The Overhead Myth

The Overhead Myth

June 26th, 2013

by Jeff Small

 

In the Fall of 2012, JGA was thrilled to help bring author and nonprofit advocate Dan Pallotta to Indianapolis to speak at Indiana Philanthropy Day. Dan’s books Uncharitable and his follow up Charity Case have driven much of the discussion on charitable transparency. At his Indianapolis presentation, Dan warned those in attendance that by artificially limiting the overhead costs of nonprofits, we handcuff their growth potential. 

Last week, Guidestar, Charity Navigator, and the Better Business Bureau’s Wise Giving Alliance echoed that message and came together to bring much needed attention to “the overhead cost myth.”

In their words, “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.” This welcome assertion marks a major moment in the effort to grow the public’s understanding of nonprofit effectiveness.

Measuring effectiveness in nonprofits is much more difficult than government or for-profit businesses.  If elected officials fail the voters they serve, they lose at the polls.  If businesses have lousy products, no one buys them and they go out of business.

Nonprofits lack that type of unfiltered feedback, because the direct users are usually not the ones funding the provision of service.  As a result, donors have often relied on financial measures like overhead cost ratios and fundraising efficiency ratios to judge how well their gifts are being used.  This judgment generally took a “less is more” view of these ratios, the lower the percentage of expenditures an organization spent on overhead and fundraising the better. 

The issue with this mindset is that overhead costs are essentially the nutritional intake of a nonprofit.  In the proper proportions, they are the expenditures that fuel innovative fundraising, nourish and grow capable leaders, support effective training programs, and ensure adequate institutional infrastructure is in place to responsibly manage programs and overall operations. 

Spend too much on overhead costs and you reduce the impact of a nonprofit and reduce the incentive for donors to give. Investing too little in overhead, however, can starve your administrative functions and sap your institutional energy, leaving your organization susceptible to stagnation or collapse in the face any new challenge.

As the three organizations behind this effort suggest in their statement, at the extremes, overhead cost ratios can be a valid data point to investigate, and clearly do help identify fraud. But for most organizations, these ratios are extreme oversimplifications or even inaccurate depictions of overall impact. 

For years, nonprofits have been complicit with this oversimplified view of what effectiveness means. In part because those charities who looked efficient by those measures had little incentive to argue against it, and in part because measuring effectiveness in nonprofits is really hard and no one had a strong enough voice to explain that on their own.

The reality is that investment in overhead and fundraising are critical for the current and future growth of nonprofits.  I applaud these three organizations for lending their credibility to this cause and banding together to move beyond the misguided belief that spending less is always better.

For more information on their effort and to pledge your support to end the “overhead myth” visit www.overheadmyth.com.

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