Some Observations on Financial Stability
by Elizabeth Merritt
This article was published in Museum News September/October 2006.
The Search for a One-Size-Fits-All Business Model
We can’t point to a successful business model that works for all museums. It doesn’t exist. Actually, it can’t exist. This is because each museum faces its own set of circumstances. Just as in nature each species evolves its own set of strategies to survive in a given environment—filling its “niche,” as it is called—each museum has to find its own unique adaptations that work in its business environment.
Even when a museum adapts successfully and finds a business model that works, it won’t and can’t last, because it only works in relationship to the museum’s current environment. And if there is one thing you can count on absolutely, right up there with death and taxes, it is that this environment will change. The stock market will go up and down. Major local businesses will be bought by national chains or move away or close. Donors will die, change their wills or give their collections to someone else. Foundations change their focus to another equally worthy cause, one that doesn’t match the museum’s mission. Tourists come, tourists go. Sometimes the very things that attract tourists—coastal beaches, fall leaves, snow—prove impermanent, victims of climate change or rampant development.
These thoughts may be depressing, but I hope they don’t turn you into a fatalist. In fact, there is a lot you can do to ensure your museum’s financial success. You can study your museum’s environment and select financial strategies that are likely to work in your circumstances. You can analyze the strengths and weaknesses of these strategies, understand where you are vulnerable and find ways to mitigate the risks. You can watch how your environment is changing and, with some success, project these changes into the future to predict what the museum will have to do to remain financially stable.
While it is true that there is not one successful business model, it is also true that there are models that are more commonly successful than others. And while every museum exists in a unique set of circumstances, if you squint a little bit, a lot of these sets look awfully similar to each other. AAM’s new publication, 2006 Museum Financial Information, presents information on the financial behavior of over 800 museums in the country. Much of the information is presented in the form of medians or percentiles: out of all the museums in this group, what percent do x, y or z? We may say, for example, “only 10 percent of museums get or spend their money this way.” This is not to say that because it is rare behavior it is wrong. It may mean, however, that this financial pattern is successful in relatively rare circumstances, or has rarely been attempted.
The information in this book is in a sense the result of a grand experiment: hundreds of museums asking, “What works?” Maybe not all these museums are “successful” at this moment (after all, 13 percent are running involuntary deficits), but on average they have been around almost half a century and most of them are not going away any time soon. The fact that they have conducted this experiment of “what works?” means that your museum does not have to start from scratch. Instead of trying out every possible strategy for yourself, learn from the experience of your peers. Look for museums that are similar to yours in certain key ways and see what generally works for them. If you are pursuing, or thinking of pursuing, a strategy that is relatively rare, be extra cautious and think about the circumstances in which it can be successful.
Observing the results of this grand experiment, we see that one pattern that is often successful is a well-diversified income mix, balanced between government, private, earned and investment. This is partly because the risk is spread out. A change in the environment that affects one income stream is unlikely to affect the other three. But it is also partly because in cultivating all four streams the museum attends to the needs and desires of a broad constituency: public officials, private donors, philanthropic foundations and consumers. By making the museum matter to a greater number of people, it builds a safety net, ensuring that more people are likely to step forward to catch it should it fall.
The feedback loop: connecting organizational culture and financial strategy
So why don’t all museums have a diverse income mix, if this is the safest model? For one thing, they did not invent their financial strategy from scratch. It evolved, shaped by their institutional history and culture. You are probably in the same situation. Either you are at an established museum or you are planning a new museum for which some of the parameters (location, governance, initial funding, mission) are already set. Before considering how you might change your financial behavior, it is useful to analyze the circumstances that shape your museum’s current financial strategy.
Numbers don’t exist in a vacuum. They are the result of decisions made by people who behave as they do for understandable reasons. To understand your museum’s financial behavior and potential barriers to change, it helps to understand the influence wielded by organizational history, structure, expectations and perceptions. Here are two thinly fictionalized examples (actually composite pictures of real museums) that dramatize the risks of heavy reliance on one source of income.
Consider a private nonprofit museum with a board comprised almost entirely of people with significant wealth. Perhaps the museum was founded and endowed by a patron who established the initial board. It included several members of his family. There is an expectation that board members give generously both annually and to endowment and capital campaigns. The endowment is large and drawing from the endowment covers a majority of the museum’s operating expenses. As a consequence, the museum is free to focus on mission-related activities rather than those that generate significant earned income. It has very high-caliber collections, exhibits, research, programs and publications. It has a store and a food service, but their major purpose is to enhance the visitor experience, not to net significant income. Perhaps the board is not concerned about building attendance, preferring to provide an intimate, high-quality experience.
