Stanford Social Innovation Review : Informing and inspiring leaders of social change

SUBSCRIBE | HELP

The Nonprofit Starvation Cycle

A vicious cycle is leaving nonprofits so hungry for decent infrastructure that they can barely function as organizations—let alone serve their beneficiaries. The cycle starts with funders’ unrealistic expectations about how much running a nonprofit costs, and results in nonprofits’ misrepresenting their costs while skimping on vital systems—acts that feed funders’ skewed beliefs. To break the nonprofit starvation cycle, funders must take the lead.

 

Organizations that build robust infrastructure—which includes sturdy information technology systems, financial systems, skills training, fundraising processes, and other essential overhead—are more likely to succeed than those that do not. This is not news, and nonprofits are no exception to the rule.

Yet it is also not news that most nonprofits do not spend enough money on overhead. In our consulting work at the Bridgespan Group, we frequently find that our clients agree with the idea of improving infrastructure and augmenting their management capacity, yet they are loath to actually make these changes because they do not want to increase their overhead spending. But underfunding overhead can have disastrous effects, finds the Nonprofit Overhead Cost Study, a five year research project conducted by the Urban Institute’s National Center for Charitable Statistics and the Center on Philanthropy at Indiana University. The researchers examined more than 220,000 IRS Form 990s and conducted 1,500 in-depth surveys of organizations with revenues of more than $100,000. Among their many dismaying findings: nonfunctioning computers, staff members who lacked the training needed for their positions, and, in one instance, furniture so old and beaten down that the movers refused to move it. The effects of such limited overhead investment are felt far beyond the office: nonfunctioning computers cannot track program outcomes and show what is working and what is not; poorly trained staff cannot deliver quality services to beneficiaries.

Despite findings such as these, many nonprofits continue to skimp on overhead. And they plan to cut even more overhead spending to weather the current recession, finds a recent Bridgespan study. Surveying more than 100 executive directors of organizations across the country, we found that 56 percent of respondents planned to reduce overhead spending. Yet decreasing already austere overhead spending (also called indirect expenses) may jeopardize organizations’ very existence—not to mention their ability to fulfill their missions. And although the Obama administration’s stimulus package may fuel rapid growth among some nonprofits, many will lack the infrastructure to manage the windfall and may well be crushed under the weight of all those well-intended funds.

Why do nonprofits and funders alike continue to shortchange overhead? To answer this question, we studied four national nonprofits that serve youth. Each organization has a mix of funding, including monies from government, foundation, and individual sources. We also interviewed the leaders and managers of a range of nonprofit organizations and funders, as well as synthesized existing research on overhead costs in the nonprofit sector.

Our research reveals that a vicious cycle fuels the persistent underfunding of overhead.1 The first step in the cycle is funders’ unrealistic expectations about how much it costs to run a nonprofit. At the second step, nonprofits feel pressure to conform to funders’ unrealistic expectations. At the third step, nonprofits respond to this pressure in two ways: They spend too little on overhead, and they underreport their expenditures on tax forms and in fundraising materials. This underspending and underreporting in turn perpetuates funders’ unrealistic expectations. Over time, funders expect grantees to do more and more with less and less—a cycle that slowly starves nonprofits.

Although several factors drive the cycle of nonprofit starvation, our research suggests that taking action at the first stage—funders’ unrealistic expectations—could be the best way to slow or even stop the cycle. Changing funders’ expectations, however, will require a coordinated, sector-wide effort. At a time when people need nonprofit services more than ever and when government is increasingly turning to nonprofits to solve social problems, this effort is necessary to keep nonprofits healthy and functioning.

Funders’ Unrealistic Expectations

The nonprofit starvation cycle is the result of deeply ingrained behaviors, with a chicken-and-egg-like quality that makes it hard to determine where the dysfunction really begins. Our sense, however, is that the most useful place to start analyzing this cycle is with funders’ unrealistic expectations. The power dynamics between funders and their grantees make it difficult, if not impossible, for nonprofits to stand up and address the cycle head-on; the downside to doing so could be catastrophic for the organization, especially if other organizations do not follow suit. Particularly in these tough economic times, an organization that decides—on its own—to buck the trend and report its true overhead costs could risk losing major funding. The organization’s reputation could also suffer. Resetting funder expectations would help pave the way for honest discussions with grantees.

Many funders know that nonprofit organizations report artificially low overhead figures, and that the donor literature often reflects grossly inaccurate program ratios (the proportion of program-related expenses to indirect expenses). Without accurate data, funders do not know what overhead rates should be. Although for-profit analogies are not perfect for nonprofits, they do provide some context for thinking about how realistic—or not—average overhead rates in the nonprofit sector are. Overhead rates across for-profit industries vary, with the average rate falling around 25 percent of total expenses. And among service industries— a closer analog to nonprofits—none report average overhead rates below 20 percent.

In the absence of clear, accurate data, funders must rely on the numbers their grantees report. But as we will later discuss, these data are riddled with errors. As a result, funders routinely require nonprofits to spend unhealthily small amounts on overhead. For instance, all four of the youth service organizations that we studied were managing government contracts from local, state, and federal sources, and none of the contracts allowed grantees to use more than 15 percent of the grant for indirect expenses (which include operations, finances, human resources, and fundraising).

Some foundations allot more money for indirect costs than do government agencies. Yet foundations are quite variable in their indirect cost allowances, with the average ranging from 10 percent to 15 percent of each grant. These rates hold true even for some of the largest, most influential U.S. foundations. And foundations can be just as rigid with their indirect cost policies as government funders.

