven individuals into charitable actions for the good of others. Examples of the creation of not-for-profit entities for the public good are as old as Plato’s Academy (387 B.C.) or the library of Alexandria in Egypt (3rd century B.C.). Ancient Judaism, Christianity, Islam, Buddhism, and other religions have also played an essential role as the vehicle for generosity and unselfish practices which have become traditions that remain up to today (Robbins 2006). All these initiatives have contributed to the proliferation of many social enterprises in favor of the needy while building a charitable culture that constitutes the foundation of the independent or nonprofit sector.
Since the early times of colonial America, voluntary actions were organized as an expression of solidarity that represented the spirit of social entrepreneurship of the young nation (Burlingame 2004). Firstly, informal and spontaneous associations were formed, such as the Junto Club created by Benjamin Franklin in 1727, which led to many civic improvements. Soon, Americans showed greater evolution compared to Europeans in the legal differentiation of public, private, and voluntary institutions (Friedman 2002). Law practitioners during the early 19th century described the distinctions between each body in terms of their functions and outcomes.
Despite the long traditions of giving and serving others, it was not until World War II that the term “nonprofit” started being used as a denomination for the sphere of philanthropic activities (Hall 2006). The policy-framing around the nonprofit sector as it is known today was the result of the structural socio-economic organization of the United States and its administration. The government started budgeting its federal expenditures in 1912 and the statistical system for National Income Accounts was implemented in 1939. That offered an estimate of the scale and extent of the American economy (Hall 2008). Consequently, as a result of organizational purposes related to the federal tax code and changes in policies in the United States, the private social-oriented organizations were called to be registered and classified as nonprofit. The Internal Revenue Code (IRS) of 1954 defined and incorporated nonprofit entities in a broad range of organizations that make up different categories under the section 501 (c) (Hall 2006).
Main distinctions between for-profit and non-profit organizations
Although the main difference between nonprofits and for-profits is generally associated with the structure of their revenues, there are other features that distinguish one sector from the other. Some of these characteristics are their mission, governance, finances, and type of labor. It is important to highlight that despite the economic implication of the term nonprofit, the true essence of the sector is in its philanthropic purpose. Therefore, the ultimate mission of not-for-profit entities is centered on social benefits for the public good.
Nonprofits are governed by a Board of Directors or Trustees, which are usually larger than in standard businesses, have fewer insiders, are more heterogeneous, and receive none or little compensation for the responsibilities assumed (Oster 1995). The sources of income for non-profits are also quite varied when compared to for-profits. They can come from grants, individual and corporate donations, bequests, fees, and other innovative sources typical of the business sector. Despite the variety in earnings, nonprofits main financial supporters are individuals, which accounted for 72% of total contributions in 2016 (Giving USA 2017). In addition, charitable organizations (501(c)(3)) can be exempted from the payment of taxes on the donations received. Donors can also deduct their contributions from their taxable income.
The nonprofit sector is well known for being heavily dependent on volunteerism, which is why it has been called the Voluntary Sector. While the for-profit sector relies on the payment of its workforce, philanthropic organizations can carry out activities with both paid employees or volunteers. As a matter of fact, there are nonprofit organizations with more volunteers than paid staff. According to figures from 2010, American volunteers (older than 16 years) represented an estimated 8.8 million full-time employees (Anheier 2014). Notwithstanding, business tends to have a more professionalized workforce, which allows them to be more efficient and competitive.
Each of the sectors mentioned above has a different function in society, which is related to the provision of different types of goods. Economic theories state that the market sector and the government are more efficient in delivering private and public goods, respectively. This is justified by the ability of the market to handle better consumer preferences, and the government authority to enact taxation and regulations. An example of a public good is police service, and a private good could be the acquisition of a car. However, the boundaries of what can be considered public or private are political, which leaves a blurry and unfulfilled space of quasi-public goods. The incapacity of both the government and the market sector in effectively delivering quasi-public goods are described in the literature as failures. In response to that, the nonprofit sector steps up to take on the unsupplied demands of society (Anheier 2014).
