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Donors Forum

Understanding The Full Costs of Nonprofits: An Interview with Michael Etzel

In this month’s Social Velocity interview, I’m talking with Michael Etzel. Michael is a partner in The Bridgespan Group, a global nonprofit organization that consults to nonprofits and philanthropists, provides leadership development support, and develops and shares insights — all with the goal of scaling social impact.

Since joining Bridgespan in 2006, Michael has focused on effectiveness across the full spectrum of social innovation financing, advising corporate, institutional, and family philanthropists and investors. Much of Michael’s work explores what it takes to use tools of innovative finance and impact investing to solve pressing social problems. His work and research in philanthropy also focuses on the question of what it takes to deliver results as a new approach to ending the nonprofit starvation cycle.

You can read other interviews in the Social Velocity interview series here.

Nell: In your research and writing you have focused a lot on what you call “Pay-What-It-Takes-Philanthropy,” the radical idea that different nonprofit solutions have different business models and thus require different costs and investments. This concept is so accepted in the for-profit world that it is a truism, but why is it a radical idea for nonprofit and philanthropic leaders?

Michael: It’s worth pausing for a moment to reflect on why business models and capabilities matter. Every nonprofit operates with an underlying business model and set of capabilities critical for program delivery. Failure to understand an organization’s business model frequently leads to underinvestment in core capabilities, and, as one program officer put it, “a hollowing out of civil society institutions.” We can’t have resilient, durable civil society organizations that deliver successful programs unless they operate from a position of financial strength.

As you highlight, segmentation and analysis of comparable performance data is common practice in the for-profit world. Leaders like Clara Miller, president of The Heron Foundation and former CEO of the Nonprofit Finance Fund, have long called for this kind of thinking in the social sector. But this type of comparison requires transparent and consistent data, something hard to come by. As one nonprofit executive reminded me, “If you think you can analyze a nonprofit through IRS 990 filings, you are in outer space.”

Yet, I wouldn’t say this a radical idea. Organizations like DataArts and CoMetrics show how this is possible. For example, DataArts gathers a variety of comparable revenue, cost, and performance data for arts and cultural organizations, and provides tools for reviewing that data. This provides grantees and grant makers with actionable data to inform management or funding decisions with an eye to effectiveness and efficiency. CoMetrics addresses a more diverse set of enterprises, providing software platforms and tools that enable those enterprises to collect, display, and compare financial, operational, and impact data against their peers. This bottom-up approach gathers data across organizations running the same type of business in the same field to form groups relevant for comparative assessment and learning.

Bridgespan’s preliminary analysis to date has shown that different types of nonprofit organizations have different cost structures based on their business model. Segmenting nonprofits by business model can help us compare similar organizations. When it comes to indirect costs, for example, nonprofit research labs have a median indirect cost rate of 63%, nearly two and a half times the 25% median rate of direct service organizations.

We plan to push ahead this year to refine and deepen our understanding of segmentation and how it applies to nonprofit cost structures and capital needs. Having this information will benefit funders and grantees alike when it comes to funding discussions.

Nell: You work with both nonprofit and philanthropic leaders, so you likely see both sides of this dysfunction. What do you think it will take to move the field to a place where those with potential solutions to social problems have enough and the right kinds of money to see their solutions come to fruition?

Michael: Nonprofits exist in a complicated marketplace, seeking capital from a broad range of funders. As in any marketplace, some influential market makers set the rules. The practice of setting limits on indirect costs in project grants to nonprofits/NGOs has its antecedents in the US government’s approach to funding R&D at universities during the post-World War II era. The federal government has changed practice dramatically since 1958, embracing the “fair share” approach—that federal agencies pay their fair share of true costs, including indirect costs.

Among private foundations, indirect cost rate policies have been common for decades. A RAND report from the 1980s captured the variety of policies at that time: “many foundations customarily pay full indirect cost as budgeted in a proposal. Other foundations may pay only a portion of… or specify a cap on the support of indirect costs.” More recently, our research has shown that many large foundations set a cap of 15% or lower on indirect costs. Yet, among the 20 large nonprofits we sampled, indirect costs comprised between 21% and 89% of total costs, with the median at 40%.

I offer this history because I see the indirect cost conversation changing. For decades, much of this conversation has been driven by nonprofit and NGO leaders’ concerns about caps on indirect cost reimbursement. But funders have begun to engage more deeply in this conversation over the last several years. In 2013, Forefront (formerly Donors Forum) convened a cross section of staff from smaller Midwest foundations to discuss barriers and potential solutions to funding indirect costs. In 2015, the three California Regional Associations of Grantmakers launched the Real Cost Project (now the Full Cost Project) with the dual goals of increasing the number of funders providing real-cost funding and building the skills and capacity of grantmakers.

Having philanthropic leaders at the table is important to overcoming the reality of power dynamics. In the same breath, it’s also important to see this issue for what it is—a complex systems issue. Acknowledging this complexity helps approach this issue from a place of empathy for funders that want to do the right thing, and nonprofits that want to own and manage the costs of delivering impact.