Many times, the indirect allowances that grants do fund don’t even cover the costs of administering the grants themselves. For example, when one Bridgespan client added up the hours that staff members spent on reporting requirements for a particular government grant, the organization found that it was spending about 31 percent of the value of the grant on its administration. Yet the funder had specified that the nonprofit spend only 13 percent of the grant on indirect costs.

Most funders are aware that their indirect cost rates are indeed too low, finds a recent Grantmakers for Effective Organizations (GEO) study. In this national survey of 820 grantmaking foundations, only 20 percent of the respondents said that their grants include enough overhead allocation to cover the time that grantees spend on reporting.2

Individual donors’ expectations are also skewed. A 2001 survey conducted by the Better Business Bureau’s Wise Giving Alliance found that more than half of American adults felt that nonprofit organizations should have overhead rates of 20 percent or less, and nearly four out of five felt that overhead spending should be held at less than 30 percent. In fact, those surveyed ranked overhead ratio and financial transparency to be more important attributes in determining their willingness to give to an organization than the success of the organization’s programs.

Not only do funders and donors have unrealistic expectations, but the nonprofit sector itself also promotes unhealthy overhead levels. “The 20 percent norm is perpetuated by funders, individuals, and nonprofits themselves,” says the CFO of one of the organizations we studied. “When we benchmarked our reported financials, we looked at others, [and] we realized that others misreport as well. One of our peer organizations allocates 70 percent of its finance director’s time to programs. That’s preposterous!”

In this context, nonprofits are reluctant to break ranks and be honest in their fundraising literature, even if they know that they are fueling unrealistic expectations. They find it difficult to justify spending on infrastructure when nonprofits commonly tout their low overhead costs. For example, Smile Train, an organization that treats children born with cleft lip and palate conditions, has claimed that “100 percent of your donation will go toward programs … zero percent goes to overhead.” Nevertheless, the fine print goes on to say that this is not because the organization has no overhead; rather, it is because Smile Train uses contributions from “founding supporters” to cover its nonprogram costs.

This constellation of causes feeds the second stage in the nonprofit starvation cycle: pressure on nonprofits to conform to unrealistic expectations. This pressure comes from a variety of sources, finds the Nonprofit Overhead Cost Study. The survey found that 36 percent of respondents felt pressure from government agencies, 30 percent felt pressure from donors, and 24 percent felt pressure from foundations.3

Underfed Overhead

In response to pressure from funders, nonprofits settle into a “low pay, make do, and do without” culture, as the Nonprofit Overhead Cost Study calls it. Every aspect of an organization feels the pinch of this culture. In our consulting work with nonprofits, for example, we often see clients who are unable to pay competitive salaries for qualified specialists, and so instead make do with hires who lack the necessary experience or expertise. Similarly, many organizations that limit their investment in staff training find it difficult to develop a strong pipeline of senior leaders.

These deficits can be especially damaging to youth-serving organizations, notes Ben Paul, president and CEO of After-School All-Stars, a Los Angeles-based nonprofit organization that provides after-school and summer camp programs for at-risk youth nationwide. “It is clear to anyone who has led an organization that the most important capital in a company is the human capital,” says Paul. “In after-school we have a saying: Kids come for the program, but stay for the staff. If we don’t hire the right people, we might as well not run after-school programs.”

Meanwhile, without strong tracking systems, nonprofits have a hard time diagnosing which actions truly drive their desired outcomes. “The catch-22 is that, while organizations need capacity-building funding in order to invest in solid performance tracking, many funders want to see strong program outcome data before they will provide such general operating support,” says Jamie McAuliffe, a portfolio manager at the New York-based Edna McConnell Clark Foundation.

Take the case of a well-respected network of youth development programs. To protect the identity of this organization, we will call it the Learning Goes On Network (LGON). Poised for a huge growth spurt, LGON realized that its data systems would be hopelessly inadequate to accommodate more clients. An analysis showed that program staff spent 25 percent of their time collecting data manually. One staff member spent 50 percent of her time typing results into an antiquated Microsoft Access database.

Staff members can become so accustomed to their strained circumstances that they have trouble justifying even much-needed investments in overhead, our interviews revealed. “We [had] known for a long time that a COO was vital to our growth but [hadn’t] been able to fund one,” relates the CEO of one of the four youth development organizations that we studied. But when his organization’s board finally created the COO position, the rest of the staff resisted. “They had lived so long in a starved organization that the idea of hiring a COO was shocking to them.”

Misleading Reporting

The final driver of the cycle that starves nonprofit infrastructure is nonprofits’ routine misrepresentation of how much they actually spend on overhead. The numbers that nonprofits report on their financial statements “[defy] plausibility,” finds the Nonprofit Overhead Cost Study. Upon examination of more than 220,000 nonprofit organizations, researchers found that more than a third of the organizations reported no fundraising costs whatsoever, while one in eight reported no management and general expenses. Further scrutiny found that 75 percent to 85 percent of these organizations were incorrectly reporting the costs associated with grants.

Our study of the four youth-serving nonprofits likewise reported discrepancies between what nonprofits spent on overhead and what they reported spending. Although they reported overhead rates ranging from 13 percent to 22 percent, their actual overhead rates ranged from 17 percent to 35 percent.

Many factors support this underreporting of nonprofit costs. According to a survey conducted by The Chronicle of Philanthropy in 2000, a majority of nonprofits say that their accountants advised them to report zero in the fundraising section of Form 990.4 Limited surveillance of nonprofits’ Form 990 tax reports only exacerbates the problem: The IRS rarely levies the $50,000 penalty for an incomplete or inaccurate return, and generally applies it only when an organization deliberately fails to file the form altogether. According to the Chronicle study, “Improperly reporting these expenses is likely to have few, if any, consequences.”