This can be a very stable financial strategy in a stable environment. But in the long run, most environments are not stable. For example, if the market has a bad year, or a string of bad years, overreliance on endowment income leaves the museum vulnerable. Fluctuations in the market are hard to predict and it takes time to develop substitute income streams. So to respond to a downturn, the museum either has to drastically reduce expenses (lay off staff, reduce hours, cut activities), or draw on its financial reserves (for example, eating into the principal of board-designated endowment). If it takes the latter route, several bad years can consume a significant chunk of the principle, in turn eroding the ability of the endowment to support operating costs.
Compounding the problem, museums with boards fitting this profile are sometimes very inwardly focused. They may not have taken significant steps to reach out to the community and cultivate a wider audience. There is some logic to this. The board is self-perpetuating. If the major criterion for election is ability to give, it may be very difficult to recruit members of diverse groups. But excluding these groups from the board bars them from the most effective form of input about the museum’s actions. Absent this input, the board’s decisions and planning may not reflect the needs of these parts of the community. So when the museum tries to broaden its support, it may find closed doors. It is hard to increase attendance because many potential audiences don’t feel the museum serves their needs. Philanthropic donors, increasingly focused on community engagement, may feel the museum does not fit their funding priorities. The situation may get even worse as the wealth of the current board passes to a generation for whom the museum is not a top priority.
Another paradigm is the museum that decides to earn its way to financial success. Staff may choose this strategy because they have to: it is clear that the other sources of income (private, government, investment) are not going to fill their needs. A common way for museums to arrive at this position is to have high fixed operating costs due to their building. These may be museums that have found a home in an old and treasured local landmark (“Let’s put a museum in it!”). Matchmakers may slot old museums in search of more space into such buildings or start a new entity or a combination of these approaches. Several museums have been placed in this way into enormous historic train stations. At the smaller end of the scale, this plays out time and again across the country as museums find homes in historic houses, libraries, even barns. Such buildings have huge appetites for money to fund restoration and maintenance.
The museums rarely bring large endowments to the match. (If they had that kind of money, they would have built their own building.) The expectation is that they will earn a large percentage of what they need to support themselves and the building. This often includes heavy reliance on admissions income and space rental. Often a new element, such as a large-format theater, is introduced with the thought that it will generate the needed extra profit. With such high expectations pinned on attendance, choices of exhibits and films are often driven by expectations of their popularity, regardless of fit to mission. Film theaters may be pressured to book the increasing number of commercially successful large-format films that are of marginal educational value. Exhibits may be geared to “blockbusters,” usually rented, or exhibit venues remain empty to make them available for space rental. Attractions such as flight simulators and interactive, high-tech games may be slotted, regardless of their compatibility with the museum’s interpretive message.
Museums that depend heavily on earned income sometimes end up devoting a relatively small percentage of their time and attention to mission-related activities. That is not to say that they fail to take good care of their collections or to conduct respected research or produce exciting exhibits and educational programs. But these constitute a relatively small amount of their overall efforts since these items are usually revenue neutral or a net loss. In an earned income model, frequently the lion’s share of energy and attention is given to the revenue-producing activities.
Besides its inefficiency, this has several weaknesses as a business model. By behaving as a commercial entity, the museum may come to be perceived as one by the public. A nonprofit museum’s unique market niche, as opposed to a for-profit entity, is that it provides goods and services to people who would not necessarily pay face value for these things. It does this by filling a role that society sees as intrinsically good and worth supporting. People see a museum meeting the needs of the underserved, or caring for cultural or natural heritage, or otherwise filling a useful role in society. When they donate money to the museum, it is an indirect purchase. Rather than getting something that benefits them directly, they fund the creation of a
community more like the one they want to live in.
The more a museum relies on a model of selling goods or services that greatly resemble commercially available goods or services, the more the museum erodes its ability to fill its unique niche. It becomes a competitor with commercial theaters or event venues or travel services that offer essentially the same products. Having created this perception, it can be challenging for the museum to look for support from donors or philanthropists.
This is not to say that either of these models—heavy reliance on endowment, heavy reliance on earned income—is bad or unworkable. Each has its benefits, each has its risks. However, they are both risky enough to warrant close examination before they become the bedrock of your financial strategy.
Common financial fallacies
While it is extremely difficult to suggest what museums should do financially, it is much easier to point to some things they should not do. Avoiding these errors may head off some of the more egregious and commonplace financial problems. Here is a rogue’s gallery of financial fallacies, in three categories: errors related to expansion, errors of omission and errors of commission.
Errors related to expansion
Even well-managed, financially stable institutions sometimes founder when they try to make the next great leap forward. Watching such cases unfold, it is sad to observe that the same mistaken assumptions lie behind many of these failures.
