Monthly Archives: September 2011

Applying Porter’s Five Forces Model to the NGO Sector

Porter’s Five Forces are designed for traditional for-profit commerce and industry scenarios. With slight tweaking they are equally applicable to the non-profit sector; an examination of these will highlight the implicit vulnerabilities of organisations working in this sector. Where Porter’s model looks at the way the forces can affect profit, the NGO adaptation of his model is more concerned with how the forces impact an organisation’s ability to perform its mission effectively and efficiently.

Porter’s Five Forces are:

  1. The power of large customers
  2. The power of large suppliers
  3. The level of rivalry among organizations in an industry
  4. The potential for entry into the industry
  5. The threat of substitute products

 

The significance of each of these will be individually engaged in a general discussion of the NGO sector. Implicit in this discussion will be the task and general environmentof South African NGOs. This discussion will close with the presentation of an NGO adaptation of Porter’s Five Forces model.

The Power of Large Suppliers and the Power of Large Customers.

For the NGO sector the activities are mainly service, and not product, based. Further, these services are social in character and based on specific skills rather than material resources. This diminishes the impact of supplier power in comparison to a production based for-profit company, as intended by Porter’s original model.

 However, the donor community and corporate funders can be seen as both the supplier and customer in the NGO model. They provide the resources, in the form of funds, for the NGO to carry out its mission, and in return they can lay shared claim to the positive social impact which is achieved through the NGO’s activity. The donor organisations need this to fulfil their own mandate; and corporate funders are able to include this in their CSI portfolio and report it in their triple bottom line.

In this regard the power of large funders, be they donor organisations or corporate funders becomes a force in the NGO adaptation of the model.  How this plays out in real-world situations is largely dependent on the strength of the NGO’s leadership. For lack of a better analogy it can become a carrot and stick scenario. A large funder is defined as one with influence in the donor community and the potential to contribute significantly to the NGO’s resource base. Funding is granted in one of two large catergories; project or operational. Project funding is typically directed towards a specific project with defined objectives and measures of success; while operational funding is directed towards the organisation’s operating costs. The later includes infrastructural, administrative and staff/organisational development, as well, as the name suggests, general operating costs.

The power of large funders can impact an NGO across both these areas. Through the lure of significant project funding it can draw an NGO away from its core vision and mission into activities which introduce scope-creep into every level of operation. Through the lure of significant operational funding conditionalities can be imposed upon which the funding, and any future funding, can be made contingent. It is not the presence of conditions but rather the nature of the conditions which can impact an NGO’s autonomy in determining its organisational structure and future strategy. It is important to state here that the impacts of this force are not necessarily negative. An organisation cannot exist as a static entity and project funding can provide the opportunity to evolve the organisation in a new direction to better meet the changing social development market. Scope-creep and evolution are two sides of the same coin; the strategy of the organisation determines which side is called. Similarly structural-adjustment-policy-style (Stiglitz, 2002) operational funding could be piggy-backed upon to bolster autonomous strategic directions and activities. Ultimately, to reiterate an earlier point, the threat posed by this force can be mitigated by strong leadership with a clear strategic vision – if someone else is holding the reins a gift-horse should be looked in the mouth.

What the power of large funders highlights is the tacitly accepted unequal power balance between NGOs and donors; remember this is social development and not charity (the distinction between these is a paper in itself). The donor organisations have a mandate to fulfil, in fact the sole reason most of them exist is to award grants towards social development activities. They are not service providers nor are they capable of carrying out the actual delivery of social development activities at the community level; they need NGO service providing partners. Similarly, corporate funders need CSI portfolios for their BBBEE scorecards and their triple bottom line reporting; NGOs provide a service they need at lower cost than they can do it in-house. The power balance exists not because the funders hold the money, but because money is incredibly tangible, measurable and traceable. The impact, for example, of the training of a community based crèche teacher on the life of a young child is not readily tangible, measureable or traceable over the course of that child’s life. NGOs and the theories of change that underpin their work believe they are making a positive difference; they are selling that change; but what they battle to do is demonstrate or measure that change as clearly as funders can demonstrate and measure their investment. What we have is a strange economy, where cash is traded for an intangible sense of positive social impact supported by rudimentary indicators (including: numbers reached and anecdotal evidence). In some case this economy exchanges cash for no more the “warm-fuzzies”.