The IRS’ ambiguous instructions likewise lead to error, report several sources. For example, nowhere does the IRS explicitly address how to account for nonprofit marketing and communications. As a result, many organizations allocate all marketing and communications expenses to programs when, in most cases, these expenses should be reported as administrative or fundraising overhead.

Government agencies likewise have varying and ambiguous definitions of indirect costs. The White House Office of Management and Budget, for example, defines indirect costs as “those that have been incurred for common or joint objectives and cannot be readily identified with a particular final cost objective.” It then goes on to say that “because of the diverse characteristics and accounting practices of nonprofit organizations, it is not possible to specify the types of cost that may be classified as indirect cost in all situations.”5

There is some good news. Currently, the U.S. Government Accountability Office (GAO) is conducting a study of various federal grantors’ definitions of indirect costs. As Stan Czerwinski, the director of strategic issues for GAO, explains, “The goal is to achieve consistency, so that when nonprofits go in for funding, they have clarity (as do funders) about what they’re actually going to get reimbursed for.” The study is in the early stages, but as Czerwinski notes, the need is clear: “We don’t find anybody telling us that we’re barking up the wrong tree.”

Proper Care and Feeding

Although the vicious cycle of nonprofit starvation has many entry points and drivers, we believe that the best place to end it is where it starts: Funders’ unrealistic expectations. Foundations and government funders must take the lead because they have an enormous power advantage over their grantees. When funders change their expectations, nonprofits will feel less need to underreport their overhead. They will also feel empowered to invest in infrastructure.

The first step that funders should take is to shift their focus from costs to outcomes. In the nonprofit world, organizations are so diverse that they do not share a common indicator of program effectiveness. In the absence of this indicator, many funders try to understand an organization’s efficiency by monitoring overhead and other easily obtained yet faulty indicators. Funders need to refocus their attention on impact by asking “What are we trying to achieve?” and “What would define success?” In so doing, they will signal to their grantees that impact matters more than anything else. Even focusing on approximate or crude indicators (for example, “Are we getting an A or a C on our impact goals?”) is better than looking at cost efficiencies, as focusing on the latter may lead to narrow decisions that undermine program results.

Funders must also clearly communicate their program goals to their grantees. Having established that funder and grantee share the same goals, funders should then insist on honest answers to the question “What will it take to deliver these outcomes consistently, or to deliver these outcomes at an even higher level of quality or quantity?”

One of our study participants, for instance, worked closely with its major funder to think through this question, and ultimately determined it needed a sizable investment in technology to support its projected growth. The funder agreed that only by making such an investment would the organization be able to track outcomes uniformly and to make program improvements quickly.

When feasible, funders should help meet grantees’ identified infrastructure needs by making general operating support grants. Grantmakers and nonprofits agree that more operating support is very likely to improve an organization’s ability to achieve results, finds the 2008 Grantmakers for Effective Organizations study. And a 2006 CompassPoint Nonprofit Services study of nearly 2,000 nonprofit executives in eight metropolitan areas reveals that receiving general operating support played a major role in reducing burnout and stress among executive directors.6 Yet although 80 percent of the foundations in this study made some general operating grants, they dedicated a median of only 20 percent of their grant dollars to this kind of support.

Regardless of the type of support they provide, funders should encourage open, candid discussions with their grantees about what the latter need to be effective. Many funders’ grantmaking processes are not set up to consider the full scope of what grantees do, and why. As a result, their grants are not as flexible as they need to be. Yet when funders fully understand their grantees’ operations, they are more likely to meet their grantees’ needs.

Although changing their expectations will have the greatest impact on the nonprofit starvation cycle, funders can also intervene in other useful ways. When making use-restricted grants, funders should commit to paying a greater share of administrative and fundraising costs. Indeed, in 2004, the board of the Independent Sector encouraged funders to pay “the fair proportion of administrative and fundraising costs necessary to manage and sustain whatever is required by the organization to run that particular project.”

Likewise, rather than prescribing an indirect expense rate for all grants, government funders should allow nonprofits to define their true overhead needs in grant applications and, so long as these needs are justifiable, pay for them. For example, some federal funding contracts allow a nonprofit to justify an indirect cost rate (within guidelines), which the organization can then use for all its federal grant applications. Extending such a policy to all federal, state, and local government contracts would go a long way toward helping nonprofits deliver better programs while being able to pay for their grants’ management.

Finally, to foster transparent and accurate reporting, funders should encourage the development of a standard definition of the term overhead. Currently, organizations have to report their overhead differently for nearly every grant that they receive. Standardization would allow funders to compare apples with apples, as well as allow grantees to understand better their own overhead investments—or lack thereof. Having a dialogue about real overhead rates could also help shift the focus to the real target: outcomes.

What Grantees Can Do

The burden of breaking the cycle of nonprofit starvation does not rest solely with funders. Nonprofit leaders also play a role. As a baseline task, they should commit to understanding their real overhead costs and their real infrastructure needs. At LGON, for instance, senior managers spent several months digging into their costs, analyzing their current systems—including the organization’s subpar tracking process—and identifying gaps in capacity. After this strategic planning process, the organization could articulate a clear plan for a new tracking system and a 150 percent increase in nonprogram staff over three years.

