The strong case for an NFP merger

In a volatile business environment, the case for NFP mergers is getting stronger – but directors should be aware of the possible trade-offs.

Disruptions to the business environment often spark merger waves. Until recently, NFPs generally enjoyed less disruptive environments than their for-profit counterparts, but no longer. So should NFP boards consider mergers?

A key disruptor in the NFP sector is government policy, in particular, the adoption of more individual-centric, market-based approaches to harness the benefits of choice and competition. The National Disability Insurance Scheme (NDIS) is a prominent example.

Under the NDIS, funds now follow individuals with disabilities. Individuals gain the freedom to choose what best suits them, while competition promotes efficiency in service provision. Sure, providers have to deal with the disruption, but political economist Joseph Schumpeter taught us long ago that the “creative destruction” inherent in competitive markets makes us better off overall. It also creates opportunities.

That’s a key reason why Down Syndrome SA (of which I am deputy chair) spent the past 18 months pondering whether to merge and with whom. This process successfully concluded last month when we announced our merger with Orana, a fellow South Australian NFP servicing the disability sector.

Mission statements

A typical NFP has a social mission to best serve a particular constituency, such as people with Down syndrome. Disruption is causing NFPs to reconsider whether and how they can best fulfil their missions. NFPs’ mission-centric focus often made them reluctant to merge. However, they’re increasingly recognising that mergers may actually help fulfil their missions. Indeed, the AICD’s 2018 Governance and Performance Study found that 36 per cent of NFP directors had discussed merging in the past year and 23 per cent thought their NFP was more likely than not to merge within two years.

Most NFPs provide “public good” services such as information and advocacy that are difficult to charge for. These services were funded through government grants and fundraising. As the funding model has changed, state/territory governments are withdrawing grants and private citizens appear to be donating less in the belief their funds won’t be required under NDIS. While NFPs should try to correct this belief, they can’t just wait for that to happen.

NFPs also provide services (such as therapies) of a “private good” nature. Clients choose what to buy from whom. Some see provision of more private good services as a way to replace lost funding for public good services. This won’t work unless those services can be provided profitably — not easy in the newly competitive environment.

Scaling up

Many NFPs think gaining scale is the solution. There are two types of scale economies: organisational and local. Bigger organisations generally have lower overhead costs per service provided. Therefore, scaling up can generate cost-saving to directly offset funding losses for public good and also improve profitability of private good provision. Many NFPs will need to scale up considerably to meet the NDIS pricing model’s assumption that overhead costs shouldn’t exceed 15 per cent of revenues.

Local scale can be important in the business world. For example, trucking costs per delivery fall with delivery density (deliveries per km). But local scale is increasingly important for NFPs under the new individual-centric model, in which services are increasingly delivered at client-convenient locations, such as homes and schools. Service-delivery staff productivity — services delivered (hence revenues earned) per staff hour — rises with client density (clients per sq km). Many NFPs need to increase client densities to meet NDIS staff productivity assumptions.

Organic growth can also deliver organisational and local scale, but not necessarily quickly enough. For many NFPs that have traditionally served small constituencies, organic growth within those constituencies can’t deliver the necessary scale and few can afford the initial cash drain organic growth entails. So boards are increasingly considering two types of mergers: “cross-border” and “local”.

The same constituencies are often served by similar NFPs in each state or territory. Cross-border mergers between such NFPs can achieve significant organisational scale economies. Last year’s merger of state-based asthma foundations to form Asthma Australia is one example.

Local interest

But most of the action is in local mergers between NFPs operating in the same geographic regions. Their big advantage over cross-border mergers is that they boost both organisation and local scale. Such a merger may enable continued provision of services that each partner would have had to cease otherwise. It may also enable provision of services in new locations (such as regional towns) neither could have served alone. Local mergers may serve each merger partners’ traditional constituencies even better. Down Syndrome SA decided to pursue a local merger over a cross-border merger because it could deliver bigger benefits to people with Down syndrome in SA.

But all merger decisions involve trade-offs. Economic research shows business mergers are less likely to deliver net benefits the more different the partners are. Likewise, dissimilarity in constituencies served and services provided means fewer potential synergies, while cultural dissimilarities make any synergies harder to realise in practice.

State/territory NFPs serving the same constituencies tend to be similar in services provided and cultures. Local merger partners, generally less so. Nevertheless, the increasing importance of organisation and local scale means that boards should (carefully) consider local merger partners they wouldn’t have in the past. For example, while Orana’s constituency is broader than Down Syndrome SA (it serves people with a wider range of intellectual and other disabilities), the shared needs of our constituencies indicated large merger benefits. We had also shared premises with Orana for several years. There is no better way to assess an organisation’s culture than to see them in action on the ground every day.

Mergers aren’t the panacea for all NFPs, but every NFP board should seriously consider merging as a key strategic option.