Assuming that increased attendance from blockbuster exhibits or new buildings will hold steady or increase after the “event” is over. More often false than true. Instead, there is often an opposite effect, with attendance falling below previous levels once the event is over. The museum may be “borrowing” from future attendance rather than building new audience or increasing frequency of visitation. Museums that successfully use new buildings or special exhibits to build attendance over the long term spend a lot of effort capturing and keeping new visitors and convincing the regular audience that repeat visits will be fresh and exciting.
Feasibility studies actually tell you whether something will work. Hah. More often they are an accurate mirror of the wishes and desires of the people commissioning the study. The few that do give bad and realistic news tend to be studiously ignored. Once a group of people is so heavily invested in a plan that they commission a feasibility study, they are loath to give the plan up. We don’t usually want a reality check for our dreams; we want reassurance they will fly. The most common variant on this fallacy is inflated attendance projections for new facilities. After all, when faced with an equation with variables that are pretty well set (cost of the building, cost of staff), the easiest way to balance that equation is to play with the “fuzzy” variables like attendance. Two or three years out, when asked why the financial projections are not being met, the beleaguered director, often hired after the facility was planned, replies, “We only have half the attendance we anticipated.”
Two can live as cheaply as one. They can’t. And a building twice the size of your old one isn’t going to be as cheap to run, either. This is the next most common fallacy associated with new building projects, and leads to unrealistically low projections of operating costs in the new building. Successful projects make accurate assessments of costs such as increased maintenance, staffing, utility bills, etc. They either build endowment along with the capital campaign or develop successful income streams to offset these costs.
Errors of Omission
Sometimes the error is not something that you have done, but something that you have failed to do.
Deferred maintenance. The roof isn’t going to fix itself, and neither is the septic system. The cost of such repairs usually goes up over time and decaying infrastructure often worsens, causing yet more damage. Leaking roofs lead to rotten eaves. Poor drainage causes erosion and flooding. Decaying electrical systems start fires. Many museums do not even keep a running tally of what it would cost to tackle their deferred maintenance, much less address these costs through financial planning.
Failure to cultivate the next generation of (fill in the blank: donors/members/audience). Who gives to/joins/comes to your museum now? Members of a particular ethnic group? First and second generation representatives of a particular immigrant community? Devotees of a special hobby? Now how are the demographics of your community (or interest group) changing? Is the ethnic makeup shifting? Is the old guard of the immigrant community dying off, while the new generation is mostly assimilated? Is the hobby becoming less popular? If a narrow segment of the public is interested in your mission, and that segment is getting even smaller, you have a choice of
- diminishing in scope as your supporters dwindle in numbers
- cultivating interest in your mission among a new audience
- moving where there is a concentration of people still interested in what you do
- changing your mission.
Or some combination of the above. You do not have the luxury of looking the other way while it happens.
Errors of commission
In some ways, these are both the most egregious and the easiest to avoid: Just don’t do them.
Drawing down the principal of the endowment. Sometimes, rarely, this is a responsible, well-reasoned action. Some museums thoughtfully work out how using the principal to invest in new infrastructure will, in the end, repay the cost, rebuild the endowment and contribute new sources of revenue. Did I mention how rare this is? In the majority of cases, it is the strategic equivalent of jumping out of a plane without a parachute. Sans a backup plan, gravity dictates that you are going to hit the ground. At best, it buys you more time to figure out what to do. At worst, it launches the museum into a financial death spiral.
Selling the collections in response to financial instability. I saved this for last because it is the absolute worst thing that a museum can do in response to financial crisis. Don’t even think about it. Regardless of whether it is a good financial strategy, it is unethical. And in fact it is a bad financial strategy because it is unethical. It damages the museum’s credibility, its ability to attract support or do business with its peers. If a museum no longer can afford to care for its collections, it is responsible to ensure they are transferred to another institution able to care for them and make them accessible to the public. This may, incidentally, help the museum’s finances by lowering its operating costs. But selling the collections with the motivation of generating funds to offset the museum’s financial failure is fundamentally unsound. It is an abrogation of the public trust, and a coup de grace to the museum’s reputation.
So that is the good news and the bad. I can’t give you the magic formula for financial stability, because it does not exist. You can be alert, however, to which strategies are successful for many museums under various circumstances—a balanced income mix, for example—and which tend to be high risk, such as reliance on a single income source. That way you can steer clear of the financial fallacies that commonly cause museums to founder.
Elizabeth Merritt is director, Museum Advancement & Excellence, American Association of Museums, Washington, D.C. This article is excerpted from 2006 Museum Financial Information, edited by Merritt and to be published by AAM in October 2006.
