Contestability on the nonprofit sector

We study contestability in non-profit markets when non-commercial providers supply a homogeneous collective good through increasing-returns-to-scale technologies.

Unlike in the case of for-profit competition, in the non-profit case the absence of price-based sales contracts means that fixed costs are directly relevant to donors, and that they can translate into an entry barrier, protecting the position of an inefficient incumbent; or that, conversely, they can make it possible for inefficient newcomers to contest the position of a more efficient incumbent.

Evidence from laboratory experiments show that fixed cost driven trade-offs between payoff dominance and perceived risk can lead to inefficient selection.

The paper speaks to the debate on the effect of government funding on the private provision of public goods and services, which has so far largely ignored the effects of government funding on inter-charity competition and market structure in the third sector.

Our analysis shows that, once entry and technology adoption decisions are accounted for, there is no longer a theoretical prior that government grants that are directed towards charities’ core funding needs should be neutral, i.e. that they should simply crowd out private donations.

On the contrary, government grants might be able to affect entry and/or charities’ technology choices – and hence provision efficiency.