By Mark Yu-Ting Chen, Lincoln J. Pan, and Hai Wu
August 2006

Like most segments of China's economy, the nonprofit sector has grown at a heady pace over the past few years, expanding from roughly 6,000 registered groups in 1999 to about 150,000 in 2005. (1) While this growth is remarkable, weak management skills and a lack of resources are making it hard for nonprofits to meet the rising demand for their services. Multinational corporations in China can help by targeting their donations to improve the organizational performance of nonprofits and by offering training and expert counseling. At the same time, China's nonprofits must create an infrastructure to strengthen the sector, in part by channeling corporate aid more effectively.

Nonprofit organizations were almost nonexistent in China before the onset of economic reforms, in the 1980s. As the sector grew, corporate philanthropy focused on funding primary education, programs to alleviate poverty (such as microfinancing for farmers), and health initiatives. These efforts helped nonprofits to acquire physical assets, such as school buildings and clinics, but programs and physical assets alone are not enough to support a nonprofit's long-term development. To achieve the most impact, corporate philanthropy must combine more flexible financial support with a hands-on effort to teach nonprofits the skills critical to running organizations effectively.

Beyond giving corporations more control over how their contributions are used, this new approach would help them demonstrate a greater commitment to improving China's social welfare, make them more attractive to potential recruits, and perhaps strengthen their relations with the government. It would also allow them to become more knowledgeable about social issues, such as the environment, that are likely to influence business decisions in China over the coming years.

To date, corporations have made little progress in understanding China's nonprofit sector, despite their interest in establishing a philanthropic track record. To help determine the causes for this problem we examined more than 100 nonprofit organizations in China and undertook an in-depth analysis of more than 40 of them. We talked to hundreds of stakeholders, including donors and nonprofit leaders, as well as current and former government officials.

The evolution of China's nonprofit sector

These nonprofits couldn't cope with the variety of new social issues resulting from China's rapid economic growth, however. The cost of medical care and higher education, for instance, has risen beyond what many Chinese citizens can afford. In addition, issues such as HIV/AIDS, rural unemployment, and pollution are putting even more strain on existing public services.

These concerns led to the emergence of a second wave of nonprofits, including a growing number of independent grassroots organizations. Few of these groups are more than five years old and most have only one full-time employee. Nevertheless, they play an increasingly significant role in Chinese society.

Initially, many grassroots groups came under heavy scrutiny from the government, which feared that they could be politically destabilizing. While the government continues to monitor some groups - particularly those with religious and political leanings - it offers support to an increasing number of nonprofits.

In late 2004, for example, the Ministry of Civil Affairs announced a new framework to recognize the foundations that finance charity in China and to offer them a variety of tax deductions, including exemption from stamp duty. Legislation institutionalizing the framework is currently under review. Officials have also initiated discussions on a comprehensive philanthropy law that would create a certification process for nonprofit organizations and provide tax deductions for individual and corporate donors.

Today the main obstacle to the nonprofits' development is neither government scrutiny nor the level of demand. Rather, nonprofits in China face unique challenges arising from the sector's immaturity and from a development path that has neglected social issues and grassroots organizations because it's guided largely by the government. The most pressing challenges - a weak funding base and a lack of resources to support critical training and counsel - are both exacerbated by the unprecedented growth in demand for nonprofit services.

Hurdles for nonprofit development

Chinese nonprofits face funding shortfalls and a skewed distribution of resources. In 2005, charitable contributions in China, including funds given to the government for disaster relief, totaled some 0.05 percent of the nation's GDP, compared with 0.09 percent in India, 0.84 in the United Kingdom, and nearly 2 percent in the United States. Very little overall contributions come from domestic sources: we estimate that international organizations and corporations account for 80 percent of all donations to Chinese charities. (4) (That figure is just 0.5 percent in the United States.) Donations from domestic companies are particularly low: a sampling of the leading ones indicates that, on average, they contribute less than 0.3 percent of their posttax income to charity, compared with more than 2 percent for most Fortune 500 corporations.

Domestic giving is likely to increase as the country's affluent class matures and charitable organizations become more established. In the meantime, the dearth of funding makes life particularly difficult for grassroots organizations. Government-affiliated nonprofits absorb 85 percent of all available resources, leaving little for the burgeoning number of smaller groups. In addition, most charitable giving in China flows through large nonprofits and government-organized NGOs based in Beijing and Shanghai - areas where nonprofits cluster, information about them is more easily obtained, and corporate efforts are more visible. Organizations outside these huge urban centers tend to be left out.

