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Philanthropy

Overhead Costs: The Obsession Must Stop

We can’t separate nonprofit programs from the people who develop and deliver them.

When it comes to charitable giving, there will always be skeptics who question where the money really goes—and donors who object to a charity using their gifts to cover overhead. This skepticism is misplaced. Nonprofits are businesses and, as they grow, they must invest in their infrastructure to survive, retain employees, and, ultimately, succeed at their mission.

Families in Schools, a Los Angeles-based nonprofit, came to this realization just a few years ago and proved it can be done. Kaci Patterson, the organization’s vice president of programs and administration, noted that as the organization grew, “it became apparent that we would need to have more balance between our external and internal priorities, and that our fundraising needed to reflect that.” After talking with a few major donors about its budget plans and getting the approval of its board, Families in Schools “restructured its indirect cost rate, making it 10 percent of all expenses (except pass-through funds).” It also decided to add more jobs focused on supporting its “internal sustainability.”

Directing donations to help fund a nonprofit’s operations has long been controversial. Earlier this year, three of the country’s top nonprofit associations publicly challenged the perception that well-managed nonprofits have the lowest administrative and fundraising expenses. In an open online letter to all US donors, BBB Wise Giving Alliance, Charity Navigator, and GuideStar joined forces to denounce the “overhead ratio”—that is, the percentage of nonprofit expenses that go to administrative and fundraising costs—as a useful measure of a charity’s overall performance.

Arguing that the overhead ratio is “imprecise and inaccurate,” the authors encouraged donors to stop obsessing over a nonprofit’s administrative costs when deciding which charity to support, and to instead focus on the big picture and what it will take for a nonprofit to achieve the best outcomes.

Under the assumption that minimal administrative and fundraising costs mean a more effective nonprofit, donors frequently seek out organizations that spend the bulk of their funding on program expenses and only a small amount on overhead. But here’s the issue: We can’t separate a program from the people who develop and deliver it. To ensure that a program can achieve maximum impact, we must actively invest in the staff who are supporting the program and make sure we have the best people on the job.

Let’s say you’re running a nonprofit that offers after-school programs for at-risk youth. Donors are happily investing in your programs as long as your organization uses the money solely for expanding and building out the initiatives. Now, your organization can serve 30 percent more youth than before, but what if your staff isn’t trained to manage the operations and services required to support the increased program capacity? How will you help your people successfully oversee this larger initiative? Without training and development in place for your team of staff and volunteers, you severely minimize the opportunities to make the most of your program.

Ultimately, every organization—for-profit or nonprofit—hopes to reach its goals and provide meaningful results. At our organization, Cornerstone OnDemand, a global talent management company that works with both the private and nonprofit sectors, we have seen firsthand the importance of giving all organizations the ability to invest in people and infrastructure to ensure their organization’s performance.

As with most companies, we have a fiduciary responsibility to the company’s employees and shareholders to spend capital wisely. Our chief executive must ensure the overall profitability of the company, and therefore has the flexibility to decide how much to invest in people, technology, finance, and internal systems to optimize growth. Why do we expect nonprofit leaders to operate under a different set of rules?

Nonprofits are driven by mission, but they too have financial targets and other performance metrics to meet. In the private sector, we see that companies with high-quality training and development programs generate 26 percent more revenue per employee and realize 40 percent less voluntary turnover than their peers. What if we translated this to the nonprofit sector? If we invested in the training and developing staff who deliver these critical programs, would we see 26 percent or more impact per staff member? Would nonprofits achieve greater success because they could focus their people, time, and money on mission-driven activities rather than covering the cost of turnover?

The belief that nonprofits that minimize investments in overhead deliver higher-quality services or better results has deprived many organizations of the resources they need to serve their communities. Leaders of nonprofits need flexibility to invest in recruiting and sustaining the best talent, training and developing employees properly, and building a strong pipeline for succession. Expenses like this are not frivolous; they’re smart.

A Bersin by Deloitte case study examining how United Way of the Bay Area manages talent explains: “In the nonprofit world, as in the for-profit world, effective talent management serves as a critical source of mid- and long-term organizational efficiency and effectiveness. In other words, money is simply better spent, and services have more impact, when talent is well-developed and well-equipped.”

We must challenge the myth of nonprofit overhead. Donors need to focus on evaluating charities based on leadership, transparency, governance, and results. With this potential paradigm shift, we recognize that there will be heightened pressure on nonprofits to better define and deliver outcomes to their funders. But that’s a good thing. All organizations are better off if they’re held to a higher standard—just not a double standard.

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COMMENTS

  • Anyone who is nodding their heads at this will want to watch Dan Pallotta’s TED talk.

