February 19, 2013

The hidden business of social enterprises

Having a social purpose does not exempt an enterprise from the essentials of business; even if it’s hard to see you must have a sound business engine at the core.

Social enterprise – business that trades for social, environmental and/or cultural purposes – is on the rise. In five years, the number of social enterprises in Australia has grown by 37%1.

However, having a social mission does not exempt a social enterprise (SE) from the rules of business. To be of benefit to society, a SE must have at its core a sustainable ‘business engine’ or commercial business model in which business revenues need to exceed business costs.

When the business engine is not sustainable, the enterprise may be draining value rather than creating it. Then community support for the enterprise – from the public, philanthropists or government – is simply propping up a poorly run business. In future, the SE will not be stable nor sustainable – and will certainly not grow.

SVA Consulting has worked with dozens of SEs that address employment exclusion (by providing employment opportunities to disadvantaged workers) to help them identify, and assess the viability of, their ‘business engine’. When they do, they are better able to create a platform for sustainable growth. The lessons can also be applied to other kinds of social enterprises.

The haze of the hybrid organisation

Established in 1999, the Nundah Co-op operates two businesses in the north of Brisbane: a café and catering business called Espresso Train, and a parks maintenance service. The Community Living Association (CLA), an organisation that assists people with an intellectual disability or learning difficulty to lead more fulfilling and meaningful lives, supported the Co-op’s start-up having realised that the ‘desire to work’ was important for its clients. Having started on a shoe-string budget with a loan and a few small grants, the Co-op today provides sustainable part-time employment and training opportunities for 24 people previously excluded from the labour market2. Together, the two businesses turnover about $350k.

…it can be hard to ascertain whether the business engine is sustainable…

For a hybrid organisation (combining social impact and commercial activities) like the Nundah Co-op, it can be hard to ascertain whether the business engine is sustainable – the view may be hazy. Most social enterprises survive from a combination of business income, and funding from either government or foundations. Also, it can be unclear which of its costs would be incurred by any for-profit producing the same goods or services, and which are additional costs incurred to meet the social purpose.

Clarity on the business engine is worth achieving, because whilst the Nundah Co-op provides a valuable service to the community – it comes at a cost. For the last few years, the Co-op has averaged a loss of approximately $20k pa despite having received grant income from time to time. This loss is willingly absorbed by CLA (the parent organisation) due to the value it places on the service to its clients.

However, this raises a few questions. Is the cost to CLA justifiable? Is it reasonable for CLA to provide that $20k pa support, or is it covering up for poor business practice? How much should it be prepared to support the business because of its social mission? And what is the cost of achieving the social impact?

A tool to see through the haze

To help employment-focused social enterprises cut through the haze and understand their business engine, SVA Consulting developed a simple methodology called Employment Support Cost Analysis (ESCA).

What are the additional costs of supporting the social impact above the costs of running a purely commercial business?

ESCA shines a light on the business core to help understand the true nature of the costs of supporting a social purpose. It answers the question: What are the additional costs of supporting the social impact above the costs of running a purely commercial business?

Whilst this tool was developed for SEs that are supporting disadvantaged workers, the principles at the heart of it can be applied to any SE.

As Figure 1 below illustrates, support costs come in three forms.

  1. Individual support costs are those costs that are incurred directly to support disadvantaged employees e.g. the purchase of uniforms that employees couldn’t otherwise afford, or additional training provided.
  2. Organisational support costs are costs of activities required to operate the organisation as a social enterprise and support employees e.g. infrastructure costs to make a kitchen more accessible, or additional social events.
  3. Community services provided are those services provided free by the enterprise to the community that support the social mission, beyond the direct support of employees.

sva.diagrams.se.seca2

Figure 1: Employment Support Cost Analysis separates support costs into three main areas.

ESCA examines the enterprise with respect to 12 buckets of costs that employment-exclusion social enterprises are likely to incur. These 12 buckets align to the four stages in the employment pipeline – hiring, training, ongoing and transitioning. (See Figure 2.)

Some common costs of supporting individuals include the provision of clothes and training, staff time providing ‘on the job’ support, cultural awareness training, additional social events, and the cost of lower productivity (due to less efficient workers).

Separately, it considers the cost of any community services (the third category) that the enterprise provides to the community that supports the social mission – such as providing advice and operational support to similarly minded social enterprises, or speaking engagements.

Figure 2: The various costs that employment-exclusion social enterprises are likely to incur across the four stages in the employment pipeline.

This methodology helped to get clearer about Nundah Co-op’s business engine. In the calendar year of the assessment, support costs totalled almost $61k. Some of the major costs included the following:

  • Staff time for ‘on the job’ support: to support the workers, the chef and the café manager both invest an additional 15 hours each week.
  • Staff time for individual and family support: a small amount of time weekly was spent by Co-op staff supporting workers off-the-job.
  • Ongoing costs: due to mistakes in the kitchen, some food is wasted.
  • Work package definition: time is spent by Co-op staff tailoring a work package to the individual needs of a supported worker.

