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Hal Weitzman: Most non-profits depend on donations, but should they be acting more like companies and focusing on raising revenue? Welcome to the Chicago Booth Review Podcast, where we bring you ground-breaking academic research in a clear and straightforward way. I'm Hal Weitzman. Today, why philanthropy might not be the best way to achieve a social goal. Chicago Booth's Rob Gertner has conducted research into what he calls social enterprises, organizations that have a social goal but achieve it in part by charging money for goods and services. So should more socially focused organizations drop their non-profit status and behave more like traditional companies?

Rob Gertner, welcome to the Chicago Booth Review Podcast.

Robert H. Gertner: It's my pleasure to be here.

Hal Weitzman: Now listen, I want to talk to you about your research about social enterprises. What are social enterprises?

Robert H. Gertner: The way I define social enterprises is organizations that generate most of their revenue by either selling a good or service, and also have an objective which is to address some social issue or problem. So that distinguishes it from a philanthropic-based non-profit. Social enterprises can be for-profit or non-profit, but rather than relying on philanthropy, they're actually generating revenue, and it's distinguished from traditional for-profits by having a social objective.

Hal Weitzman: Okay. So a social objective, meaning? What would be an example of a social objective?

Robert H. Gertner: Well, it could be any way in which the founders or the organization decides to use what it's doing to address some problem. It could be education, healthcare, environmental, anything across the board. Critical in the way I think about it is to distinguish objective from either motivation or a strategy which is social. So a motivation might be a founder says, "I really want to build an education technology company because I care about education," and education is going to help the world, but other than that initial motivation, the company is built just like any other traditional for-profit organization might be.

So what I mean by an objective is they actually are willing to give up some profit for the social mission of the organization, which means that they're willing to make trade-offs of some kind.

And social strategy is something we're starting to see some companies do, which say, "Hey, I can make more money if I am an environmentally conscious company, because consumers might pay more. I can track better workers," or something along those lines. But if the ultimate objective is still just profit, I will also not call that a social enterprise. And the reason why I think this is a useful definition is because once you have those dual objectives, then you need to think about the way you're managed, the way you're governed, and the way you're financed differently than a traditional organization.

Hal Weitzman: Okay. Yeah, because as you say, there's probably no company on Earth that doesn't think it's doing some good for society, but you're saying that's not the principal aim. And there's also a lot of companies, I think of Patagonia, that make a big deal about their environmental activism, but you're saying Patagonia is still ultimately a money-making clothing company?

Robert H. Gertner: Well, let's take those both. I would actually probably call Patagonia a social enterprise, but we'll get to that. I think that yes, all companies to some extent are social. Any company that is profitable is selling something for more than the marginal cost of production, so that difference from basic economics is value. That value is going to people, so if you're a utilitarian, that's creating social value. So in that sense, oil companies create social value, which is why I think a definition of a social enterprise based upon what it does is actually somewhat problematic, so that's why I like going to the motivation piece as opposed to does this company create lots of social value? I think Patagonia quite explicitly actually manages its business in a way that is willing to trade off profit for a mission, and I think not too many other companies will go tell you about how you should buy less and keep using it and help you to keep using the product and not-

Hal Weitzman: So you don't think that's just a trap to get you to buy more stuff?

Robert H. Gertner: It's really hard to tell. So again, it is hard to know. They've created an ownership structure and the like that really makes it such that I think it's certainly plausible that it's not all a gimmick.

Hal Weitzman: But it's interesting, there is a bit of a blurred line there, isn't there? And you're talking about social enterprises that produce revenue. And so on the one hand, what we think of might have been nonprofits, but they're focused on revenue, getting as much revenue in. And on the other hand, there's for-profit firms that might not be profit-maximizing, right?

Robert H. Gertner: That's correct.

Hal Weitzman: So it's a blurry line there of what a social enterprise really is.

Robert H. Gertner: And I like this grouping of actually for... Although it's hard to define exactly and it's hard to determine the line that defines it, I like that both for-profits and nonprofits could be in it. Because I think I've been working through the Social New Venture Challenge with Booth and other student social venture-

Hal Weitzman: That's our entrepreneurship competition, but for social ventures.

Robert H. Gertner: That's correct. I've been working with those. We're in the 15th year now, and what I've learned is that whether you choose to be a for-profit or a nonprofit is, it's an important decision but it's not the only decision. And the key thing is if you're trying to start a venture with a social mission, that you should be thinking about what's the right business model? Where can I get revenue? How do I create the greatest social value? And then the question becomes is the best way to implement this as a for-profit or a nonprofit?

Hal Weitzman: So we'll talk about that structure, but these for-profit social enterprises are sort of hybrid. That's partly what we're getting at. They're a combination of for-profit and not-for-profit. What are the specific challenges those kinds of hybrid organizations face?