The role of nonprofits embracing the territory left by the government becomes more important in heterogeneous societies like the United States. With the increase of diversity in the population, the perception of the common good varies significantly since each ethnic and social group has different needs. In addition, policies and government change periodically due to electoral reasons, and politicians try to please the demands of the median voter (Anheier 2014). In any case, nonprofits turn into an alternative solution to fill the gaps, either in the provision of goods and services or giving voice to the unheard.
Ties to the Philanthropic Sector
While nonprofit organizations constitute the infrastructure that supports the philanthropic sector in market economies, for-profit organizations act as the capital infuser of charitable activities. In other words, for-profit entities are proven to be the most efficient mechanism for the production of wealth and resources. Nonprofit organizations provide a way for the redistribution of wealth.
Although major contributions to philanthropy are made by private individuals, corporations have also joined the list of philanthropists. According to Giving USA 2017, in 2016, corporations donated $18.55 billion to the non-profit sector, which represents an increase of 3.5% over the previous year (Giving USA 2017). Many firms contribute to the sector through the implementation of philanthropic practices such as matching the donations of their employees to certain causes or the returning of part of their contributions.
Key Related Ideas
- Contract failure is another theory related to deficiencies of the market sector that are solved by the nonprofit sector. Sometimes the quality, quantity, or cost of a service is difficult to judge by the consumer, so businesses may take advantage of it. In this case, individuals trust more in the nonprofit sector due to the non-distribution constraint that bounds these organizations (Hansmann 1987, 29).
- Market failure theory is an economic theory that establishes the scenarios in which the business sector is not efficient in the provision of services and goods, so another sector has to take on the unsupplied needs (Anheier 2014, 201). An example in which the market fails is in the provision of public and quasi-public goods, hence government and nonprofits must intervene.
- Social Economy is a European term that includes more organizations in the categorization of nonprofits in comparison with the American definition. This classification includes cooperatives, mutual societies, social enterprises, and other business-type organizations (Anheier 2014, 61).
Important People Related to the Topic
Relevant individuals in the development of the nonprofit sector as a distinctive sphere apart from the business and the government are:
- Alexis deTocqueville (1805 – 1859) was a French political scientist, diplomat, and historian known for being the earliest observer of the associational style of life in the United States. This is relevant due to the influence of such a feature of the American culture in the evolution and development of its nonprofit sector. More information about deTocqueville and his observations can be found in a briefing paper previously published on this website.
- Benjamin Franklin (1706 – 1790) was a polymath who pioneered the development of American philanthropy. Franklin’s extensive services to the field can be found in a previous briefing paper devoted to him. It is important to highlight his contribution to the tax exempts laws. He has been reported to have led the first effort in Colonial North America of offering tax reduction in exchange for charitable actions. What is more, Benjamin Franklin initiated the concept of matching grants during the fundraising period for the construction of Pennsylvania Hospital (Levenick 2017).
- John D. Rockefeller III (1906 – 1978) belonged to the third generation of the wealthy and influential Rockefeller family. He was an active philanthropist, whose contribution was not limited to financial support but he was also a powerful advocate of philanthropy as a major social force to be taken seriously by the government. Rockefeller’s effort led him to the creation of the Commission on Foundations and Private Philanthropy (also known as the Peterson Commission) and the Commission on Private Philanthropy and Public Needs (also known as The Filer Commission). The more transcendent suggestion of the Filer Commission was that all tax-exempt organizations were part of a “third”, “non-profit”, or “independent” sector that was key for the future of democracy. Rockefeller also advanced the initial funding for the first academic research center for philanthropy, Yale’s Program on Non-Profit Organizations (PONPO) (Robbins 2006).
Related Non-profit Organizations
The first two nonprofits provided are highly relevant due to their role in the organization and functioning of the sector. For a better understanding related to the differences between nonprofit and for-profit entities, an example is given of a renowned brand-name company that operates as a business but also gives a name to a nonprofit.
- GuideStar is a nonprofit organization whose purpose is to provide organized information about American nonprofit and charitable entities in the form of a directory. Its database was reported to include information about 2.5 million organizations and it is used as a digital platform for research and the verification of nonprofits accountability (Wyland 2016) (www.guidestar.org/Home.aspx).
