Last week I blogged about the Not-for-Profit model and how such organizations exist to provide a needed service, not to make money.  In most cases, Not-for-Profits not only don’t make money, but can’t possibly break even without outside contributions.  This doesn’t mean they’re badly run, as some people think.  It’s just that the cost of fulfilling their mission exceeds its earned revenue potential.

The most obvious example of this is the Church.  No one would suggest that the local congregation start charging $15 admission; if it did, it would quickly go under.  In the case of most churches, anyone can attend, and although a freewill offering is taken, no one is under obligation to contribute.  Thus most of a church’s revenue is contributed rather than earned.

The formulas are different for different types of organizations.  Some not-for-profit hospitals and academic institutions are sustained primarily by earned revenue.  Even within the performing arts industry there are significant differences.  For example, volunteer community ensembles raise 60% or more of their budgets from earned revenue – including ticket sales, program advertising, concessions, and musician membership fees (it is common for musicians of such organizations to pay a modest annual sum for the privilege of belonging and playing).   Educational ensembles like youth orchestras and community ballet schools, largely supported by student tuition fees, raise from 70% to 90% of their budgets from earned revenue.

Since professional orchestras pay their musicians, their budgets look very different from community and educational ensembles: what is a revenue line for the latter is an expense line for the former!   (Please, nobody misconstrue: I’m a strong believer in paying professional musicians.  I’m simply stating facts.) 

Professional orchestras may be able to command higher ticket prices than community ensembles, but it is rarely enough to make up the difference – and the more the musicians are paid, the more this is true.  No matter how you slice it, earned revenue as a percentage of budget is going to be lower for professional orchestras.  

In recognition of this, the League of American Orchestras established what has long been considered the “best practice” model, the one to which professional orchestras should aspire.  According to this model, the most sustainable budgetary practice calls for operating revenue in the following configuration:

• 40% from earned revenue
• 30% from contributed revenue
• 30% from endowment earnings

A disclaimer is in order here:  few orchestras actually achieve this model on a regular basis.  But it is seemingly a sensible one.   40% earned revenue is a stretch goal but one that is deemed realistic and achievable.  And because raising the remaining 60% of your budget solely from contributed revenue is challenging for a Board to muster year in and year out, the League recommends working to build an Endowment capable of generating sufficient earnings to offset 30% of the organization’s budget. 

How do endowments work?  There are a few basic rules:  you’re not supposed to eat into your endowment principal, and you should leave a little of your earnings alone so that your investment pool keeps growing.  Accordingly, the general rule is to limit annual distributions to 5% of the value of the Endowment.  Thus an organization with a budget of around $1 million would need an endowment capable of generating $300,000 a year:  in other words, about $6 million.

Unfortunately, not every organization has an endowment of this size, and you can’t raise one overnight – it’s the most time-consuming kind of fund raising there is.  The TSO’s endowment, though growing, is still small (under $500,000).  This isn’t an indictment of our management practices; the TSO has only been a professional orchestra for 17 years, and endowments take decades to build.

The issue is compounded by the fact that the TSO has not been able to reach the 40% earned revenue goal (we’re consistently at about 30%).  The reasons for this are largely market-driven, and we’re working to improve it, but solutions are not simple.  For example, we can’t simply raise ticket prices because we’d price ourselves beyond many people’s reach.  Moreover, the size and nature of our performance venue, the Broadway Center, would actually make it nearly impossible to reach 40% earned revenue. 

We could shrink the expense budget down to size, but this would likely leave us without the resources to support our mission, so revenue would diminish as well – thus potentially starting a downward spiral that would eventually imperil the mission.

The result of all this?  The TSO is raising 69% of its budget annually from contributed sources.

The good news is that the TSO’s vision is robust, its governance is conscientious, and its donor base is loyal, enthusiastic and growing.   Moreover, many other orchestras are struggling with this Rubik’s cube of a problem, and some have begun to question the League’s old “best practice” model and develop new ones. 

This came out of the current recession when, ironically, some of the orchestras who were closest to fulfilling the “best practice” model ended up in the worst financial trouble.  Their endowments diminished in value to the point where they couldn’t make their budgeted annual draw, and they didn’t have a large enough donor base to make up the difference.  The TSO was actually in a better position because, although we weathered some downturns in corporate and foundation giving, we were used to raising a lot of money every year!

So although our model isn’t perfect, we’re working to improve it.  We decided early on in this recession to focus most of our attention on cultivating our individual giving program; national studies demonstrate that individual giving is the least affected by economic downturns.   Indeed, gifts from individuals to the TSO have increased 65% in the past three years! 

And currently there are some interesting new models being pioneered in cities like St. Paul and Cleveland, which we’re looking at closely.  Will elements of these new models translate to Tacoma?  We don’t know – but tune in again next week, and we’ll take a look.