How social enterprises are facing up to the challenge of sustainability

By Dr Sidney Leung and Professor Phyllis Mo

Dr Sidney Leung, Associate Head and Associate Professor in the Department of Accountancy, and Professor Phyllis Mo of the Department of Accountancy show how Hong Kong's burgeoning social enterprises sector is shaping up to the challenge of maintaining financial independence. This article is based on "Enhancing the competitiveness and sustainability of social enterprises in Hong Kong : A three-dimensional analysis," by Sidney Leung, Phyllis Mo, Howard Ling, Yanto Chandra, So Sum Ho, published in the China Journal of Accounting Research, 2019.

Hong Kong social enterprises have reached an all-time high and increasing numbers can sustain themselves financially, breaking the stereotype that they depend on government bailouts. There are, however, tensions in the DNA of these organisations, particularly with regard to financial discipline. How important is the bottom line? Is self-sufficiency sufficient? Or is it acceptable if business revenues cover only part of the costs? Modern-day ideas of managerial accountability tend to encourage a regime of profit, so that SEs can reinvest in social activities or support further social causes. So how are Hong Kong's SEs doing?

Profitability of Hong Kong social enterprises

  • 27% of SEs made no profit over the past five years
  • 41% generated profits in one to three of those years

Growth of Hong Kong social enterprises

  • 222 in 2008
  • 654 in 2017

In a society of rampant inequality, The Hong Kong SAR Government and social service sector have been actively promoting the development of social enterprises with entrepreneurial thinking and innovative approaches. The idea is to enable the socially disadvantaged to be self-reliant through employment, and to meet the needs of various community groups. But SEs are not merely benevolent entities. They are also welfare operations that work according to market mechanisms in an effort to generate substantial social value and jobs for the socially disadvantaged in the community.

Inequality: Hong Kong's Gini coefficient now stands at 0.539, its highest level in 45 years, the eighth most unequal country in the world. By comparison, Singapore is at 0.459 and the US is at is 0.450. This inequality is most starkly apparent in the housing market. Hong Kong is ranked as the world's least affordable housing market. It takes an average family 20.8 years of savings to afford a home. In the Gini coefficient, zero represents maximum equality and one represents maximum inequality.

Source: http://worldpopulationreview.com/ countries/gini-coefficient-by-country/

A harsh reality - many SEs suffer losses

Many SEs with important social missions have failed after a few years or are struggling to survive. The findings of the Fullness Social Enterprises Society Report (2015) provided a glimpse into their sustainability. This report showed that only 19% of SEs were able to achieve break-even or profit by the end of their second year of operation, rising to 53% by the end of the fifth year. This improvement is encouraging, but also points to a harsh reality that many SEs suffer endemic financial losses in their operations. The 2015 report also showed that 23% of SEs ceased operations within five years and the non-survival rate increased to 55% within ten years.

As they wean themselves away from government funding, SEs are now facing up to the challenge of achieving economic sustainability. There is an increasing demand from SE practitioners, the government and other stakeholders for a better understanding of what causes the success or failure of Hong Kong SEs. Our study, "Enhancing the competitiveness and sustainability of social enterprises in Hong Kong: A three-dimensional analysis," focuses on the impacts of three key dimensions of social entrepreneurship on the SE's profitability, business planning and management: (1) investment objectives and financial goal; (2) major funding sources; and (3) governance structure.

Can social enterprises survive without support?

Through two rounds of invitation sent to randomly selected SEs, a total of 22 SEs agreed to participate in our study. In-depth interviews based on the questionnaire were conducted with the owner/founder or key manager of each selected SE during the period from December 2017 to April 2018. The participating SEs operated mainly in retail businesses (45%), catering businesses (23%), and workshops (14%).

Regarding investment objectives, 55% of SEs aimed at dual investment objectives, that is a mixture of social impact and financial return, whereas the remaining 45% said that social impact was their sole investment objective. In terms of financial goals, less than one-third (32%) rated "profitability" as their financial target. Nearly half of the SEs (45%) aimed at "self-sufficiency." Another 23% accepted losses and their financial goal was "contribution," that is business revenues should cover part of the costs.

In terms of profitability, 27% of SEs had never made a profit in any single year over the past five years, 41% of SEs had generated profit in one to three of those years, whilst about one-third (32%) recorded profit in at least four of the past five years.