“One cannot refute that CSI reports carry “warm-fuzzy” value and that pictures of impoverished yet smiling African children in annual reports and media have become a form of currency and are interpreted to be an indicator of development.”

(Roberts, 2011)

This recognition presents an opportunity for NGOs to leverage competitive advantage through being able to demonstrate the impact of their work to funders in a manner that is more tangible, measurable and traceable than other NGOs working in their field. Achieving this, will also lay the foundation for NGOs to educate their funders and partner organisations as to what are reasonable processes, outcomes and measurable impacts of social development activities in relation to a given sum of donor funds; effectively benchmarking.

(A note at this juncture: Not all funders need to be educated, nor do they all assume tacit domincance.)

 

 

The Level of Rivalry Among Organisations in an Industry

Local NGOs, to my understanding, have always had a tacit agreement to not work in, or encroach on each other’s area of operation. However, the social development NGO sector, broadly, is at a crossroads. South Africa is not the darling child of the international donor community that it was during apartheid or through its transition and establishment as a true democracy. International donors who were in some ways the staple providers for a range of activities have shifted their country focus, or shifted their activity focus, or both. There is a smaller pool of International Donor Funding than in times past, further to this, the remaining pool of International Donors was not impervious to the financial recession of 2009. There are fewer funding sources available to the sector. Because the funds are scarce donors are placing (and rightly so) an increasing emphasis on measurement and demonstration of the impact of their investment, this is discussed above. While the increasing scarcity of resources and changing mood of the environment does not necessarily translate to the cut-throat vistas painted by corporate rivalry, it does create a competitive environment. In terms of the well being of the broader social development sector this is not a bad thing at all. If any sector should be focussed on efficiency and effectiveness of delivery it should be the social development sector; and where slack can be cut out or better managed competitive advantage can be gained; and greater positive impacts achieved.

 

Potential for Entry into the Industry

Barriers of entry into the non-profit sector are extremely low.

 

The Threat of Substitute Products

Within the NGO sector the threat of substitute products must be seen to take the form of competing funding requirements between different development focuses; for example between HIV/AIDS programmes, ECD programmes, Nutrition programmes, Psychosocial programmes etc. For the model adaptation this shall be renamed the threat of competing needs. With positive social impact being the end goal of all investments and activities there is strong debate around which areas should be key focus areas, and if more than one area is identified which area should be seen as the core set of service needs upon which the others can be attached. Again, the ability to demonstrate tangible, measurable and traceable impacts will leverage competitive advantage here. (If all NGOs were able to measure impact fully and perfectly some serious discussions would need to take place, and priorities agreed upon by the entire sector. In this event individual NGOs could not serve themselves before the bigger picture.)

It must be highlighted here that NGO’s are ultimately working towards making themselves obsolete. Fully functional government service delivery would be the ultimate substitute product. NGOs actively advocate for this as part of their operations. Perhaps this substitute, then, should rather be seen as a goal than a threat.

What Porter’s Five Forces model does not make provision for, but which is central to an NGO’s mission are beneficiaries. For individuals outside the development sector it might be assumed that all intended beneficiaries are able to, and gladly and willing engage in development initiatives. This is not the case. Individuals and communities set their own development agendas, and rightly so. Communities experiencing severe malnutrition may not be able to fully participate in and benefit from programmes that deliver ECD support. Similarly, communities faced with chronic poverty may be too pre-occupied with subsistence livelihood strategies to take advantage of a workshop or some other activity that engages a need higher up along Maslow’s Hierarchy. They may abandon your project as soon as an Expanded Public Works Project, or some similar stipend paying project enters the community. People know what they need. Therefore, the fifth force for the NGO adaptation of Porter’s Five Force model should be, the ability and willingness of beneficiaries to participate.

 In summary of this sector overview the adaptation of Porter’s Five Force Model will be presented.