The nonprofit sector also lacks training programs and resource centers to support the development of its business skills. The dominance of government-established NGOs, which tap government resources to build these capabilities, has forestalled the formation of a strong independent support network. A growing number of grassroots organizations - particularly those operating outside the biggest cities - will require such an infrastructure to get the resources and training they need.

Many nonprofits have relied on their entrepreneurial ability and the unwavering commitment of their founders to overcome the hurdles and create innovative, sustainable programs. These organizations will doubtless grow stronger in response to legal and regulatory measures intended to develop the sector. We estimate that from 500 to 800 high-caliber nonprofit organizations in China have the scale, impact, and expansion potential to benefit greatly from the increased managerial skills and other kinds of support that corporations could provide.

One example is the Sherig Norbu Jigme Gyaltsen School, in Qinghai province. Qinghai's public schools provide only a modern Chinese education, in Mandarin, while the region's Tibetan monasteries don't have the resources to teach students modern sciences and languages. To serve Qinghai's large population of Tibetan children better, Jigme Gyaltsen founded the Sherig Norbu in 1994, using personal savings of 3,000 renminbi ($400) and about 13,000 renminbi in borrowed money. The school combines a traditional Tibetan education, which includes logic and debating techniques rooted in Buddhism, with a modern Chinese education taught in Mandarin and English.

The school operates several for-profit businesses, including a Ragya yak cheese factory, which accounts for a significant part of its annual income (27 percent in 2004). Despite Sherig Norbu's success, it could benefit from corporate support - rudimentary management skills, for example, could help improve the sales and distribution of its cheese.

The corporate challenge

In 2004 multinational corporations in China donated $50 million to $75 million to the country's NGOs. While financial support is always welcome, these companies would make a greater impact by directing their money more effectively and by complementing their financial support with help in developing the nonprofits' management and operating skills - making experienced staff available, for example.

In-kind services with intellectual muscle

In some countries, nonprofit organizations have access to paid and pro bono networks of accountants, consultants, lawyers, and trainers. The Boston-based group New Sector Alliance, for example, coordinates the activities of a variety of volunteers (including professionals, MBA students, and undergraduates) to advise and train nonprofits. Only a handful of organizations have initiated comparable training programs for China's nonprofits, despite the glaring need.

Corporations can help fill this gap by, for instance, funding research into social issues or allowing employees to dedicate a specific number of hours each year to help Chinese nonprofits, which, unlike their counterparts in more developed economies, need training in basic business skills such as accounting, management, marketing, and logistics and distribution. Corporations can teach these skills effectively through long-term volunteer projects.

Such projects offer companies two benefits that funding alone cannot. First, the direct transfer of skills and services gives donors greater control over the outcome of their philanthropic efforts. Second, by creating a window into the nonprofits' operations, this kind of interaction will enable companies to tailor their future donations.

Consider the potential impact of the corporate presence at a grassroots organization that provides housing and psychological counseling for children of incarcerated parents. In 1998 Zhang Shuqin established Sun Village at Xian, in central China. The organization now has four centers serving more than 400 students, as well as a solid base of corporate donors. It also solicits donations for planting jujube trees on its land and then sells the fruit, used in Chinese medicine, to generate additional revenue.

Sun Village has been slow to expand, despite adequate funding and increasing demand for its services. Instead of adding new ones or building new centers, it has become overly focused on day-to-day operations. Zhang continues to make nearly every organizational decision - from setting funding targets to determining how the van is used. Corporate volunteers could help by coaching managers in how to set strategic goals, raise funds, and delegate responsibility.

Corporate executives should also seek seats on the advisory boards of nonprofit organizations. Until recently, these boards often didn't function well, since the benefits of organizational governance were not fully understood. Our discussions, however, show that nonprofits are slowly recognizing the need for greater corporate participation and are increasingly open to extending the invitation to private-sector executives. Board representation not only allows a company to ensure that its donations are used wisely but also gives it the opportunity to improve the governance and professionalism of nonprofits and to enhance their performance in the vital areas of marketing and strategic planning.