When the support costs are removed, Nundah’s commercial costs are $193k.

The income also needs to be separated; there is ‘non-commercial’ income associated with being a ‘social enterprise’ – funding from the community, on top of ‘commercial’ income generated by the business. With commercial revenue sitting at $210k, and commercial costs lower at $193k, the Co-op has a sustainable business engine.

Figure 3: Whilst Nundah Co-op’s overall income was lower than its expenses, its commercial income was higher than its commercial costs. This shows that the business model is currently sustainable.

The costs of a struggling business engine…

SVA Consulting developed a plan for financial sustainability for another social enterprise operating to reduce employment exclusion. Backstreet Printing 3 sells direct mail and digital printing services and provides employment opportunities for people with a disability. For most of its life, the business has sustained itself through a combination of sales income, and case-based funding from the Federal Government. Steadily attracting more customers, it expanded its operations and by 2008 was employing about 40 clients. However over the following five years, Backstreet ran up an average yearly loss of approximately $170k. The parent organisation had been absorbing these losses but it could not afford to keep doing this.

The analysis pointed to a couple of key areas where Backstreet had failed to apply rigorous business thinking. Firstly, it had not considered whether the accessible market was big enough. Information on competitors showed that there were nine other social enterprises offering a similar direct mail service in the area – as well as a few very large for-profits. Furthermore, third-party research indicated that the global direct mail market has shrunk as many choose email as a more cost-effective medium for direct marketing.

Given its current cost base, Backstreet would require sales revenue of approximately $1.1m each year to break even. Over the previous five years, it had averaged only $700k which indicated how steep a climb was needed.

…using the ESCA tool, the problems with the business engine became even more apparent.

Secondly, even if the market was big enough, the organisation was not investing sufficiently in attracting new customers. The sales data showed that the business was highly reliant on just a few customers. Although it had serviced 141 clients over the previous three years, 80% of its sales came from just 31 of them. Furthermore, 40% of its sales had come from just two large clients, leaving them in a fragile position if one of these no longer required its services.

Backstreet acknowledged that it invested little in marketing and relationship management – indeed it had no specific plan for how it would acquire new sales. It set monthly sales targets, but not targets for the activities needed to generate them (eg. phone calls, meetings, letterbox drops). As a result, business from new customers (which had made up just 20% of sales over the previous year) came almost entirely through word-of-mouth.

Over the last five years, the cost of these poor business practices had been substantial; the enterprise was costing the parent organisation hugely. It was a burden, rather than a benefit – despite having been started with the best of intentions.

When Backstreet’s business costs were analysed using the ESCA tool, the problems with the business engine became even more apparent. Whilst the average enterprise loss over the last five years was $170kpa, the commercial loss was actually $280k.

These losses were offset by the substantial amount of non-commercial revenue (case-based funding from the Federal Government), which was much higher than the marginal costs of delivering the social impact.

Unlike Nundah, where a $20k subsidy covered the support costs and was thus justifiable, the funding received by Backstreet was simply covering poor business practice.

Many SEs in their start-up phase will initially make a loss – it takes time for any business to turn a profit. The potential long-term benefits justify that the community subsidise these initial losses. However, as it matures, the enterprise needs to be confident that it is built on a profitable business model.

Failures in the business engine

There are two common ways in which SEs break the ‘rules of business’.

The first is that they overstate the size of the available market. Often people think that because they are running a social enterprise and ‘doing good’, the enterprise will achieve enough community support to get the sales it needs. However, there are limits to how many consumers will be attracted to a product and to the premium that they will pay because of the product’s associated social impact.

The Big Issue who applies creative solutions to the issue of homelessness started a Community Soccer Program offering homeless and marginalised people weekly soccer training as a low-barrier opportunity to re-engage with society. The program was funded 75% through government funding and 25% through corporate sponsorship. For the management team, SVA Consulting assessed the viability of running a fee-based corporate soccer league to cover the program’s costs and reduce the reliance on just a few funders.

The analysis demonstrated that this proposition was not viable. Firstly, it showed that the lunchtime league model was financially risky –­­­ a consumer price ceiling of $10 per game and low margins meant an extremely large league would be needed. Secondly, the analysis showed that the market was not big enough. The estimated $450k Sydney market was already highly competitive with experienced commercial businesses.

Furthermore, the social impact of the lunchtime league model itself would be small: it would create only a few employment positions for homeless and marginalised people, and would not provide them with enough opportunities for meaningful social engagement. As a result, the Big Issue sought other ways to fund the program and has since implemented a stand-alone event, an annual Street Football Festival, with fee-paying corporate participation.