Nonprofits must then speak truth to power, sharing their real numbers with their boards and then engaging their boards’ support in communicating with funders. Case studies of organizations that have successfully invested in their own infrastructure have repeatedly noted the need for a shared agenda between the leadership team and the board. The executive director of LGON, for example, communicated early and often with her board members throughout the strategic planning process. She also facilitated several meetings to address infrastructure needs.

For their part, board members should ask the tough questions before funders do, namely: “What does this organization really need to succeed?” “Where are we underinvesting?” and “What are the risks we’re taking by underinvesting in these areas?” Board members should encourage nonprofit leaders to develop strategies that explicitly recognize infrastructure needs. In developing plans for infrastructure, board members can help, notes Chris Brahm, chairman of the board of directors at Larkin Street Youth Services, a San Francisco nonprofit that serves homeless and runaway youth: “The people running agencies are often consumed with programs and raising money. Board members, whether businesspeople or otherwise, can bring external perspective on overhead services.”

At LGON, for example, the executive director identified a handful of board members who were fervent supporters of the emerging strategic vision. These board members then communicated to their colleagues how much overhead this vision would require.

During these discussions, both board members and managers should focus on how investments in infrastructure will benefit the organization’s beneficiaries, rather than reduce costs. Even within the confines of a “cost conversation,” they should emphasize how infrastructure investments may actually reduce the costs of serving beneficiaries over time. One organization in our study, for instance, determined that an investment in technological infrastructure yielded $350,000 per year by freeing up staff time and consolidating “scrappy” systems.

Finally, organizations must attempt to educate their donors. “Donors don’t want to pay for an organization’s rent, or phone bill, or stamps,” notes Paul, “but those are essential components of everyday work. You can’t run a high-performing organization from your car. And there are many ways to explain these types of expenses to donors.”

Both funders and grantees are feeling the sting of the current recession. But this economic downturn is no excuse to cut overhead funding. “If a nonprofit’s leaders are feeling as if they cannot raise money to support overhead, I think they’re confusing the issue,” says Brahm. “The real issue is that they can’t raise enough money, period. Either they do not have, or they have not been able to communicate, a results story that is compelling to funders.”

Rather than being the reason to reduce overhead spending, the recession is an excellent opportunity to redress decades-long underinvestment in nonprofit infrastructure. “There is real potential for change if all of the major stakeholders—government, private funders, and the nonprofits themselves—take steps to acknowledge that capacity building is critical to the health of an organization,” says McAuliffe. And although the forces that fuel the nonprofit starvation cycle are strong, the opportunity to achieve more for beneficiaries in the long term should compel funders and grantees alike to stop the cycle.

Former Bridgespan Group manager William Bedsworth contributed to this article.

Notes

  1. See also Kennard Wing, Tom Pollak, and Patrick Rooney, How Not to Empower the Nonprofit Sector: Under-Resourcing and Misreporting Spending on Organizational Infrastructure, Washington, D.C.: Alliance for Nonprofit Management, 2004. Wing, Pollak, and Rooney are three of the lead researchers on the Nonprofit Overhead Cost Study.

  2. William H. Woodwell Jr. and Lori Bartczak, Is Grantmaking Getting Smarter? A National Study of Philanthropic Practice, Washington, D.C.: Grantmakers for Eff ective Organizations, 2008.

  3. Kennard Wing and Mark Hager, Who Feels Pressure to Contain Overhead Costs?, Paper presented at the ARNOVA Annual Conference, 2004.

  4. Holly Hall, Harvy Lipman, and Martha Voelz, “Charities’ Zero-Sum Filing Game,” The Chronicle of Philanthropy, May 18, 2000.

  5. White House Office of Management and Budget, Circular A-122 (Revised): Cost Principles for Nonprofit Organizations.

  6. Jeanne Bell, Richard Moyers, and Timothy Wolfred, Daring to Lead 2006: A National Study of Nonprofit Executive Leadership, San Francisco: CompassPoint Nonprofit Services, 2006.


Ann Goggins Gregory is the director of knowledge management at the Bridgespan Group and a former consultant in Bridgespan’s strategy area. In her consulting work, Ann’s clients included education and youth development organizations, as well as foundations.

Don Howard is a partner at the Bridgespan Group, where he leads the San Francisco office. His clients have included foundations and nonprofits working to alleviate poverty, end homelessness, revitalize neighborhoods, end inequities in education, and improve the environment.

 
Tracker Pixel for Entry
 

COMMENTS

  • BY Rich Cowles

    ON August 21, 2009 07:47 AM

    For many years, the Charities Review Council has maintained a Use of Funds standard that calls for no more than 30% of expenses on admin and fundraising combined. In that time, we too have seen nonprofits make short term decisions not in their long term best interests in order to meet the standard, or in order to feed the charitable giving monster that rewards minimal admin and fundraising costs.

    We have developed a new set of standards—currently in preliminary form and are seeking public input on our smartgivers.org website. Included is a shifted Use of Funds standard that takes into account the many good points made in this article and the fact that there is no standardization in how nonprofits categorize indirect costs. Many nonprofits, funders and individual donors participated in the development of this standard.

    The proposed new standard allows a program ratio of 60% - 100%, but asks nonproifts with ratios in the 60%s or 90%s to provide an explanation to donors about why they’re not in the 70%-90% “sweet spot”, as some consider it. At the same time, we’ll be offering the donor public things to think about when evaluating the nonprofit response, including the fact that there is no one ideal balance point for all nonprofits—or even for the same nonprofit in different years. We see it as an opporunity to inform donors and funders about the perils of underfunding organizational infrastructure.