Porter’s Five Force Model – Adapted for NGOs

  1. The level of rivalry among organizations in an industry
  2. The potential for entry into the industry
  3. The power of large funders
  4. The threat of competing needs
  5. The ability and willingness of beneficiaries to participate
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Faced With a Growing Need for Sustainable Development Should Corporations Aim to Maximise Profit?

In order to discuss and answer the seemingly straightforward question each element that comprises it will be unpacked and engaged. Namely in terms of defining the role of the corporation in a 21st century globalising world, and in terms of defining profit. The latter cannot be limited to one-line financial textbook definitions; it will need to probe these definitions and unpack the essence of the elements that make up those definitions. This must then be married to economic definitions of profit which will lift profit out of the microcosm of a single corporation and deal with it in a way which appreciates the interconnectedness of business and social systems on a global level. Implicit in this discussion will be the broader issue of how corporations can and should maximise profit.

Following this the significance of maximised corporate profit for the social and physical world, as we know it, will be discussed. Finally and in conclusion an answer to the problem question, supported by the discussion will be given.

Unpacking the Question Elements

The Corporation

Businesses exist in a range of forms, these will not all be laid out here but the characteristics of one of these forms, the corporation will be defined. A corporation is a business in which the business itself is constituted as a legal entity separate from the individual owners. This is called limited liability, and protects the owners from liabilities arising from obligations of the business (Graham and Winfield, 2010, p.3). The legal entity of the corporation therefore is recognised by the law to have rights and responsibilities, as if it were a person. Of interest to this discussion Wikipedia goes further to define corporations as being able to exercise human rights against individuals or the state, and very importantly, corporations themselves can be responsible for human rights violations, criminal offences, fraud and manslaughter.  If corporations can be held responsible for these things where does the imperative for the individuals, who constitute corporations, to act justly and legally come from? Jeffrey Immelt, CEO of General electric is quoted as saying, “It’s up to us to use our platform to be a good citizen. Because not only is it a nice thing to do, it’s a business imperative” (Savitz, 2006, p.21). What Immelt  is alluding to here is not an idealistic call for business to become more philanthropic but the recognition that financial investors and creditors are becoming increasingly sensitive to issues of corporate citizenship; and how good corporate citizenship is seen to decrease the chances of any future social risk or potential corporate liabilities (Tialogue, 2004, p.13). Investors are learning through the “Enron, Global Crossing, Imclone, Tyco, World Com and Martha Stewart” scandals that socially irresponsible business not only loses shareholder value but has dire consequences for larger financial systems and stakeholders (Hollender and Fenichell, 2004, p.vii). In the 21st century corporate reputation is not only as important as financial outcomes (Trialogue, 2004, p.13), but is in fact its most crucial asset (Hollender and Fenichell, 2004, p.54) which ultimately underpins a corporation’s ability to generate shareholder value.

The second characteristic of a corporation is that because it exists as an independent legal entity the business’s lifespan is not tied to specific individual owners, and the business can continue to exist in perpetuity despite change in ownership. This characteristic is called perpetual succession (Graham and Winfield, 2010, p.293). It is paradoxical then that the behaviours which erupted in the financial scandals at the start of the 21st century and during the 2009 recession were characterised by traders and CEOs employing blinkered short-term projections and strategies (Hollender and Fenichell, 2004, p.32; The Smartest Guys in the Room). The pursuit of quarterly figures and reports were leading (in some case majestic) generations old corporations by the nose towards the abattoir of catastrophic share-value collapse. This “frontier mentality” (Savitz, 2006, p.233) and its blindly optimistic short-term profit seeking ultimately depleted shareholder wealth; and destroyed corporations which, all things being equal, could have generated profit for generations to come had a longer-term approach been employed.

Profit

Financial accounting textbooks will define profit as: The residual amount that remains after expenses have been deducted from income (Graham and Winfield, 2010, p.293). This can be simplified to read as profit = revenue – costs.

Financial accounting textbooks, however, do briefly introduce a discussion around arguments that the objectives of a business need to go further than merely maximising profit for their owners but must also include the wellbeing of employees, the natural environment and the wider social environment. This is accompanied by the acknowledgment that these factors underpin and are critical to the long term achievement of the objective of maximising profit (Graham and Winfield, 2010, p.5). This has given rise to triple bottom line financial reporting, where profit as well as people and planet contribute to the bottom line.