…so busy supporting the ‘social’ aspect that they neglect the fundamental business obligation…

The second reason business engines often ‘fail’ is that the enterprises are so busy supporting the ‘social’ aspect that they neglect the fundamental business obligation to invest in the sales pipeline. Business managers get tied up in management responsibilities to the detriment of business development; working ‘in the business’ rather than ‘on the business’. This is mainly because they underestimate the cost of supporting the social impact.

For example, at a restaurant and catering service employing refugees, part of the support package that SVA provided was funds for a business manager to focus on business development. However, because the business lacked a capable supervisor, the manager spent a large part of her time running the kitchen rather than seeking new business. Consequently the restaurant ran into financial difficulty because of slow customer growth.

At the Nundah Co-op, during 2011 when the coordinator could not find sufficient time to promote the café, a marketing consultant offered her services at a reduced rate – and secured some excellent promotional spots in media outlets. The resulting publicity drove an increase in patronage, and the café broke even for the first time.

The most effective way to fix this problem is to have targets around sales activities (such as phone calls, meetings, or whatever is relevant), not just sales outcomes. Setting targets around achievable activities which drive the desired outcomes helps ensure that business managers prioritise the activities that matter. They must then be held accountable to these targets.

Part of the problem in SEs is that it is hard to find people that have both business and/or product ability and an enthusiasm for the social cause driving the enterprise. Typically, SEs are started by people that are experienced in the cause. It is much less common that SEs are started by people with business experience. As a result, the founders rarely have a business plan outlining how the enterprise will generate income, and those that do only sometimes test it against realistic assumptions.

Understanding the business engine reaps rewards

Understanding the business engine enables troubleshooting as well as justifying the social enterprise’s existence. It can also provide the knowledge that will support the business’s growth.

Ensure sustainability

At Backstreet Printing, the first step was to invest sufficiently in marketing. From the financial modelling, SVA Consulting set a monthly target for new customers and then set the activities required to both achieve that target and maintain existing clients. It also recommended that one person dedicate two days each week entirely to sales and customer relationships, and that the parent organisation support by advising on a marketing strategy and regularly holding the SE accountable to these activity targets.

If, after 12 months, Backstreet was not able to meet the projected targets, implying the market was not big enough, the recommendation was to downsize to a cost base that could be sustained with current sales.

At Nundah Co-op, having confidence that its business engine was healthy, it sought further donations. As Co-op coordinator Richard Warner explained “knowing that the community funding is sustaining the actual costs of supporting the employees, we feel more comfortable seeking funds”. It ran its first public fundraiser a few months after the analysis.

Dream big

A thorough understanding of its business engine enabled Melbourne-based SE, STREAT to grow rapidly. (See STREAT’s ahead: funding social impact with equity)

In 2011, it set its ambitious plan that by the end of financial year 2014-15, 100 young people would complete its program each year, and the business would be financially sustainable through its earned revenue. SVA Consulting developed a financial model that considered all the variables for expansion over the coming years. With this model, STREAT was able to answer the questions it had, such as “How much return can we expect from a particular rate of expansion?” “Will we be able to pay-off any loans we take?” “What will our sales target need to be, to be financially sustainable?”

STREAT tested and refined its business engine with the help of business mentors including the founder of a large national coffee franchise and employed a new General Manager of Operations with experience running and scaling hospitality enterprises both in Australia and abroad.

This understanding and honing of its business engine meant that STREAT was ready to take its model to scale when in 2012 it purchased two cafés and a coffee roasting business, doubling its capacity overnight and setting it well on target for its 2015 goal.(See the full story on how STREAT achieved this rapid expansion)

Apply the rules of business to survive

Whilst SEs are a part of the solution to Australia’s social problems such as employment exclusion, running one is challenging.

SEs need to apply the rules of business to survive let alone thrive. In particular, they must assess, rather than assume, the market available to them. And they must ensure that they commit sufficient time to their sales pipeline – holding business managers to account on activities, not just outcomes.

With a commercial and social aspect, it can be hard to understand how successful the enterprise is and where it needs to improve. The first step is to see through the haze of the different incomes and costs and assess the ‘business engine’ that sits at the core. Then, not only can SEs justify the support of the broader community, but they will be able to build a strong platform for future growth.


If you’d like to know more, contact us on consulting@socialventures.com.au


Endnotes

1. http://www.probonoaustralia.com.au/news/2012/04/study-reveals-australia’s-growing-‘fourth-sector’

2. There are estimated to be up to two million Australians who could have jobs and be contributing to Australia’s wealth, but who for various reasons are unemployed or underemployed. (Speech by Prime Minister Julia Gillard to the Committee for Economic Development in Australia in February 2011)

3. The name, location and other identifiable details of this enterprise have been disguised, for confidentiality.