Summary: A
recent survey found 62% of Americans believe nonprofits spend too much money on
overhead. Increasingly, the most
critical determination of a nonprofit’s effectiveness is a low overhead
ratio. Unfortunately, nonprofits are
complicit in focusing attention on how little we spend instead of how much we
accomplish. By perpetuating the
“overhead myth” by trumpeting low overhead percentages, nonprofits are caught
in a self-defeating cycle. When
nonprofit leaders buy-in to overhead as a good measure of our effectiveness, we
place limits on ambition and innovation.
By banding together to push for a deeper understanding of the business
of philanthropy, we invite donors to think with greater complexity about our
work and the type of investments necessary to make meaningful change.
Originally
published by the Colorado Nonprofit Association’s October/November 2013
newsletter, “Nonprofit Colorado.”
http://www.coloradononprofits.org/wp-content/uploads/NonprofitColorado_NovDec13.pdf
The Overhead Myth: Embracing the Business of Philanthropy
The good news for the
nonprofit sector is 2013 is the year people started addressing “the overhead
myth” in a meaningful way. The bad news
is nonprofits need to adopt a unified front to debunk overhead costs as the
best measure of effectiveness which may not be in the best interests of
individual nonprofits in the short-term.
To effectively
execute its programs a nonprofit must spend money on management to plan and
build the infrastructure of the organization and fundraising to cover program
and management expenses. Money spent on
these two activities – managing an organization and generating income – is
known as “overhead”. The “overhead myth”
is that money spent on these activities is wasteful and donors should avoid
funding these activities. The issue is
further oversimplified by using the ratio of overhead expenses to all expenses
as the single greatest determinant of a nonprofit’s effectiveness.
Whether or not you
work in the nonprofit sector you’ve probably heard some of the following
sentiments: “How much of my money
actually goes to programs?” “If it were
really a charity the people would work there for free.” “If they can afford to mail me a fundraising
letter, they don’t need my money.” These
thoughts all stem from the perception that nonprofits don’t spend money
effectively. A BBB Wise Giving Alliance
survey found 62% of Americans believe nonprofits spend too much on overhead.
Along with the complex social issues
nonprofits address, we also must contend with the general perception that most
nonprofits don’t run businesses well.
Over time, this has
led to a sector that overtly cannibalizes itself by juxtaposing individual
success with a myth we know is self-destructive. Every time a nonprofit trumpets a low
overhead percentage, the myth that nonprofits are generally inefficient is
given greater authority. The nonprofit
sector is caught in a self-defeating cycle and it is time to make a collective
effort to fight “the overhead myth.”
Three Major Myth Busters
The first signal of
changing times was when Dan Pallota’s March 2013 TED Talk, “The way we think about charity is dead wrong”,
went viral. In his talk, Pallota
questions why a ratio has become so much more important than results. He argues that a small nonprofit with a 3%
overhead raising $10,000 for the hungry should not be considered more effective
than a fundraising nonprofit with 40-50% overhead that raises $100,000,000 for
the hungry. He rhetorically asks, “Although
donors are taught to value the low overhead percentage, what would the hungry
prefer?” This highlights a key
contradiction of using the overhead ratio as a measure of success: as funders
want us to focus more on outcomes than outputs, our primary measure of success
is still based on a calculation of outputs.
Pallota asks us to consider whether equating morality with frugality
when it comes to nonprofit financial decision-making is an effective way to
solve large-scale problems.
In June 2013 came a
second high profile effort to change donors’ perception of infrastructure
costs. GuideStar, Charity Navigator, the
BBB Wise Giving Alliance issued a joint letter to the American people titled.
“The Overhead Myth.” The three most accessed
sources of information about nonprofits said it simply, “The percent of charity
expenses that go to administrative and fundraising costs—commonly referred to
as “overhead”—is a poor measure of a charity’s performance.” The groups went a step further to suggest
that most nonprofits should actually spend more
on overhead. The letter included the
following language nonprofits should use to translate the concept of overhead
to donors: “Overhead costs include important investments charities make to
improve their work: investments in training, planning, evaluation, and internal
systems—as well as their efforts to raise money so they can operate their
programs.” It says a lot about the
nonprofit industry and our “watchdog” counterparts that making the case for
running a strong business was revolutionary.
Back in 2009,
Stanford Social Innovation Review published an article titled, “The Nonprofit
Starvation Cycle”, which was highlighted in the “The Overhead Myth”
letter. The article exposes the
self-defeating cycle in which nonprofits participate. The first step is the unrealistic perception
of overhead costs held by many donors and funders. The second step is pressure to conform to the
expectations. The next step is the
nonprofit response: “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.” This leads to donors and funders continually
expecting nonprofits to do “more and more with less and less – a cycle that
slowly starves nonprofits.”