- Independent Sector is a national membership-based association that gathers multiple nonprofits, foundations, and corporations towards the common good. It was founded in 1980 as a result of the fusion between the National Council of Philanthropy and the Coalition of National Voluntary Organizations. The organization focuses on the networking of its members and the building of knowledge while doing advocacy on behalf of the nonprofit sector (independentsector.org/).
- The Ford Foundation is a grant-making organization established in 1936 by Edsel Ford, son of Henry. The purpose of the foundation is to provide financial resources in support of the public welfare. At present, the organization is a steward of a $12 billion endowment and it is led by a board of trustees of 16 members from 4 continents. The Ford Foundation is totally independent of the Ford Motor Company and makes $500 million in grants per year all over the world in support of social change (www.fordfoundation.org).
- The Ford Motor Company is an American multinational automaker founded in 1896 by Henry Ford. In 2016, Ford was ranked as the 10th American-based company on the Fortune 500 list, with global revenues of $151.8 billion, which are distributed among owners and executives (Fortune) (corporate.ford.com).
- Why would someone choose to form a nonprofit enterprise instead of a for-profit company?
- Can you think about an issue in your community that could be addressed by a nonprofit organization?
- Anheier, Helmut. Nonprofit Organizations: Theory, Management, Policy. New York, Oxon: Routledge, 2014.
- Burlingame, Dwight. Philanthropy in America: A Comprehensive Historical Encyclopedia. Santa Barbara, Calif: ABC-CLIO, 2004.
- Ford Foundation. http://www.fordfoundation.org
- Ford Motor Company. https://corporate.ford.com
- Fortune. Fortune 500. http://fortune.com/fortune500/ford-motor/
- Friedman, Lawrence J. "Philanthropy in America: Historicism and Its Discontent." In Charity, Philanthropy, and Civility in American History, by Lawrence J. Friedman and Mark D. McGarvie. Cambridge, United Kingdom: Cambridge University Press, 2002.
- GIVING USA. 2017. See the numbers- GIVING USA Infographic. https://givingusa.org/tag/giving-usa-2017/
- Hall, Peter. "Chapter 2- A Historical Overview of Philanthropy, Voluntary Associations, and Nonprofit Organizations in the United States, 1600-2000." In The Nonprofit Sector: A Research Handbook, by Walter H. Powell and Richard Steinberg. Yale University Press, 2006.
- Philanthropy, The Welfare State, and the Transformation of American Public and Private Institutions, 1945-2000. Cambridge, MA: Hauser Center for Nonprofit Organizations, Harvard University, 2008. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=262652
- Hansmann, Henry. "Economic Theories of Nonprofit Organization." In The Nonprofit sector: A Research Handbook, 29. New Haven: Yale University Press, 1987.
- Levenick, Christopher. "Benjamin Franklin." PhilanthropyRoundtable. http://www.philanthropyroundtable.org/almanac/hall_of_fame/benjamin_franklin
- Oster, Sharon M. "The Nonprofit Board of Directors." In Strategic Management for Nonprofit Organizations: Theory and Cases, by Sharon M. Oster. Oxford University Press, 1995.
- Payton, Robert, and Michael Moody. Understanding Philanthropy: its meaning and mission. Bloomington, Indiana 47405 USA: Indiana University Press, 2008.
- Robbins, Kevin C. "Chapter 1-The Nonprofit Sector in Historical Perspective: Traditions of Philanthropy in the West." In The Nonprofit Sector: A Research Handbook, by Walter H. Powell and Richard Steinberg. Yale University Press, 2006.
- Smith, David Horton, Robert A. Stebbins, and Michael A. Dover. A Dictionary of Nonprofit Terms & Concepts. Bloomington, IN 47404-3797 USA: Indiana University Press, 2006.
- Wyland, Michael. "The Nonprofit Quaterly. Non Profit News for Nonprofit Organizations." 2016. GuideStar Introduces Program Metrics Section for Nonprofit Profiles. May 11, 2016. https://nonprofitquarterly.org/2016/05/11/guidestar-introduces-program-metrics-section-for-nonprofit-profiles/
This paper was developed by students taking a Philanthropic Studies course taught at the Lilly Family School of Philanthropy at Indiana University in 2017. It is offered by Learning To Give and the Center on Philanthropy at Indiana University.