  • Reynolds-Anthony Harris's avatar

    BY Reynolds-Anthony Harris

    ON August 22, 2009 08:56 PM

    Very good work Bridgespan.  We really must reinvent funding frameworks and administrative decision making behaviors.  The scarcity mentality continues to lead many non-profits down the road towards ineffectiveness—short cuts never work.  hope someone takes this up as a serious set of work that needs to be done.

  • BY Barry Horwitz

    ON August 23, 2009 02:27 PM

    This is a well-argued point, and an issue that is commonly understood by executive directors of many nonprofit organizations.  It leaves out one additional factor that keeps this practice active - and that is the guidance that individual donors (often a critical base of reliable donors that are needed to sustain small to mid-sized nonprofits) receive from sites like Charity Navigator and others - who rank nonprofits by the percentage of their funds used to deliver programs - in other words the percent of funds NOT used for infrastructure and administration…. 

    A nonprofit whose administrative costs are reported to be above 15-20% risks losing significant individual contributors.  So more than just the large foundations need to modify their standards and evaluation criteria if this situation is to change.

  • Horsnell's avatar

    BY Horsnell

    ON August 24, 2009 07:03 AM

    This article strikes at the heart of the problem that plagues the nonprofit sector - acute AND chronic underinvestment in organizational capacity, which has engendered a culture of downgraded expectations.  This results in, among other things, extraordinarily high staff turnover - resulting from low salaries, no benefits, understaffing, and minimal supervision and training - which in turn translates into program quality that is lower than it needs to be.  Yet, when this topic comes up around a table of nonprofit leaders, the general response is to shrug and say, “Yeah, yeah - we KNOW it’s a problem, but that’s just the way it is [with nonprofits].”  Then someone trots out the tired joke, “Yeah, nonprofit jobs - the hours are long, but the pay is low.”  And, because many of the people on the receiving end of this lower-than-it-needs-to-be program quality lack a strong political voice, this is allowed to go on.  Great article.

  • Carrie Varoquiers's avatar

    BY Carrie Varoquiers

    ON August 24, 2009 01:10 PM

    I agree with Barry that this problem extends well beyond large Foundations and should also be addressed by individual donors and sites like Charity Navigator.  In fact, I think this problem has already been recognized by many Foundations and that more information/education needs to be provided to individual donors if we are really going to change the system.

  • BY Holly Ross

    ON August 24, 2009 03:49 PM

    Exactly!  I kept whispering “Amen!” to myself as I read this article.  These are things that anyone who’s worked in the sector knows to be true, but having realy numbers and a course of action make this article a real treasure.  At the Nonprofit Technology Network, we see how nonprofits short-change their infrastructures every single day, and it’s disheartening.  But I agree that it’s really up to us to change the paradigm.  Managed a post about our experiences here: http://nten.org/blog/2009/08/24/maybe-we-have-ourselves-blame

  • BY Steve Delfin

    ON August 25, 2009 02:54 PM

    A major part of the problem is governance.  Too many charitable boards have bought into the historic metrics promoted for many years by United Ways (less than 10%—are you kidding!?) and self-appointed charity rating services.  Like with other governance issues boards need to have their historic perceptions challenged.  My foundation has stopped considering restricted funds because they often come with “overhead” limits—sometime “0”.  But those who want their funds restricted without administrative expense also want accountability, transparency, reporting, etc., etc.  Get real. If you ran a business like that, you’d be out of business. This article does a great job of making the case for change. Everyone should share it with their Board members.

  • BY Ingvild Bjornvold

    ON August 26, 2009 10:12 AM

    Great article – thanks for pointing out that the need for adequate infrastructure is critical for many reasons, but primarily because unless nonprofits have the tools, training and time to manage performance, they will not be able to achieve the outcomes they intend for their clients, the very purpose of their existence.

    For too long, people (not just the general public; foundation and nonprofit staff as well) have assumed that no matter what we do, some good – however modest – will result. Unfortunately, that is not true. Unless performance is managed well, services could have unintended negative consequences or, more frequently, simply be ineffective. Consider the opportunity costs of ineffectiveness (resources could have been spent in better ways), but also the possibility that ineffectiveness can equal harm if services fail to prevent negative outcomes (e.g. HIV, violence).

    It’s time for the focus of the conversation to move away from the nonprofits and onto the people who need their services. THEY need nonprofits to spend reasonable percentages on overhead so they can spend what they need to spend on the tools, training and time to manage performance and ensure that people benefit as intended. And the nonprofits need to be funded for it. I couldn’t agree more with your statement that funders need to shift their focus from costs to outcomes.”

    Thanks for an excellent contribution to this conversation. Now, let’s see some action from funders.

  • BY Margaret Egan

    ON August 26, 2009 09:12 PM

    This has been my mantra since beginning my consulting practice many years ago but more so now as times are so very hard all around.

    I am excited and find it a hopeful statement that SSIR published this articule.  There are many funders/donors who do really ‘get this’ particularly when it comes to “capacity building” but that is matched often by a need to see ROI.  Facilitating transition or improvements to services etc. is a long tail but if the provider is without that internal strength then the outcomes can’t begin to evolve. 

    Business acumen and practices are always critical to any organization’s practices, being more accountable and transparent is dictated by the (c)3 status at the very least but this article does drive home that if general operating support is part of the supporter’s approach (even a formulaic 8-12% each donation) then we avoid a significant M&A;historical moment in the sector due to such starvation.

    Educating donors is the key that underscores mission and expanding comprehension of your work will always take repetition and time.  It has always puzzled me why we comprehend letting portfolios grow when investing or saving but when it comes to contributing to a nonprofit organization people want to see quick results?