  • Kathleen Paylor's avatar

    BY Kathleen Paylor, conscious capital

    ON October 3, 2013 12:15 PM

    Yes, and a huge shout out to Dan Pallotta for bringing this subject front and center.

  • BY Carol Davidson

    ON October 3, 2013 12:18 PM

    This is an important and well thought through piece.  What it stops short of mentioning is that in some cases, other nonprofits are our worst enemy.  When The Robin Hood Foundation puts in big, bold print that every dollar given goes to fight poverty, it gives donors the false impression that there are no overhead costs.  That’s fine - when overhead is being funded by a group of extremely generous board members - but money is money and it’s still coming from somewhere. I know Robin Hood means well, and they certainly DO well, but this particular message they are delivering is misleading at best, and damaging at worst.

  • BY David McConnell

    ON October 3, 2013 12:19 PM

    So good to hear and read that the artificial barrier between ‘program’ and ‘overhead’ is being torn down.  So much of what is considered ‘overhead’ is indeed CAPACITY.  For more on this, including other reading, check out the Chicago Donor’s Forum micro site at http://donorsforum.typepad.com/realcosts/ and check out the LINKEDIN group on this at under “solving the overhead challenge” as well.

  • Lindsay's avatar

    BY Lindsay

    ON October 3, 2013 01:51 PM

    Dan Pallotta gets some credit for generating conversation, but I have to admit, some of the percentages of cost/amount brought in at his events are shocking. I’m all on board with not using an overheard percentage as a guideline for effective nonprofits. But when your event costs 80% of the total revenue brought in, don’t you think that’s extreme? There’s raising a lot of money, and then there’s raising a lot of money and doing it efficiently. 80% doesn’t strike me as efficient (http://www.commondreams.org/headlines.shtml?/headlines02/0827-08.htm).

  • BY Julie Brandt

    ON October 3, 2013 03:52 PM

    Great comment David,  I like your suggestion of using the term “CAPACITY” versus overhead which tends to have a negative connotation.  Thanks for the invitation to join your group and look forward to catching up with you soon

    Hi Lindsay-
    While I agree that we should be mindful of the operational dollars we spend for fundraising, it is important to also think of the total impact generated by the event.  Events like these tend to have long tails that help build relationships with potential donors and partners, a good opportunity to get some face-time with donors and also help better define the mission and brand to key audience members.  Measuring total impact may be a better indicator of event success and how much actual long term revenue was generated. 

  • BY Mitchell Anderson

    ON October 4, 2013 06:55 AM

    This issue is further aggravated when non-profits provide services to non-federal government entities.  Most cap their indirect reimbursement amounts leaving the non-profit to find funds to cover the shortfall.  The GAO did a great report on this in 2010 and the Urban Institute issued a similar report.

    http://www.gao.gov/products/GAO-10-477

    http://www.govtcontracting.org/problems/failure-pay-full-costs

  • BY Dan Pallotta

    ON October 4, 2013 12:21 PM

    To Lindsay,

    Your concern is understandable, but your comment illustrates one of the big problems with these overhead measures, and that is the reduction of rich, complex realities to one moralistic figure. Let me elaborate:

    - The measure allows for sensationalization of wholes based on small data points about individual parts. The Pallotta TeamWorks events did not eat up 80% of the proceeds. Even if you used the traditional overhead cost accounting, on average our events netted 55% of every donor dollar contributed. An average is arrived at by a range of results. Some of our events netted 73% for the end cause and a handful had expenses that rose to 80% or more.

    - The measure gives incomplete information on individual data points and demonizes disappointments. People tend to react viscerally to high percentage costs and immediately make character accusations on the basis of them. You might ask, why did some events have very small net returns? In the case of the event you cited, it was in Washington, D.C. and we were in the middle of recruitment when the Pentagon was attacked. That event traditionally had much higher returns. In some cases we were in an area of the country where, for example, AIDS fundraising was difficult. We would have the same costs, but lower revenues, leading to higher percentage costs, so the ratio discriminates against causes or regions for and in which it is harder to raise funds.

    - The measure is unjust because it fails to alert the user to differences in accounting methodologies. Some of the events that followed us allocated as much as 50% of their event costs to the “cause” side of the ledger so as to avoid the criticism we got for having high costs. Had Pallotta TeamWorks used those accounting shenanigans our historic average net return would have been 80%!

    - The measure does not take triple bottom line into account. Embedded in those expenses were good-paying jobs for hundreds of people committed to social change, advertising to raise public awareness about important issues, life-affirming experiences for people with HIV and breast cancer and depression, and much more. So it it perverse to label the cost side of the equation as a negative, without any social value, when social value is not being measured or accounted for.