These three
developments in breaking the overhead myth were groundbreaking for
nonprofits. The sector finally had
external voices arguing that infrastructure is a necessary part of a good
business; even, if not especially, businesses dedicated to long-term social
benefit rather than short-term profit reports.
Smart Overhead is Good Business
In the private
sector, overhead is similarly made up of as “SG&A” (sales, general, and
administrative) and is viewed as a necessary element of doing good
business. Different industries have
different tolerable ranges of overhead percentages and it is accepted those
ratios will fluctuate over the course of the business lifecycle. While you endeavor keep these percentages
low, you also make space for R&D, building your human capital, and the cost
of launching new products and acquiring new customers. If you didn’t spend money on these things,
you would be considered a poor business leader.
Imagine you have a
friend who is asking you to invest in her new pottery business. Being a smart investor, you ask her a few
questions about her management perspective.
“I see you’re naming your store ‘Poverty
Pottery’. That’s an interesting
name. Did you get any marketing advice
before developing your brand?”
“On no… It’s not about the brand; it’s about the
pottery.”
“How are you going to get the word out about your
business?”
“I don’t think it’s
right to waste money on advertising that could be used making pottery. I’ll set up a Facebook page. Maybe I’ll get some friends to set up a table
at street fairs on weekends and hand out flyers.”
“What kind of technology are using to track
sales?”
“Software is very
expensive! There is an amazing option
that exists but I would rather spend money on the pottery. When in doubt, more pottery! We are pretty resourceful about plugging
holes. We’ll cobble together some Excel
sheets for now.”
“The industry you are working in is extremely
complex. In fact, no one has ever solved
poverty, I mean pottery. How did you
find the right people on your staff?”
“I’ve found that
people with experience in pottery are incredibly expensive. I look for people with a can-do spirit and
pay them very little. They don’t stay
very long but there are a lot of people who feel strongly about pottery so I
can replace them fairly quickly.”
“What are you going to do with my financial
investment?”
“Well, I absolutely
assure you I won’t invest it in building the infrastructure of my
business. 100% will go to pottery. That’s how effective I am.”
“How are you going to keep this business going
with so many challenges?”
“That’s the beauty of
it! I pay myself last and work double
shifts when needed. This business
doesn’t work without some sacrifices at the top. It’s a stretch sometimes but you can count on
me.”
“Let me think about this for a day or two. I mean, it is beautiful pottery.”
After this
conversation, it would be clear you were being asked to invest in a business
that is destined to fail. Yet, in the
nonprofit industry, the answers above are the functional norms for too many
organizations. Spend as little money as possible on infrastructure. Only invest in improvements when they are
absolutely necessarily and fully funded. Money spent on overhead is money wasted. Continually get leaner or your donors will
leave you.
What We Can Do to Debunk the Overhead Myth
1. Stop Spreading It!
Nonprofits have been
our own worst enemy by embracing the overhead myth when it suits us. Every time a nonprofit trumpets its low
overhead it is tacitly buying-in to low overhead as the most legitimate measure
of quality operations. It’s time to stop
focusing on how little we spend and start focusing on how much we
accomplish. Less reporting on ratios,
more reporting on results.
This includes
Community Shares. We are rated 4-Stars
by Charity Navigator and only 10% of nonprofits achieve this rating for three
consecutive years. Unless significant
changes are made to their rating system, I will make the case to my board and
staff we should stop highlighting our rating in 2014 or couch it on an educational
page about the importance of infrastructure.
2. Translate the Jargon
Explain to your
donors what we are actually doing when we are accumulating big, bad,
overhead. Point out smart uses of
administrative and management time and funding.
Highlight short-term wins and the importance of long-term planning.
3. Think Long Term
Identify specific
donors (e.g., small business owners, entrepreneurs) that may prefer to support
you as investors in infrastructure improvements. They may even want to play a collaborative
role in identifying long-term operations improvements.
In the end, we’re all
in this industry together. When we
buy-in to overhead as a good measure of our effectiveness, we place limits on
ambition and innovation. By banding
together to push for a deeper understanding of the business of philanthropy, we
invite funders to think with greater complexity about our work and the type of
investments necessary to make meaningful change.
Alyssa Kopf is the CEO of
Community Shares of Colorado and has a MBA from the Daniels College of Business
at University of Denver. Community
Shares connects Coloradans to the charities and causes they care about
most. Community Shares features a
diverse donor base and an inclusive nonprofit membership base. With an average donor gift of less than $1 a
day, Community Shares has raised $26+ million for Colorado nonprofits. Connect with Alyssa at www.linkedin.com/in/alyssakopf/.