  • BY Michael Sola

    ON August 27, 2009 12:04 PM

    When you have organizations like Charity Navigator driving organizations so hard to spend their donor dollars on programs and not overhead and infrastructure in order to get that infamous 4 star rating, it makes funding for technology solutions difficult.  I’ve been at this NPO tech gig for over 10 years now and it’s like pulling teeth to get grant dollars and program allocations put towards infrastructure.  I’m with Holly Ross - Amen.  NPO need to treat the investment of technology just as for profit organizations do.

  • BY Kimberly Williams-Rivera

    ON August 27, 2009 12:58 PM

    I too believe this is a great article. I am also in agreement with Ingvild and am an advocate for organizations to build infrastructures which includes tools and systems to manage their performance. A system of self correction which involves tracking progress towards success and adjusting programs practices to promote program outcomes. Ultimately, as a result, it is the clients who are better off. This should be a priority; however, most nonprofits cannot afford it or sustain it so let’s stop placing restricting limitations on nonprofits that are being responsible and managing performance and then we will be well on our way to demonstrate effective, positive change in our communities.

    Our Piece of the Pie (OPP), in Hartford CT. manages performance, because we see it as an obligation to our clients; it has helped us improve services, and it has helped us with funders. We have made a huge investment in building this infrastructure and work at its longevity with unrestricted and administrative revenues. Here at OPP there is a culture of continuous improvement so we always strive to be smarter and make enhancements to the way we render services, collect data, and measure outcomes. An example of this is that over the past few months our Chief Operating Officer, myself, and an external consultant have been working together researching and analyzing our service model to make enhancements. We have added benchmarks, indicators and measurement to inform and ensure the intentional outcomes of our clients. We have quantified movement along Pathways, (OPP’s Service Model). To be strategic, accountable, transparent and reporting, as Steve said above, can not be accomplished if funders do not want to pay administrative expenses. So yes it’s time for funders to change their traditional ways and do something about this.

  • BY Clifford Duke

    ON September 16, 2009 08:43 AM

    It is worth noting for federal grants and agreements that organizations can have negotiated indirect cost agreements that are applicable agency-wide. The organization negotiates an indirect cost rate with one agency, called the cognizant agency, based on specific and reproducible calculations, i.e. which costs count as indirect costs. That negotiated rate can then be cited in applications to any other federal agency. The rate is adjusted each year, so changes in the organization’s costs can be accounted for. It would be great if foundations would adopt a similar policy.

  • vinylhero's avatar

    BY vinylhero

    ON October 6, 2009 12:11 PM

    Nonprofit organizations with robust infrastructures also underreport their overheard costs, particularly as they seek evermore funding to sustain their overall organizational—as opposed to single program—growth due to the ineluctable rise of fixed and variable operating costs. In other words, organizational growth cannot always be correlated with increased capacity and, as a consequence, restricted funding often goes to overhead even if the funder forbids it. While all organizations have a responsibility to demonstrate fiscal transparency, this is an issue that reinforces the need for more unrestricted funding, provided, of course, that organizations stick to their stated missions.

  • During my short tenure with my agency, i have focused much on infrastructure and so glad i did. Some funders and elected officials, however, are constantly scrutinizing our overhead costs.  This is a great article to help enlighten them.  We all need this reinforcement so that we don’t feel guilty about maintaining our standards of quality service through a strong infrastructure!  Excellent work Bridgespan!

  • Center for Social Innovation's avatar

    BY Center for Social Innovation

    ON October 28, 2009 05:11 PM

    The Fall 2009 issue has two excellent feature articles that promote new perspectives, strategies and opportunities for philanthropists, both individual and institutional – “Catalytic Philanthropy” and “The Nonprofit Starvation Cycle.”  Each makes a compelling case for reform and renewal in philanthropy.  On one hand, a philanthropist can be a catalyst of systemic change by focusing diverse actors on a key problem or obstacle.  On the other hand, a philanthropist can build capacity in the non-profit sector by providing realistic financial support for organizational infrastructure.  Both are sorely needed, so I hope these will become compatible rather than competitive trends. 

    However, these two articles could be interpreted to offer fundamentally inconsistent advice for philanthropists – focus on the cause not the organization vs. focus on the organization not the cause.  Taken together they lead to powerful results.  Taken separately they create conflict that prevents results.

    “Catalytic Philanthropy” has another unexamined implication.  I hesitate to make this point, because I fully support the author’s thesis, and I know too well that an author cannot communicate effectively and still cover all the possible angles.  But this angle is really too important to ignore—the wealthy and successful have disproportionate and unaccountable power to influence the course of society.  “Catalytic Philanthropy” encourages use of this power without sufficient reminder that a person of wealth and success in one sphere of society or business does not necessarily have better information or analysis of social ills and their causes.  So his or her power to champion a particular theory of change by marshalling diverse actors with relevant expertise, influence and money is not necessarily a good thing for the larger social, economic and ecological systems.  In principle and in fact, the catalytic philanthropist’s power to act on his or her own theory, especially when sheltered by unassailably good intentions, is a fundamental threat to inclusive, pluralistic, democratic society.  Why?  Because he or she is not accountable to the normal checks and balances that produce broadly acceptable compromise. 

    I am as impatient a social activist as any, but I have been humbled enough (and humiliated enough) by my own ignorance to exercise due caution.  I have to listen carefully to and even be accountable to competing theorists of change.  Wealthy and successful people often haven’t been made so painfully aware of their own ignorance.  “If I were king of the world” is an interesting thought experiment, but most of us would not want to live with the consequences of those experiments turned into real life.  Perhaps I make too much of this “remote” threat from the wealthy and successful philanthropic catalyst, but a threat unnamed is all the more dangerous.