Robert H. Gertner: Yeah, I think there's several. I think perhaps one of the biggest challenges is actually funding them and financing them, because I think if you're an entrepreneur and you go out there and say, "Well, yeah, I'd like to make some money, but I care as much or almost as much or more about the social mission," that makes the financial value proposition to a potential investor or venture capitalist or someone else not quite as attractive. And therefore, you may struggle or you'll need to find investors who are aligned to care about not just the financial returns, but also the mission. And there's been this growing but still somewhat small sector of impact investors who are specifically doing it.

Hal Weitzman: Which we've talked about in the podcast before, yeah.

Robert H. Gertner: We have indeed. And the other big challenge I think is managerial. I think the challenge of trying to organize and manage business effectively for those dual objectives can be quite challenging.

Hal Weitzman: And I know one of the things you are interested in in your research is the structure, and there's various different structures, legal, governance structures that social enterprises can take. Just briefly give us a survey of what those options are and why a social venture might choose one over another.

Robert H. Gertner: Yeah. So their one big choice of course is for-profit or non-profit. If you choose to be a for-profit, really, you can be a very traditional for-profit and still have the social mission. So you could be a traditional S Corp, C Corp, LLC, and if you're not public, you can just go about your business and make those trade-offs as you see fit. Or you can organize one way. A relatively new legal structure is called a benefit corporation or a public benefit corporation. As you well know, you incorporate at the state level and not at the federal level, so every state has a somewhat different set of rules. And in fact, not all states make this available, but a majority of states, including Delaware, do have statutes that allow for the creation of these public benefit corporations, which require that the company states a specific social mission, something they're trying to do, and then there's a reporting obligation. So every two years, you have to report to your investors and to the state about how you're working to achieve that second social objective.

Hal Weitzman: So what's the advantage of a public benefit corporation structure then?

Robert H. Gertner: Well, it's not clear there's much of an advantage. I think the-

Hal Weitzman: Why did it come into being? What was the demand?

Robert H. Gertner: I think that there is this notion that... One potential benefit is that it works as a signal to consumers, to employees, to the community, to investors, that you care about more than just making money, and that could help your business, and therefore could help you both achieve the social mission and your financial objectives. So I think that's one of the reasons for it existing. Whether it works that effectively, because it's not very well known or not very well understood, is unclear.

And the other thing is over time, rather than just doing it without having a formal legal and institutional structure, over time, some case law will develop so that for example, one question right now is if you have a misleading social impact report as a public benefit corporation, can your shareholders sue like they could if you are a public company and you make false statements in your financial statements? I don't think that's been resolved yet, so somehow, some case law will develop over time and a set of institutions and legal practices and rules and norms around how these companies operate will develop, and that I think could in the end be quite useful. We're still a ways away from actually being there.

Hal Weitzman: If you're enjoying this podcast, there's another University of Chicago Podcast Network show that you should check out. It's called Entitled, and it's about human rights. Co-hosted by lawyers and law professors, Claudia Flores and Tom Ginsberg, Entitled explores the stories around why rights matter and what's the matter with rights.

Rob, in the first half, we talked about social enterprises, what they are, how they're structured. You talk in your research about how social enterprises can internalize externalities. Can you translate that for us and give us an example?

Robert H. Gertner: Sure. I think the simplest example is pollution. You could imagine a company that creates pollution and then society has to pay to clean it up, and that's usually way more expensive than just not creating the pollution in the first place. So if the company was motivated to care about and cared about the environment, then even if it were profit maximizing to create that pollution, they might choose not to, and therefore, society is better off.

Hal Weitzman: I see. Okay, so they internalize that damage, and therefore, you get less damage, you get fewer externalities in the first place.

Robert H. Gertner: Exactly.

Hal Weitzman: Okay. Now, let's talk about pricing, because you are defining social enterprises as organizations that many of which will bring in revenue. They're selling something, and they can offer, you say, socially beneficial pricing and quality. So how does their pricing differ from a traditional? And you referred to this a little bit in the first half where we talked about Patagonia and some of the trade-offs involved. What are the sort of considerations that go into pricing when you're saying, "I'm not just going to maximize profits"?

Robert H. Gertner: Yeah. I think this is a really rich set of questions and issues, and certainly if the social mission the company's addressing involves their buyers because selling to people who are in some sense especially needy, then thinking about pricing becomes really important. I think the cleanest example to think through this is microfinance, where you're making loans to very poor individuals or groups of individuals. And certainly a socially motivated microfinance institution might choose to make the terms of the loan more attractive than the profit maximizing firm would do, and might especially be much more willing when a loan gets into trouble to renegotiate in a way that's especially beneficial to the borrower. So I think there was actually a really nice debate in the microfinance world about pricing. If you price higher, then you'll make more money and you'll be able to grow and provide services to more people. Well, if you price lower, then you'll be creating more value for the beneficiaries that you ultimately care about.

