What does a not-for-profit firm do with its surplus?🍋
The story behind NZIER's Public Good Programme
Not-for-profit firms (NFPs) are an important and ubiquitous feature of modern economies. Sporting clubs, social service providers, and churches are examples of New Zealand NFPs. As are some banks, ski fields, and electricity distribution companies. NFPs range in size from tiny clubs through to large business enterprises.
NFPs are poorly understood, in part because the term ”not-for-profit” is misleading. NFPs can and do make a profit — a surplus of revenue over costs. Indeed, they need to do so over the medium-to-long term to ensure their survival and further their mission.
NFPs are poorly understood, in part because the term ”not-for-profit” is misleading. NFPs can and do make a profit… Indeed, they need to do so…
So, if for-profit and not-for-profit firms both make profits, then what distinguishes the two? The key distinction is that NFPs cannot return any financial surplus to their owners.
Owners, in the context of a for-profit firm, means those persons with (a) a claim on profits; (b) decision-making rights; and (c) the right to sell (a)+(b)+(c) to other parties. Ownership is murkier for NFPs, as (a) does not exist by definition. Some NFP firms have shares with decision-making rights that can be sold to others; such shareholders could be said to be owners. But the far more common arrangement is for NFPs to have members with decision-making rights.1 Membership is open to those meeting specified criteria, such as paying a subscription fee, but cannot be sold to others.
A better label for NFPs would be “firms without owners” or “un-owned firms”. But, for practical purposes, we’re stuck with “not-for-profit”.
Why do NFPs need to make a profit?
Every firm starts its life with a balance sheet with $0 equity, made up of $0 assets and $0 liabilities. But to actually do anything it needs productive assets and working capital (i.e. a bank balance large enough to cover timing differences between receipts and payments). For-profit firms have three potential sources of funds: share sales, debt, and retained profits. NFPs, with no (profit-earning) shares to sell, have only debt and retained profits. As NFPs find it harder to raise debt than do for-profits, retained profits are their main, and typically only, source of funds. And to make profits, you need a source of revenue larger than the costs of producing that revenue. And if that sounds awfully like running a trading business, it’s because it is.2
In many industries, NFPs compete directly with for-profit firms. For example, the NFP Southern Cross sells health insurance in direct competition with for-profit firms such as NIB.
This requirement to make a profit might appear less pressing for well-established NFPs. But many of those are driven by a mission bigger than their current capacity, creating a need for further growth, which in turn requires them to make and retain profits. Those well-established NFPs not seeking growth can apply most, if not all, of their financial surplus to furthering their mission.3
I’ll round this post off by describing one such NFP: how it makes its a surplus, and what it applies that surplus to. And in doing so document a small part of the history of economics in NZ.
NZIER’s story
The New Zealand Institute of Economic Research (NZIER) is a membership-based NFP. NZIER was set up in 1958 to undertake research and advance the study and understanding of economic matters.
In its early days, NZIER was mostly funded by membership subscriptions and grants. Over time the grants progressively fell away but for some much-appreciated contributions from the Reserve Bank and the Treasury.
Membership subscriptions have continued to fund services such as the Quarterly Survey of Business Opinion and Quarterly Predictions.
Today NZIER relies on commissioned research from commercial clients for most of its income, competing with a raft of for-profit economic consultancies.
(The shifting locations of NZIER reflects this evolution. From an academic base at Victoria University of Wellington’s Kelburn campus, NZIER moved closer to its members and clients at the iconic wooden house in Halswell Street in Thorndon, where the Moniac Machine once sat, then to Wellington CBD locations and an Auckland Office alongside other consultancies.)
Prices for consulting work are set in competitive markets. NZIER prices at market rates, and tries to maximise its surplus, as that maximises the amount available to pursue its mission. The Public Good Programme (PGP) is NZIER’s answer to what to do with this surplus.
The Public Good Programme
The PGP’s kaupapa (guiding principle) is to educate and inform debate on significant economic and policy issues confronting Aotearoa New Zealand. Consistent with that purpose, the PGP provides financial assistance for the publication of Asymmetric Information, and sponsors prizes at NZAE’s annual conferences.4
In the last financial year NZIER spent $300,000 producing many public-good outputs, including four issues of Consensus Forecasts, seven issues of Shadow Board, and contributions to the long-running Insight series of short think-tank pieces. Some of these have directly influenced government policy, such as the reduction in the number of DHBs and the extension of 90-day-trial periods.
A more recent addition to the PGP is the annual Prime Minister’s Summer reading list, which takes a “broad church” view of economics to show in a practical sense how economics appears in everyday life. You might not think it’s economics at first, but Coco Solid, author of the 2022 selection How to Loiter in a Turf War, disagrees — showing how gentrification affects young urban Māori and Pasifika might just encourage some to study economics and find out how markets do, or don’t, work.
NZIER’s NZ Economics Prize has been revamped to a biennial early career economists award, and a new Māori Economics Scholarship has been established at VUW.
NZIER sources Insight topics from staff, members and key opinion leaders in business and government. In the year ahead, keep an eye out for think pieces on Closer Economic Relations (CER) at 40, fiscal policy and climate commitments, teacher quality, diversity in economics graduates, and other gems.
If you have an idea for a PGP project, please get in touch with me or Todd Krieble at NZIER.
You might notice I’m skating over cooperatives, some of which distribute profits to their members. I can only cover so much in one post!
The same logic applies to NFPs whose primary source of revenue is grants or donations.
An inflationary environment can play havoc here. Organisations need to make an accounting profit that at least covers devaluation of their assets, just to stand still.
Full disclosure: Asymmetric Information receives funding from the NZIER’s Public Good programme. NZIER has no decision rights over, or responsibility for, the newsletter.
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