While economics recognises the appropriateness of the accounting definition of profit (above) as being sufficient for the purpose of financial accounting, economics as a discipline also makes use of the concept of economic profit. Where the above accounting definition of profit being equal to revenue – cost, economic profit is calculated as revenue – economic costs (Schiller, 2011, p.112). The concept of economic costs is key to this discussion as economic costs don’t just include the explicit costs as used in accounting, but take into account implicit costs that are incurred through the use of resources that are not explicitly paid for (Schiller, 2011, p.112). This notion of implicit costs is important because it paves the way for the economic concept of social costs, which is defined as the full resource costs of an economic activity (Schiller, 2011, p.192); those costs that are borne by all of society, as opposed to private costs which are incurred directly by the producer. What this means is that there must be a recognition that every action undertaken by a corporation will produce two simultaneous outcomes: “an impact on profits, and an impact on the world” (Savitz, 2006, p.28). When looking at aggregated profit and cost data through an economic lens we are then able to include environmental degradation and social dissolution as costs of certain activities. An economic approach to profit needs to lead this discussion.

Profit Maximising

According to classical economic theory the production of goods and services, the core function of corporations and the means through which income is generated, is dependent on what are termed the factors of production (Schiller, 2011, p.6; Mohr and Fourie, 2009, p.6). The factors of production represent limited, or scarce, resources (Mohr and Fourie, 2009, p.4); and they include natural resources, labour, capital and entrepreneurship. Money is not a factor of production, merely a means of exchange (Mohr and Fourie, 2009, p.25). Therefore the generation of financial profit alone does not necessarily ensure a reinvestment into, or the sustainability of the factors of production. Where the factors of production are scarce or finite the production possibility curve can be pushed outwards by a more efficient use of resources (Mohr and Fourie, 2009, p.20-21), and the reduction of waste born from efficiency can create abundance, not limits (Hollender and Fenichell,2004, p.87).

Following on the above and the concept of social costs Hart (2005, p.33) argues that the global economy is in fact constituted of three superimposed economies: the money economy, the traditional economy and nature’s economy. The money economy is that sphere of industry and commerce making up the developed and emerging economies (Hart, 2005, p.34). 2 billion people participate in the money economy. The traditional economy refers to the activities of some 4 billion participants who engage very sparingly in the money economy but whose livelihoods are almost wholly based on subsistence activities, dependent on their natural environment (Hart, 2005, p.36). Finally and most critically is nature’s economy, this is the environment, its ecosystems and natural resources upon which the money and traditional economies are dependent (Hart, 2005, p.37). Some elements of nature’s economy are renewable (as long as their propensity for regeneration is not degraded) while others are non-renewable. The manner in which the money economy conducts itself directly impacts the well being and sustainability of nature’s economy and the traditional economy (Hart, 2005, p.40); that is the negative externalities of the money economy are borne by the other two economies. Based on this and the above acknowledgement that the factors of production are limited resources, choices need to be made as how best to use and allocate them (Mohr and Fourie, 2009, p.4) and these choices will be coloured by whether short-term or long-term profit maximisation is desired.

This discussion has already recognised that short-term profit strategies will need to operate within certain parameters if long-term profit maximisation is desired. These parameters may curtail the realisation of maximum short-term profit but will ensure the critical resources (including corporate reputation) for long-term profit maximisation are not depleted or degraded beyond a point from which they are able to renew themselves.

This is where sustainable development needs to enter the discussion. Sustainable development requires long-term thinking as it aims to meet current performance goals whilst both ensuring the long-term survival and performance of the company, and considering the wellbeing of future generations (Savitz, 2006, p.233; Hollender and Fenichell, 2004, p.81). Critically, however, Savitz(2006, p.244) that whilst sustainable development will require a move away from a short-term focus on maximising shareholder wealth, towards a greater focus on long-term stakeholder wellbeing it does not automatically translate to corporations needing to sacrifice profit or to be satisfied with diminished financial performance.