    - Our fees were just 4.01% of the gross total we raised over the course of nine years. The overhead measure was consistently confused with, or sometimes deliberately characterized as our fee, which was a gross inaccuracy.

    - For the complete data set, visit http://www.pallottateamworks.com

    In summary, it is oxymoronic to say I agree with not using overhead as a measure but look at how bad the overhead was on these events. The measure is broken and doesn’t give you the data you need to characterize things as good or bad.

  • BY Michelle Stratford

    ON October 5, 2013 04:55 AM

    In the UK the drive to demonstrate outcomes has gathered pace over the past few years, but still, particularly in smaller organisations with little spare capacity, there is resistance (perhaps in some cases because of what it will show) or a struggle to find the resources to do this.  Unless this culture of measuring outcomes becomes the norm in our sector there will always be an unwillingness of donors and public to recognise the need to spend money to make a difference.

    That said, I know some great local voluntary sector organisations who can demonstrate amazing impact, but funders still resist the need to commit long-term with core funding - one of the biggest challenges we face in our current UK economic climate.  They really do believe charities are there to do something great for free - perhaps a myth the sector has contributed to itself over the decades.  Chickens have now come home and roosting is in full swing.

  • Nouman Ashraf's avatar

    BY Nouman Ashraf

    ON October 5, 2013 05:25 AM

    Apposite commentary and timely.

  • BY Daniel F. Bassill, D.H.L.

    ON October 5, 2013 07:55 AM

    It’s good that this issue is being discussed in a lot of places.  However since non profits come in all sizes, have very different missions and cost structures, it’s difficult to find a “one size fits all understanding, or solution.”

    I’d like to see sector-specific discussions around these topics, and collaborations that work to generate solutions.  I work in the youth serving field, focusing on volunteer-based tutoring, mentoring programs that connect innercity youth with workplace volunteers and non-school learning opportunities.

    I’ve written several blog articles focusing on challenges in our sector, and on the Pallotta ideas.  In this one I suggest that we break each of his TED talks into a separate conversation and work to address each within our sector. http://tutormentor.blogspot.com/2013/08/pallotta-ted-talk-discussion-solutions.html

    I hope that articles on SSIR and other high profile forums will lead to more people connecting in sector-specific forums and if any of your are hosting this discussion with a focus on non-school youth mentoring, tutoring in big cities, please share links to your own blogs and forum sites.

  • Jin Wen Huang's avatar

    BY Jin Wen Huang

    ON October 6, 2013 08:27 AM

    1. The lower the overhead the better the NGO. That logic is seriously flawed. However, the logic that the higher the overhead the better the NGO is equally flawed. Therefore the issue is really not the higher or lower overhead. 2. The public considers lower overhead as good simply because it is the most simple, apparent and available quantitative and comparable measures on NGO performance. NGO does not have gross margin as enterprises have. That means, NGO does not have a quantitative measures as simple as overhead ratio that demonstrates convincingly that it’s impact or outcome is “amazing”. 3. Therefore be tolerate on public perception of lower overhead, and disclose as much as possible program effectiveness with solid evidence of facts and data. If NGO does that, I believe the public will not be obssessed by lower overhead any more.

  • BY Stephen Peelor

    ON October 6, 2013 01:26 PM

    It’s good to see this issue discussed by the widest possible group of people. I think one way of comparing nonprofit to for-profit organizations is from the fiduciary perspective: would the persons responsible for a nonprofit’s retirement plan be likely to invest in companies that have annual employee turnover of 40%? Yet they make management decisions that reflect that very choice, by starving their organizations of capable talent. As Dan Pallotta consistently says, the scale of the solutions do not begin to approach the scale of the problems. This is a key reason why.

  • While every charity, of course, needs funds to continue operating, some of these charities are utterly RIDICULOUS in their “administrative” costs. Some pay their “CEOs” hundreds of thousands of dollars a year (hell, one charity I looked at paid theirs over ONE MILLION DOLLARS A YEAR). Frankly, sorry, but NO ONE deserves those kinds of salaries (not athletes, not politicians, not charity CEOs, not big business CEOs and no, not even doctors).

    So while, yes, you shouldn’t base whether you support a charity SOLELY on their administrative costs, those costs should bloody well be taken into account because some of them are HIGHLY unnecessary!

    Check out charity navigator - they give a really good breakdown of each of the charities they list, what their costs are for administrative, fundraising, donations etc. What their policies are on everything from financials to donor privacy policies. The key is to educate yourself about WHERE the money is going. There’s a difference between the administrative costs keeping a charity running, and keeping the CEO in a fancy office.

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