    Christopher Dunford
    President
    Freedom from Hunger
    Davis, California

  • BY Tim Tabernik

    ON November 9, 2009 09:59 AM

    This is an excellent article that is germane to some very interesting efforts underway in the Bay Area. There are foundations, cities and counties that are stepping up to provide training, technical assistance, and capacity building funding to their nonprofit community. These efforts are a result of the belated recognition that most of the governmental organizations cannot deliver vital social, educational, environmental, and arts services without a healthy nonprofit community. Unfortunately, given the recession, there is an ambivalence to this help and a sense that the nonprofits got themselves into this mess and need to expend more effort to solve the problem.

    While I agree that the nonprofit agency bears some significant responsibility to report what it actually does (or should) cost to deliver quality services and outcomes, the article clearly points out that the power differential makes nonprofits reluctant to go out on limb with the truth. It seems, however, that nonprofit coalitions and trade associations could more safely take this issue up on behalf of the sector.

    One of the other respondents mentioned that philanthropy could engage in something like the federal indirect cost rating for nonprofits - and I might add could recognize the rates established by the feds when nonprofits have gone to the trouble of getting such a rating. This would go a long way to using a common set of measures to acknowledge the infrastructure needs of nonprofits.

  • Putnam Barber's avatar

    BY Putnam Barber

    ON December 17, 2009 06:12 PM

    Nonprofits acting alone are not quite as helpless as “The Nonprofit Starvation Cycle” suggests.

    Nonprofits can skip the beggar-your-neighbor strategy of trumpeting competitive “efficiency” ratings based on simplistic financial ratios
    published by self-appointed oversight organizations. They can omit the sleazy pandering to donors that’s buried in the claim from heavily sponsored galas (true in only the most technical of senses) that “100% of your donation” goes to the charitable purpose. They can answer with greater candor when prospective donors ask “What do you need to get the job done?”

    True, major funders have the upper hand in one-on-one negotiations. No doubt challenging the terms in an RFP after it’s been published is a losing cause.  But working together through state associations and professional groups, nonprofit leaders could issue louder calls for sanity without incurring personal jeopardy - and do a good thing for themselves and for their hard-pressed colleagues even if change is slow to come.

    It’s hard to say which is more corrosive: rotten infrastructure or pressure to prevaricate. Nonprofit leaders should not be asked to do
    their work under such distracting burdens. Every foundation staffer or government official who reads Gregory and Howard’s article should ask themselves what they might do to change these damaging practices.  And so might every nonprofit development officer, executive, or board member.

    Putnam Barber
    Idealist.org
    Seattle

  • If we are looking at other ways funders (private and public) contribute to the starvation cycle, there are three ways that have not yet mentioned:
    1) funders who refuse to pay for a variety of costs (rent, food, transportation, etc) that are integral to program success.
    2) funders who insist on matching funds expressing the notion that “if the contractor really wants to provide these services they should be willing to provide matching resources”. 
    3) contracts that do not provide COLA’s which means that a contract that would have covered the cost of providing the services initially requires an ever-growing fundraising burden in subsequent years.

    And finally we all experience pressure to “prove” that funds have been spent to greatest impact, and have continued to raise requirements for non-profit sector partipation in evaluation activities without increasing resources to cover those additional costs.

  • Dan Pallotta at Harvard Business School writes about this all the time.  The percentage spent on programs vs. admin/fundraising is just a very simple breakdown that everyone can understand.  That is further pounded into society as the mark of a successful charity by “evaluation” groups such as Charity Navigator.  But that’s just it, its too simple a solution.  The organization I work for has a four-star ranking on CNav and to be honest, 90+% of our first-time donors pick us because we have the highest rating (we are a small disease-specific organization in a sea of large national disease-specific organizations).  We embrace (and then some) our four-star status and I will not lie, we market the heck out of it.  The economic recession caused us to tighten our belts a little in 2008 and spend slightly less on programs than in previous years.  This will undoubtedly cause our ranking to drop on CNav and I expect that we will get calls from previous donors who are upset by this.  We are worried that the drop in ranking will coincide with a drop in our donations.  Not only that, we participate in the state and federal employee charitable campaigns, most of which require that you have an overhead of no more than 25%.  It’s EVERYWHERE and in EVERYTHING we do.

    Spending millions more on programs than fundraising/admin does NOT necessarily make your programs more effective. We, as nonprofit leaders, need to re-evaluate how we evaluate ourselves.  CNav makes it simple and easy to at least find a charity that isn’t spending all its money paying its people or throwing lavish parties, but this article is correct, it forces us to go bare bones in order to compete.  I am also pleased to hear the rumors that in 2010 CNav will begin to measure a charity’s effectiveness and it will certainly be interesting to see how they are going to do that.  Basically what we need here are multiple measures of “success” and “effectiveness” in order to get a truer picture of whether or not we are worthy of a donor’s $50.  Overhead is simply too simple.

  • This has gotten to the point that many nonprofits just flat out lie about their allocation between G&A, Fundraising and Programs. They adopt the mindset that “all work is on behalf of programs” so they allocate based on a methodology that seems reasonable TO THEM. They simply shift all their G&A and much of their fundraising into Program expense categories and, IF they get an audit, their auditor doesn’t question the reasonableness because GAAP standards do not exist at such a granular level. It is up to the judgment of the nonprofit and, because it’s to their advantage to shift toward a high ratio of program spending, they allocate many admin costs aggressively to programs. I’ve seen more than a few 990’s with about $7 of telephone expenses in the fundraising column and 70% of their funding comes from contributed sources. Come on. Of course, they do this to their own disadvantage because it becomes more difficult to manage your cost structure when your assumptions are delusional.