Savitz (2006, p.22) writes about the sustainability sweet spot, a way to conduct business in a manner that simultaneously meets and furthers company and stakeholder interests. Savitz (2006, p.243) argues that a corporation that can find and leverage this sweet spot, through being sincerely socially responsible, will make more profit than its competitors in the long run. Hollender and Fenichell (2004, p.27) support this view when they argue that visionary corporations, those driven by core-ideologies which are not primarily centred on profit maximisation, ultimately generate greater profit than their profit-driven competitors. But Hollender and Fenichell (2004, p.27) also underscore a point made earlier in this discussion about long-term orientation; they state this is a critical component because the tangible impact (maximised profit) brought about through sustainable approaches and social responsibility requires a longer time frame to manifest itself.

The Significance of Maximised Profit for the Social and Physical World

Corporations’ value chains are now global and sustainable development with an eye to profit maximisation must be discussed at a global level (Hollender and Fenichell, 2004, p.111). Hart (2005, p.33) states that the achievement of global sustainability, in the face of population growth and limited resources, will require the creation of trillions of dollars worth of new products, services and technologies. Supporting this, Dr. Brundtland (in Hollender and Fenichell, 2004, p.80) when addressing the 1985 World Commission on Environment and Development claimed that given the exploding world population, “the problems of poverty and underdevelopment cannot be solved unless we have a new era of growth in which developing countries play a large role and reap large benefits”. Echoing this, Hart (2005, p.32) argues that the wellbeing of the poor [assumedly including the traditional economy, global value chains and ultimately every human being] will “require the creation of new wealth on a massive scale”. The global population is projected to peak at between 8 and 10 billion people by 2050 (Hart, 2005, p.32). Because poverty and population growth are each positive functions of the other, and birth rates have an inverse relationship with education levels and standard of living (Hart, 2005, p.32) sustainable development without economic growth is not enough to ensure global sustainability. Hart (2005, p.32) hazards to suggest that global economic activity will need to grow to ten times its current level to support this future population.

The above paragraph highlights the fact that in order ensure the basic survival and upliftment of our social and physical world we will not only require an almost unfathomable amount of economic growth but a simultaneous fundamental shift in the way the money economy conducts itself. This demands a fundamental increase in the efficiency and sustainability with which mankind uses natural resources; and the adoption of a new paradigm of working in a socially responsible way.

 These most critical needs will be met through the outcomes and positive externalities of the corporate long-term profit maximisation behaviours discussed above.

[If] yesterday’s businesses were often oblivious to their negative impacts and today’s responsible businesses strive to reduce their impacts, tomorrow’s businesses will learn to make a positive contribution [because it is in the interests of profit maximisation].

(Hart, 2005, p.33)

In closing, “Should corporations aim to maximise profits?”

All things being equal, absolutely.

References

Books

Graham, M. and Winfield, J., 2010. Understanding Financial Statements. 2nd ed. Cape Town: Cape Business Seminars.

Hart, S., 2005. Capitalism at the Crossroads: The Unlimited Business Opportunities in Solving the World’s Most Difficult Problems. New Jersey: Wharton School Publishing.

Hollender, J. and Fenichell, S., 2004. What Matters Most: Business, Social Responsibility and the End of the Era of Greed. London: Random House Business Books.

Mohr, P., Fourie, L. and associates, 2008. Economics for South African Students. Pretoria: Van Schaik.

Savitz, A., with Webre, K., 2006. The Triple Bottom Line. San Francisco: Jossey-Bass.

Schiller, B. 2011. Essentials of Economics. 8th ed. New York: McGraw-Hill/Irwin.

Trialogue, 2004. The Good Corporate Citizen: …pursuing sustainable business in South Africa. Inaugural ed. Cape Town: Trialogue.

Websites

Wikipedia:

URL: http://en.wikipedia.org/wiki/Corporation

Date Accessed: 3/9/2011

DVD

The Smartest Guys in the Room. 2005. [DVD Documentary] Alex Gibney. United States of America: Based on the 2003 book of the same title by Bethany Mclean and Peter Elkind.