By Marcus Coetzee, 4 August 2023.
Our organisations all desire to achieve a big and profitable source of income from a friendly client, funder or investment. It helps to stabilise their financial situation and creates a foundation for growth.
However, these situations all carry a hidden risk – that our organisations become too dependent on this income stream and too distracted or complacent to do anything about it.
I can tell many stories of organisations blindsided by the loss of this income for a multitude of reasons. While some organisations recovered, many closed down or became a shadow of their former selves. They were ill-prepared despite forewarning from me and others.
There were various causes for this loss of income. In some cases, they lost a contract to a competitor. In others, their funders changed their funding policy or their customers decided to bring the service in-house. Some even lost income because of macroeconomic factors such as a change in a commodity price or currency.
Organisations must therefore be mindful of the risks of having a single large contract or income stream. This risk is higher where this income accounts for a significant proportion of overall income, seems reliable, and when you must shift how your organisation operates to accommodate a client or funder.
This article will explore the advantages and disadvantages of a good single source of income. It also provides some ideas for how you might mitigate the risks associated with this favourable situation.
1. Some organisations are designed around a single source of income
Some types of organisations are inherently insulated from this risk. These are primarily special-purpose vehicles to act as a conduit for funding or implementation. For example, a corporate might establish a foundation to distribute its charitable funding. Similarly, a community trust might be linked to a mine or wind farm as a shareholder or community benefit partner. A local authority might also have established an arms-length organisation (ALEO) for a specific purpose such as to manage some of its programmes or assets.
This article rather discusses the risks facing the thousands of charities, non-profit organisations, social enterprises and businesses that derive a significant proportion of their income from a single source. It doesn’t matter whether this income is in the form of donations, grants, dividends, or revenue. What matters is the state of mind it might cultivate – one of dependency and complacency.
2. The advantage of a good source of income
There are many positive benefits to securing a large source of income, especially from a customer or funder that is friendly, supportive and reliable:
- It creates financial stability that enables organisations to enter into longer-term relationships with their staff and suppliers.
- It allows organisations to refine their operations and impact rather than chase money all the time.
- It gives some breathing space to reflect and innovate.
- It creates a launchpad for organisations to grow further and cultivate additional sources of income.
All organisations should strive to secure such income streams, provided the terms are favourable and result in a net benefit for themselves.
3. The risk of a single source of income
A good source of income can lull organisations into a sense of complacency. This risk is insidious if the organisation that provides this income is supportive and seems likely to continue over the long term. I can cite examples of where this has been the case yet something nevertheless happened that undermined this arrangement.
Some causes that I’ve seen include:
- A tax authority changing a tax policy to redirect a stream of royalties into its coffers.
- A government department updating its strategy and consequently downgrading its funding to an organisation or choosing to bring the activities in-house.
- A fall in commodity prices reducing income from dividends or trading.
- An international funder revising its global strategy and withdrawing from a country.
- An organisation losing a large ‘reliable’ government contract that it had built its identity around.
- A competitor winning the contract by undercutting pricing and promising a low-priced and questionably ‘better’ solution.
- A customer changing its procurement policies – either how proposals are scored or by adding compliance requirements.
- A customer or funder adding compliance requirements that are impossible to meet. I’ve seen this happen to several African organisations that had prohibitively strict ESG requirements suddenly imposed on them by their European customers or funders.
I found it surprising that many of these organisations have been forewarned of these risks by the customer or funder themselves. Yet they either left the problem to the last minute or succumbed to ‘normalcy bias’ – a tendency to underestimate the impact of future hazards. Perhaps they were trying to cope by being optimistic or overly reliant on dogma or a limited mental model of how things work.
There is also a risk of mission drift – when an organisation adapts itself to the agenda of its customer or funder rather than its own. This increases dependency because the organisation is no longer focused on its own mission and determining its own optimal future path. It is rather focused on serving the strategy of the organisation that provides the money.
I’ve also noticed that large, stable and seemingly reliable sources of income amplify the greatest benefits and the biggest risks. On one hand, it is a blessing to get a steady source of income from an organisation that values and supports what you do. This creates an amazing foundation for growth. However, on the other hand, the more comfortable and seemingly indefinite this relationship is, the more likely it is to lull your organisation into a state of complacency. This creates a paradox. Organisations must pursue these sources of income, and then when they achieve them, they should do everything possible to decrease their reliance on them.
4. Five considerations to diversify your organization’s income
The good news is that your organization can use this large income stream to improve its strategic position and cultivate income from other sources. It can emerge stronger than before. Here are five things that will improve its situation.
a) Acknowledge the situation and the risk involved
Clearly and openly acknowledge the advantages and disadvantages associated with this income stream. On the one hand, it brings stability, extra resources and some breathing space. It helps to create a foundation for your organisation to grow. But it also carries the risk that it may become overly reliant on this source of income and too distracted or complacent to mitigate it in time. Therefore, you must consider the consequences for your organisation should this income stream suddenly disappear.