  • BY Carrie Roberts

    ON February 8, 2010 03:39 PM

    Absolutely concur!

  • BY Kevin Johnson

    ON April 30, 2010 05:00 PM

    In my consulting practice I have seen many boards and executive directors make checkbook management kinds of choices recently—not strategic ones. One of the many areas they cut was in development. The irony is that the cost of raising a dollar is going up and this at a time when people are clamoring to be more, not less, involved in the work of nonprofits.

    You may have seen one of the stories or research report about the decline of department stores that describe that it was not the economy that hurt, but that instead they had neglected things customers wanted including, among other items, “having helpful people staffing the store.” As a result these stores lost ground with the affluent customers - the ones they need the most. Imagine if Apple cut back the staffing in its stores as a “cost saving measure”? If you have been in an Apple store lately, you have had to fight the crowds—but there always seems to be someone ready to help. They are thriving. 

    Cutting development (the customer service and marketing side of nonprofits) will likely result in the same troubling effects in terms of contributions both today and in the future. Such “cost saving” cuts will have negative ripple effects for years to come. Despite the dramatic emotional opening presented by economic shock, many nonprofits then failed to connect with their donors who now had an even greater vested interest in the success of those nonprofits; instead they looked inward, cut expenses, and are quietly prayed for a miracle. For most, there will be no miracle: too many of their donors will have moved on to do other things and invest their time and money differently.

  • BY Swarna Rajagopalan

    ON June 28, 2010 06:18 AM

    I wish I could share this article with people around me.

    We are under three years old, work almost entirely with volunteers. We have an excellent vision and great ideas, but I cannot hire the ideators because salaries are regarded with the same disdain as overheads. How will I run programmes without full-time people? How will I retain competent full-timers without paying them a living wage if not their full-market value?

    And while we don’t work out of a car, we work out of one room in my home, which means everyone can’t be here together, and I cannot actually seat full-time staff. I might be able to rustle up rent, but how will I pay for utilities, etc? What kind of research centre are we without a library where people can sit and read?

    Now there’s also the impact assessment thing. People want to know what impact we are going to make. Fine, I can cook up something, but the reality is, unless I know what my human resources are going to be, I cannot realistically tell you whether my programmes will cover three schools or thirty.

    I re-tweeted the link to this, but I wish I could do more to make this research available to many.

  • BY Michelle Hensley

    ON September 14, 2011 06:00 PM

    Coming from a small non-profit which started out just serving people a basic need which is food, it can be overwhelming just to do your job which is to serve the people in need. I understand the need for transparency and it should be required. Although I could use a paycheck, that is not why I do the work nor the volunteers who work along side of me. I have been questioned over and over again why I am not able to take a paycheck and the truth is all the money we receive we do our best to buy more food. Plain and simple but there are many foundations who don’t believe me. I have to sign an affidavit to prove it is true.  Then as we received funds from the community, everyone asked for a 501c3. So we incorporated. Then we were denied many funds because we were not audited. So we did an audit. Now what? Still no funding. We still struggle day to day to meet the huge growing demand of people needing food. All of the information and record keeping is time consuming so that is I can’t write grants either. Very few people want to work for free and I can’t blame them, otherwise, they are standing in line with the many others who we serve. But my heart is filled with joy to serve. I can only do what I can do and go to sleep at night knowing I was honest with my overhead, scrimping along the way and blessed to serve those who need serving. My co-laborers feel the same. And every week, we do it all over again. Most of us start this way….and most of us should end this way. Perhaps I am simple minded but I am glad to hear of others at least understanding how I can learn to communicate better to foundations or the individuals who donate to us. We do not have any government funding, our desire is to be part of a solution to a bigger problem. Thanks to those that contribute these articles. I learn more and more every day.

  • Great Article!  The mentality of pressuring non-profits to maintain low-operating cost comes from donors’ and would-be donors’ disillusionment with non-profits that spend too much on overhead or overtly steal funds (or somewhere along the continuum).  But now the pendulum has swung in the other direction, and an organization might end up with a large grant or donation but no means to put it to work, thus opening the door to fund manipulation, the very thing that the funders were trying to avoid. 

    The tightening of the belt on overhead is a faulty solution to a problem that could be helped by greater transparency, fund tracking, and public awareness.

  • BY Robert Longley

    ON January 4, 2014 10:41 AM

    So many organization think they can’t afford automation but at the same time spend countless hours with spreadsheets and paper reports.  They also end up with inconsistent intake processes and data that is often useless.  I definitely feel that an investment in case management automation makes a big difference for non-profits of all sizes.

  • Craig King's avatar

    BY Craig King

    ON February 15, 2014 10:59 AM

    Many non-profits actually do under-invest in infrastructure and over-head: it’s not necessarily a matter of under-reporting to funders the true cost of overhead. The starvation cycle often begins internally, through Board members expectations of low overhead. This perspective can be self-serving, in that it conveniently takes Board members “off the hook” for fundraising to help support the costs of delivering quality services. The result is poor service quality and reputation, burned-out staff, etc.

  • BY http://google.com/

    ON September 1, 2014 12:57 PM

    Hi there colleagues, fastidious post and nice urging commented here, I am genuinely enjoying by these.

Leave a Comment

 
 
 
 
 

Please enter the word you see in the image below: