Overcoming the Anti-Overhead Mindset

As I described in previous posts here, here and here, one of the ways in which the nonprofit sector is broken is that it is undercapitalized.  It is not able to generate an adequate amount of capital in order to scale and solve the problems it seeks to address.

This undercapitalization comes not from a lack of program-related fundraising, funds that go directly to the services being created, but rather from a lack of infrastructure or administrative capital.  The distinction is between funds raised to BUY services versus funds raised to BUILD organizations.  The latter is very hard to come by in our current state.  Donors and foundations tend to shy away from funding “administrative” or “overhead” costs.  And many nonprofit rating systems reward nonprofits that keep their administrative and fundraising costs as low as possible.  The end goal seems to be nonprofit organizations who plow 100% of their revenue into their programs, with no infrastructure (staffing, fundraising, technology, buildings, accounting, planning, training, professional development) to make the programs successful.

Paul Brest, president of The William and Flora Hewlett Foundation, recently wrote an attack on the notion that administrative costs in the nonprofit sector are somehow unnecessary or unworthy.  As he points out, the end goal of any organization (profit or nonprofit) is to optimize costs, not minimize them.  Costs are appropriate and necessary when they increase an organization’s ability to achieve its mission, or, in other words, provide a net increase to the impact the organization is creating.  Costs in and of themselves are not bad.  Rather, those costs that contribute to an organization being more effective and reaching more people are actually very good.  He argues that in the for profit sector the idea of necessary and justified costs is well understood and that the same principles should be applied to the nonprofit sector:

To use an example from the business sector, assume that a widget manufacturer’s only mission is to make a profit for its owners. Then, an additional administrative expense of 1¢ is justified if it is likely to produce an additional 2¢ of profit. The underlying idea is not different for nonprofits. Their missions are to achieve particular social, environmental, educational, religious, health, etc. goals. And an incremental expense is justified to the extent it has the potential to increase the organization’s net social value.

It is a simple concept, but one that nonprofits and the philanthropists who fund them are only beginning to discuss.  The assumption that nonprofits have to be as cheap as possible, no matter the other “costs” (inefficiency, fewer people served, diminished impact), is outdated. It is a holdover from a time when the nonprofit sector was referred to as “charity,” and philanthropy as “benevolence.”  It was our duty to ameliorate the symptoms of social problems (feed the hungry, clothe the needy, provide shelter to the homeless).  But now we are all realizing that that isn’t enough.  We have to resolve the underlying issues that are causing these problems and that requires whole systems and infrastructure to change.  And for that kind of change to happen it requires well-thought out plans, technology, top talent, clear understanding and management of our financial resources, and significant capital.

I believe this discussion is all part of a growing sophistication in the sector.  Nonprofit leaders are no longer content to scrape by with hopelessly inadequate resources, and philanthropists are beginning to realize that the very principles that created their own wealth need to be applied to the sector which they are trying to support.

I’m glad to see that these conversations are beginning and that people like Paul Brest are leading them.  But the discussions need to move beyond the blogs and journals and into the boardrooms of the nonprofits, foundations, and businesses that are working to solve the very issues the social sector was set up to address.

Tags: capital, Foundations, Hewlett Foundation, Nonprofits, overhead, Paul Brest, philanthropists