Viewpoints

The Market for Nonprofit Lemons: Andrew Means on Transparency in the Social Market

We need new and improved methods for disclosing impact in the social sector.

I’m not going to bury the lede. I think the nonprofit sector has too many ineffectual organizations with too many resources. I think it’s a problem when the quality of impact isn’t correlated with the quantity of dollars donated. But to get us all to my point of frustration we’re going to take a nerdy journey into the world of market economics.

In 1970, George Akerlof, an economist and professor, wrote a seminal article entitled, “The Market for Lemons.” Akerlof described a used car market where the seller has perfect information about the car they are selling: how well it runs, its accident history, how it starts shaking when you hit 70 mph. The buyer does not have perfect information. They aren’t a mechanic and don’t know the vehicle’s history. They can’t judge the quality of the vehicle, and they are at the mercy of the seller to reveal the information they need to make a good decision.

This asymmetry is the death of markets. Markets rely on valid, transparent information. When asymmetry exists, there is temptation to not be completely transparent. It leads to buyers purchasing substandard goods—the “lemons”—while also driving good, transparent players from the market because they appear worse. They are telling the truth in the midst of less scrupulous sellers, but because the buyer cannot tell the difference between the truthful and dishonest sellers, the transparent ones seem like they are selling an inferior product.  

Akerlof put this in precise terms: “The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”

We create lots of ways to protect against asymmetric information. In the used car market we have Carfax. When buying stuff on eBay and Amazon, we have (hopefully) unfiltered customer reviews to help gauge the quality of the product and the reputation of the seller. In the stock market, businesses are required to present standard financial information so that all investors are working from the same information when valuing companies.

So what systems do we have for transparency in the nonprofit market?

The first thing that comes to mind is the 990. This form, which every U.S.-based nonprofit reports to the IRS, collects standard organization and financial information and is made publicly available (and finally in machine readable format). Organizations like Guidestar and Foundation Center have built tools using this information to allow people to easily search, sort, and explore the data.

The problem is that the 990 doesn’t provide the kind of information relevant to making a decision in the nonprofit market. The product being sold is impact. The 990 doesn’t really provide any information about impact. People have tried contorting the data to find potential correlations to impact (the disastrous overhead ratio), but the 990 doesn’t provide transparency about which organizations are working to solve which problems and how effective they are in their efforts.

It’s as if publicly traded companies were required to report how many widgets they sold, but not their revenue and expenses. If you were making a financial investment decision, that information isn’t enough to make a good decision.

The time has come to create better tools to improve information transparency about impact in the social sector. We need more efficient and effective ways of helping organizations share standard programmatic impact information, which will allow them to be held accountable for the results they are creating in naturally forming markets.

Put simply, the resources available to an organization should be correlated with their ability to create change. I want organizations that have a great product (impact!) to see more money flowing toward them, and those whose product can’t compete in the market to be put out of business. We have limited resources that need to be directed toward interventions that are working.

Stay tuned to Markets for Good: I’ll be posting more pieces about how we can foster greater transparency in the social sector, and I’ll highlight some organizations that are leading this charge. If you have any ideas, please leave a comment below or send your thoughts my way via @meansandrew and @marketsforgood with the tag #HonestImpact. I’d love to hear from you.


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