Most of the work of my consulting firm is focused on the development and operation of performing arts venues. Often, as a part of that work, we develop pro-forma operating budgets that suggest what it will take to financially sustain the proposed facilities. That work reveals the first reality of our world, one that we must communicate to clients: from community arts centers to opera houses, facilities must be sustained by a combination of earned and contributed income. At this point, someone from the community usually pipes up and says:
“You mean, they lose money.”
We disagree. Performing arts venues don’t lose money by nature. But they don’t generate an operating surplus simply with ticket sales, rent and concessions, either.
There are some exceptions to this reality, on Broadway and in markets like Las Vegas and Branson, MO. That said, most performing arts venues also require grants, donations, sponsorships and other forms of contributed support. This is not a bad thing, as long as the venues are delivering value to their owners and their communities in such a way that grants and donations represent money well spent.
The work we do in developing pro-forma operating budgets is really about figuring out the combination and balance of earned and contributed income that will sustain a facility out into the future. How do we do it?
Our theory is that sound financial projections must be based on sound activity projections. So if our client is considering the development of a new performing arts venue, our job is to predict how that space will be used by a combination of programmatic elements: presenting (paying for touring shows and assuming the associated risk), mission-based rentals (subsidized access for nonprofit arts groups), market-based rentals to corporate and other commercial users, and educational programs (either produced by the facility or by various producing partners).
It’s not hard to make a list of what’s possible, but it’s extremely difficult to predict how much activity and related revenue will actually materialize, especially during the first few years. Arts organizations tend to be far too optimistic about their ability to book dates and fill seats. We have to moderate that optimism by discounting their estimates of dates and sales.
Good activity estimates lead to strong projections of earned revenue (ticket sales, rent, food and beverage operations, ticketing operations). Activity estimates also allow us to project staffing, programming, administrative and occupancy costs. The difference between those two numbers (operating expenses less earned revenue) gives us our annual funding requirement. Then by making five-year activity projections, we are able to show how annual funding requirements will grow and change over time.
That annual funding requirement becomes the key puzzle to solve. Will the proposed activity and community service have sufficient value to warrant that required level of support? How likely is it that this contributed income will break down in a healthy way between public and private sector sources? Can these various sources grow over time as the building and its programs mature?
I love spending hours and days creating these models and tinkering with assumptions, but their real value lies in the process of building, sharing and adjusting them with our clients. The more of them involved, the better the result. Here’s why.
First, building a pro-forma operating budget requires a multitude of explicit assumptions. Each conjecture expressed and agreed upon is one more win against cognitive dissonance. It is amazing, the unrealistic ideas that people have in their heads about the potential financial performance of theaters. The more we dispel crazy thinking and align expectations at this early point in the process, the better.
Second, we try to build these financial models in parallel with the first versions of a capital budget. Our clients need to see the relationship between the two and have the opportunity to test assumptions. Say, for example, a local government is seeking a net-zero facility, which is one that produces enough renewable energy to sustain its own energy needs. We then need to understand the capital investment required by that choice, and measure it against the life-cycle costs of ongoing operations.
Third, building and refining these budgets forces the consideration of both intended and unintended consequences. What happens to the neighborhood when this new operation arrives? Will the venue generate significant positive economic impacts on the broader community? Will local arts organizations put themselves in a position to succeed in new facilities –- ramping up audience development and programming to fill seats with happy customers? And how will the additional fundraising associated with the venue impact the fundraising efforts of users and other important nonprofits in the community?
The biggest threat of building pro-forma operating budgets is that they suggest a future that is incremental and predictable — a 2% annual growth rate here, plus a 3% consumer price index change there, and we’re all set. But this is not how the future unfolds. Any incremental approach will be blown to pieces by war, recession, unpredicted competition — even elections. What works is building budgets that are conservative and which include an accumulation of reserves to protect against a coming rainy day.
To use current parlance, we try to build resilient budgets to go with resilient buildings, and to create budgets that can deliver strong, continuing value during uncertain times.