For example, as I write this article, I’m contemplating that one of my primary income streams may be reduced in 8 months’ time. I am very aware of this risk and its consequences for my financial well-being. I have reflected on what it might mean for us. I have thus been exploring opportunities to diversify my income.
b) Create a sense of urgency and get the timing right
Some people struggle to see beyond a certain time horizon whether it be a month or a year. The possibility that their organisation might lose a significant chunk of their income seems far into the future. Fortunately, most good CEOs, directors and trustees are considering the next five years and plotting a course of action for their organisations. It is their duty to remind their organisations of this risk and ensure that they act as if the event is imminent. These leaders will need to keep it on the agenda and insist that their organisations start to do something about it.
Leaders should consider the dates when the income stream might be threatened. Here are some examples of threats I’ve been affected by:
- The date when a contract or grant is due to be renewed.
- The date when a funder or customer is due to revise their own strategy.
- The date when a certain government policy is due to change that may influence levels of funding, procurement or the way that something must be done.
One must also be mindful of trigger events for a macroeconomic shift in currency value, commodity price, inflation rate or interest rate. These events might range from a change in political leadership to a drought, flood, civil unrest or war.
It is also worthwhile to consider the buying or funding cycle of your customers or funders. This is the lead time that you will need to get additional income. For example, some funders might only issue a single call for proposals each year. Organisations that miss these deadlines need to wait until the next year to access this opportunity. These are the types of factors that make it difficult to develop last-minute plans to rescue an organisation.
c) Review your cost structure and restructure accordingly
Organisations have a mixture of fixed and variable costs. Fixed costs are those expenses that it incurs each month regardless of its current level of activity. These will be things like rent, website hosting and salaries. Fixed costs are different from the concept of administrative costs that some funders restrict. Variable costs are those costs that change with the level of activity such as how many projects are running or how busy one is. It is wise to adopt a lean fixed-cost structure since this will improve your likely sustainability. This involves trying to convert as much of your fixed costs into variable costs while maintaining your basic infrastructure and economies of scale.
It is worthwhile calculating the total fixed costs that will be unallocated should your organisation lose one of its big contracts or sources of income. Calculate the proportion of fixed costs that could be covered or absorbed by other income streams and/or subsidised by reserves. This will reveal the number of months an organisation has to either reduce its fixed cost structure or find replacement sources of income. This is the length of the metaphorical runway for your organisation to gain momentum and take off before it crashes.
For example, let’s assume that a project-based organisation would have £10k of fixed costs each month that can’t be absorbed into other projects. Assume that each project absorbs about 25% of the organisation’s fixed overhead. Then the organisation will need to earn another £40k income each month to cover this month’s shortfall. This might be £40k from a new source or four £10k projects.
It is straightforward to do these financial calculations and scenario planning on a spreadsheet. It just requires a clear head and time to reflect.
d) Be aware of the planning fallacy
It is likely to take more time and effort than anticipated to diversify your organisation’s income streams and decrease its reliance on a single customer, funder or investment. In other words, to use it as a launchpad rather than becoming dependent on it.
When developing plans, we must be mindful of the planning fallacy. This is a phenomenon whereby humans underestimate what is required to succeed with a project and are overly optimistic about their capabilities. It is part of human nature.
It is very difficult to grow and diversify income, even when a good foundation exists. Here are some of the difficulties that I’ve experienced firsthand when being in this position:
- Distractions such as crises or other attractive opportunities.
- Strong competition that has made more headway than anticipated.
- Delays such as waiting for a permit, decision, meeting or bureaucratic process.
- Extra costs for things like technology, specialist support and travel.
- The need to revise your business model or develop new products.
- Interference from above such as a trustee or new CEO.
- The realisation that an opportunity is less attractive than anticipated.
- Additional skills that must be developed.
To counteract the planning fallacy, we must build in extra margin in our plans and budgets, and schedule time to assess the status of our efforts. Be prepared to allocate more resources further down the line.
e) Dedicate and ringfence sufficient time and resources
There is a tendency for organisations to say, “We’ll do it later as soon as we’ve finished with [insert urgent task].” I’ve often been guilty of thinking like this. But as we all know; this rarely happens because there is always another urgent task in the queue that will take its place. Then before you know it, it’s too late. Everyone wonders why the organisation neglected to prepare itself for a sudden drop in income or change in circumstances.
Some organisations make it a priority to pursue additional income and decrease their over-reliance on a single source. They might put it into their strategies and delegate responsibility to the CEO or someone in marketing, business development or fundraising. There have been times when I’ve managed to ensure this. But too often, something urgent and important happens that hijacks these efforts and draws upon these resources. We then wonder what went wrong with our plan since we had forewarning.
The solution is to keep the decision to diversify income on the strategic agenda, allocate ample resources to this task and try to not hijack the team. Then maintain a sense of urgency by reminding people of the deadline for diversifying the organisation’s income, and the possible consequences should it fail to do so.
Having a significant, stable source of income from a single source is a blessing to organisations. It provides some stability and breathing space and time to refine their approach and pursue the next milestone on their journey.
However, such an income source does create the risk of dependency and complacency which in the long term is not good for organisations. It can lull organisations into a state where they believe that the status quo will continue indefinitely. Organisations might dedicate all their resources to fulfilling their existing obligations rather than investing resources to diversify and improve their income.
The solution is simple. Acknowledge that your fortunate situation carries its risks and that your organisation must do something before it’s too late. These positive situations have a way of coming to an end when least expected. Allocate and ringfence the resources to improve your other sources of income and lay the required groundwork. Act boldly and decisively before time runs out.