Funding human resources and training

In addition to providing volunteers, corporations should rethink the way they distribute charity to nonprofits. Most organizations direct their donations toward program expenses (such as the operating costs of a school or a women's center) but not the costs of administration, fund-raising, or staff development. Further, many donors focus on issues that are high on the government's list of priorities (and therefore widely publicized), such as the environment, vocational education, and improving rural villages. As a result, many nonprofits amend their programs merely to increase the donations they receive - even if in doing so they neglect their core mission. Because funds for environmental problems were available, for instance, one of China's larger, education-focused organizations developed side projects to address them; another nonprofit, which operates orphanages, has started a number of vocational-education projects purely to attract donors. Diversification would be appropriate if these organizations had the right skills, but given their tight resources and narrow capabilities they would be better off focusing on their core mission.

To encourage nonprofits to deepen their program expertise and expand their core capabilities, corporations can supply funds to improve the way they develop, recruit, and retain employees. Providing the resources to build and staff a school is helpful, for instance, but corporate support of teacher training - directly or through third-party organizations - will go further toward sustaining nonprofits in the longer term. At Sun Village, for example, a corporation might consider paying for programs to train employees in psychological counseling or providing them with child care.

Corporations should also provide more multiyear grants. Donors in China generally offer support for only one year at a time, on the theory that the annual reapplication process is the best way to motivate and assess a nonprofit's performance. However, this practice creates significant administrative burdens. A typical midsize organization with 5 to 15 workers, for example, may write more than 25 grant proposals a year, expecting to receive funds for perhaps 5 to 12 of them. Multiyear grants, which would lighten this administrative task, could be made conditional on meeting specific performance targets, reviewed regularly.

Creating a new nonprofit infrastructure

While the private sector's participation is critical to developing nonprofits in China, they themselves must initiate reforms aimed at building skills and resources. China needs to develop national organizations, similar to the International Red Cross, that can direct funding and services to grassroots nonprofits, for example. With government-established NGOs absorbing most of the available funds, the current allocation of resources is inefficient. Large NGOs are not always best placed to respond to society's changing needs, whereas smaller, more nimble grassroots organizations may be better able to tailor services to local conditions. In Shanghai, for instance, an organization called MOPA Housekeeping not only employs and trains migrant workers so they can perform basic housecleaning services but also provides cultural centers and group homes to help them manage the difficult transition from rural to urban life - a need that larger nonprofits have overlooked. The creation of Chinese foundations focused on supporting small, grassroots nonprofits would make resources more widely available.

Some government-affiliated NGOs have the capacity and scope to organize national foundations. Their strengths include good relationships with the Chinese government, networks of volunteers, stable international and domestic financial support, and experienced managers. The China Youth Development Foundation, for example, is in a good position to take on this challenge: it channels resources to smaller nonprofits that concentrate on rural education and youth-centered projects but that work in ways (or areas) that the foundation's own efforts don't cover.

A network of domestic foundations could help spur the development of national resource centers to provide nonprofits with advice, teach them fund-raising skills, and perform research services. Currently, the one-year-old NPO (Nonprofit) Development Center, in Shanghai, and the six-year-old China NPO Network, in Beijing, plan to offer some of these services. But there is room - and need - for more. Corporations could ally themselves with large NGOs to finance both domestic foundations and national nonprofit resource centers, particularly in the interior and western regions where China needs them most.

Finally, China's leading nonprofits can set and publicize governance standards for themselves and others in the sector. The China Youth Development Foundation, the China Foundation for Poverty Alleviation, and the NPO Network, for example, have begun discussions to create an initiative to build public trust, attract donors, and establish nonprofit standards, including audited financial statements, functioning boards of directors, Web portals, and appropriate organizational structures. Nonprofits that meet such standards would receive formal recognition as "higher-quality" organizations. While this initiative is a good first step, it must be implemented fully and effectively to serve as a catalyst for change, and similar efforts should be established at the national level.

Increased government and private-sector efforts will be critical to ensuring that China's nonprofit organizations can respond effectively to the growing demand for their services. Corporations can choose from a variety of tactics beyond monetary donations in order to provide China's proliferating nonprofits with the most useful resources - financial and beyond - and to supplement the government's efforts to help these groups build a sustainable future for the country.

Mark Yu-Ting Chen is an alumnus of McKinsey's Taipei office of and adviser to McKinsey; Lincoln Pan is an alumnus of the Hong Kong office; Hai Wu is a principal in the Beijing office.

This article was originally published in the McKinsey Quarterly.