Hal Weitzman: Okay. And translate that to a nonprofit that's operating in a different sector.

Robert H. Gertner: Yeah, I think it's always an issue. Lots of social enterprises sell to government, for example, or sell to nonprofits. And I think again, there, the ability to reach more to make the services affordable and therefore achieve the mission will rely on prices being lower than the profit maximizing price.

Hal Weitzman: In other words, getting stuff out there. When the mission is not principally about money, then you can look to other metrics.

Robert H. Gertner: Exactly.

Hal Weitzman: Okay. Now let's talk about scaling, something that a lot of nonprofits struggle with, and you've argued in your research that nonprofits can scale without philanthropy, in other words, they would depend on earning revenue. So is there a ideal balance between the two, between earning revenue and getting donations?

Robert H. Gertner: I think it varies depending upon the nonprofit organization, but I think that the nice thing about having a business model which relies very little or not at all on philanthropy is the possibility that you can scale more easily. So if you're making money or breaking even on every sale, then you can easily do a lot more of it. Well, if all expansion requires additional philanthropy, you have to find it, and philanthropy is just hard. It's hard to raise money. There's lots of competing interests, and therefore, a very small number of nonprofits get to the point where they really can have impact at scale if they require philanthropy to do it.

Hal Weitzman: You talk about economies of scope. What are economies of scope?

Robert H. Gertner: So economies of scope, they are a way in which doing two things, each of them together, is cheaper than doing them individually. So it's the analogous to economies of scale where doing more makes it cheaper. Here, it's doing more things makes it cheaper. And I think this goes back to another reason for having social enterprise is a little bit like what we talked about internalizing externalities. Sometimes the reason why it makes sense to have the social mission as part of the organization is because it actually creates economies of scope with something that's actually profitable and profit maximizing.

So for example, a company that came out of our Social New Venture Challenge called LuminAID creates portable inflatable solar lights, and it has uses in disaster relief and in refugee camps, but it also has uses for people in their homes for emergency kits or for camping. So to some extent, if your mission is to create benefits of lighting, which creates safety in refugee camps, then doing both, having that traditional business for camping makes it easier for you to provide the social mission. And in fact, for LuminAID, what they did was they had a buy one give one campaign, which was very successful. So people who would buy one for camping would also in effect be donating one to be used-

Hal Weitzman: Which is a model other companies use. You buy a pair of shoes, somebody else gets a pair of shoes who needs them.

Robert H. Gertner: Exactly.

Hal Weitzman: So because they're already creating and selling these lights for camping uses, they become a really efficient provider of lights for disaster relief.

Okay. Let's talk about some of the choices then, if you are a social entrepreneur, the choices that you're actually facing. And you've talked about Khan Academy, Sal Khan of course, again, I think with math, but now it's all sorts of topics. I confess that I have an interest in this because my kids use Khan Academy, and I'm just wondering, so in retrospect, when you looked at Khan Academy and the way that Sal Khan thought about setting it up, what were the key factors that led to him to choose this kind of a non-profit model and depend on philanthropy?

Robert H. Gertner: Yeah. So I think it's a bit of the exception that proves the rule. So they're a company that's done extraordinarily well using philanthropy, and I think the reason why-

Hal Weitzman: Just so I understand, just so we know that there's no revenue at all for Khan-

Robert H. Gertner: There is revenue. They sell in effect services to schools and school districts that combine, and so they do have a number of significant... The last time I looked, I think about 20% comes from earned revenues and about 80% from philanthropy, but that was several years ago. And I think that the reason why they chose the philanthropy model is because he just got a ton of traction in philanthropy really quickly. Bill Gates discovered it and, one, gave them some money and created lots of publicity, and then philanthropy became especially easy.

But you could imagine if at day one, Sal Khan thinking about creating this organization with this mission, it would seem quite plausible that there is a way to do this by selling these upstream services to schools that could support the entire organization. So it is one of those things where they could have chosen to become a sustainable nonprofit social enterprise in my language, and they could have done it as a for-profit as well where they could still be providing free videos to individuals, but selling to schools and school districts in a way that allows them to actually generate profits.

Hal Weitzman: Okay. So let's try and boil this down for somebody who's got a nonprofit, was thinking about starting one and wants to think about the structure. Is the bottom line that they should be open to behaving a bit more like a traditional profit making company and seek revenue opportunities?

Robert H. Gertner: I think generally, the answer is yes. I think that what a nonprofit should do is think, who am I creating benefits for? Who's benefiting from this? Can they pay? Should they pay? Is there a way to get some party that's benefiting to pay something? As a way to allow the organization to be successful, to grow, to rely less on philanthropy.

Hal Weitzman: All right. Well, Rob Gertner, this has been great discussion. Thank you very much for coming on the Chicago Booth Review Podcast.

Robert H. Gertner: Thank you. I enjoy chatting with you.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research.

This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.