In terms of main funding source, 41% of SEs relied on private funding, 32% on funding support from non-governmental organisations and 27% on government funding. Regarding governance structure, the majority (64%) were run by non-owner managers. In the remaining 36%, the owner also served as the key manager. Just under half, (45%) of SEs had established an overseeing/ advisory committee.

The investment objective makes a difference

Unsurprisingly, we found that SEs with a dual investment objective of social mission and financial return were more sustainable than those only aiming for social impact. SEs with dual investment objectives had an average of 2.75 profitable years in the last five years, outperforming SEs with the sole objective of social impact (2.1 profitable years).

High-profitability SEs, those with at least four profitable years in the last five years, were more likely to aim at either "self-sufficiency" or "profitability" as their financial goal and to adopt more rigorous business and financial management than low-profitability SEs. Specifically, 86% of high-profitability SEs aimed at either "self-sufficiency" or "profitability" as their financial goal. In contrast, 50% of low-profitability SEs considered "contribution" (business revenues cover part of costs) as their financial goal. Over 70% of high-profitability SEs had a business plan and were more likely to use budgeting to measure business performance than low-profitability SEs. Also, high-profitability SEs produced cash flow forecasts more frequently compared to low-profitability SEs.

The funding source makes a difference

We partitioned the sample into three groups based on their major funding sources, namely NGO-funding, government-funding, and private-funding, and compared various attributes of their business and financial management. We found that 86% of NGO-funding SEs had dual investment objectives, reflecting that NGOs typically expect their SE subsidiaries or units to earn profit and be self-sustainable. Indeed, NGO-funded SEs were the most profitable with an average of 3.29 profitable years in the last five years. Only 33% of government-funding SEs had dual investment objectives. Although many government-funded SEs had a single objective of social impact, their profitability index (2.67 years) ranked second out of the three groups. It is alarming that privately funded SEs had the poorest record of profitability (1.67 years only) even though they had ranked "profitability" as their first preference in terms of financial goal. Such SEs had the lowest scores in financial planning and management.

The presence of an ownermanager makes a difference

As with any for-profit enterprise or family firm, the presence of an owner-manager impacts on how an SE is managed. SE governance structures vary according to funding source. Specifically, 67% of privately-funded SEs were run by owner-managers, compared with just 33% for government-funded. As expected, all NGO-funded SEs were managed by professional managers. The establishment of an overseeing or advisory committee was not common in privately-funded SEs (33%). Half and slightly more than half of government-funding and NGO-funding SEs respectively had an overseeing/advisory committee.

We analysed the differences in profitability and business management practices between owner-manager SEs and nonowner- managed SEs. The results showed that non-ownermanaged SEs performed better in profitability (2.71 years) than owner-manager SEs (two years). Compared to owner-manager SEs, non-owner-managers SEs had more detailed budget including capital expenditure and operating expenditure of start-up costs and were more likely to profile competitors in the business plan. Non-owner-manager SEs were also more sophisticated in financial planning and management. These findings are consistent with the notion that SEs managed by a non-owner key manager are more competitive and sustainable than owner-manager SEs.

We also addressed the question "Does having an overseeing/ advising committee matter in Hong Kong SEs?" The results showed that SEs with an overseeing committee prepared more detailed budgets and had a greater tendency to adopt updated business plans than those without one. SEs with an overseeing committee also developed their business start-up plans more comprehensively and thoughtfully such as by setting up a supply chain for their product/ service in business start-up plans.

Policy implications and recommendations

Collectively, the research findings showed that Hong Kong SEs are in general not yet embracing the importance of financial sustainability, nor the notion of "social enterprise" as a for-profit business.

To enhance the competitiveness and sustainability of the SE sector in Hong Kong, we have the following recommendations.

  • SEs should embrace realistic and sustainable dual investment objectives and should manage and run their enterprises from a sustainability point of view.
  • SEs should prepare quarterly, if not monthly, cashflow and profit and loss forecasts, evaluate the operating performance with the forecasts and revise business plan and forecasts accordingly.
  • SEs should establish an overseeing/advising committee with at least 3 members, at least one from sales and marketing, one from accounting/finance and one from the expertise in the related industry.
Dr Sidney Leung
Associate Head and Associate Professor
Department of Accountancy
Professor Phyllis Mo
Department of Accountancy