Funders have the opportunity to ask grantees their true costs of programs and to be prepared to pay their fair share of the operational and financial support it takes to deliver those programs. Meanwhile nonprofits can focus on knowing their costs and advocating for them. Funders cannot pay their fair share if grantees don’t tell them what it is!

Nell: Beyond researching and consulting on these topics, you also serve on the board of two nonprofit organizations. What has been your on-the-ground experience as a board member trying to put these concepts to practice?

Michael: Creating space for a conversation among peer board members has been important in establishing a shared understanding of the issues—and why sometimes the executive director very rightly chooses to say “no” to a grant that doesn’t cover true costs.

The reality of this “complex marketplace” also hits home—there is no one-size-fits-all solution. That puts a big burden on the executive director and finance team to effectively report and manage costs.

Photo Credit: The Bridgespan Group

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Making Nonprofit Giving Smarter: An Interview With Jacob Harold

Jacob HaroldIn today’s Social Velocity blog interview, I’m talking with Jacob Harold, CEO of GuideStar, the clearinghouse of information on nonprofits. Jacob came to GuideStar from the Hewlett Foundation, where he led grantmaking for the Philanthropy Program. Between 2006 and 2012, he oversaw $30 million in grants that, together, aimed to build a 21st-century infrastructure for smart giving. Jacob was just named to the 2014  NonProfit Times’ Power and Influence Top 50.

You can read other interviews in the Social Velocity Interview Series here.

Nell: It has been over a year since the Letter to the Donors of America about the overhead myth. Where are we today in getting donors (and board members) to understand that overhead is a destructive mindset? 

Jacob: I’m glad to report that the response to the first overhead myth letter far exceeded our expectations. Hundreds of articles have been written about the letter. It comes up almost every time I hold a meeting or give a talk. For at least a few people, I think it’s been a deep affirmation of something they’ve known a long time. And, indeed, many others in the field have been working on this: the Donors Forum, Bridgespan, the National Council on Nonprofits, and others.

But we also know that we have a long road ahead of us. The overhead myth is deeply ingrained in the culture and systems of the nonprofit sector. It will take years of concerted effort for us to fully move past such a narrow view of nonprofit performance to something that reflects the complexity of the world around us. But it’s essential if we want to ensure we have a nonprofit sector capable of tackling the great challenges of our time.

Nell: The Letter to the Donors of America was obviously focused on the donor side of the problem, but how do we also change the mindset of those nonprofit leaders who perpetuate the Overhead Myth in their reporting, conversations with donors and board members, etc.?

Jacob: This is a critical aspect of the challenge. Every year nonprofits send out something like one billion pieces of direct mail to donors that prominently display their organization’s overhead ratio. It’s no wonder that donors think that’s a proxy for performance—we’ve trained donors to think so!

That’s why the CEOs of Charity Navigator and BBB Wise Giving Alliance and I are currently working on a second overhead myth letter—this one to the nonprofits of America. We’re still finalizing the text, but in it we will be calling on nonprofits to be more proactive about communicating the story of their programmatic work, their governance structures, and the real costs of achieving results. And, more, we want to recruit nonprofits to help us retrain donors to pay attention to what matters: results. In the end, that means that nonprofits have to cut the pie charts showing overhead versus program—and instead step up to the much more important challenge of communicating how you track progress against your mission.

Nell: At the Social Impact Exchange Conference you announced some pretty exciting plans with the GuideStar Exchange to, in essence, create a marketplace of information about nonprofits so that the best nonprofits receive more resources. Talk a little about your plans for the Exchange, and most importantly, how you plan to bring nonprofits and donors there.

Jacob: The GuideStar Exchange is our mechanism for collecting data directly from nonprofits. By going straight to nonprofits we can build on the data we already have from the IRS Form 990. The 990 is a regulatory document, it’s not meant to offer a comprehensive view of nonprofits and their programs—that’s what we’re trying to do with the Exchange. And it also lets us get information much more quickly!

So far we’ve had great success. More than 100,000 nonprofits have shared data with us through the GuideStar Exchange and more than 38,000 have reached one of what we call our participation levels—Bronze, Silver, or Gold. But we have a long way to go if we want to approach a comprehensive view of the marketplace. So we’re adding new incentives for nonprofits to share data through the Exchange, building new ways to distribute that data through other channels and improving the user interface to make the process easier. Right now we’re collecting quantitative financial data and qualitative programmatic data but later this year we’re going to release a tool for collecting quantitative programmatic data, too.

This comes back to the overhead myth campaign. If we’re going to ask donors to go beyond the overhead ratio when considering nonprofits, we have to offer an alternative. GuideStar Exchange is a critical part of that alternative: a chance for nonprofits to tell their story in a structured way that forces them to articulate in clear terms what they’re trying to accomplish, how they’ll get there, and how they’ll measure progress along the way.

Nell: The Money for Good reports that came out a couple of years ago rather discouragingly found that the majority of donors don’t give based on nonprofit results. With the GuideStar Exchange you obviously think that is changeable, so how do we go about changing donor interest and behavior?

Jacob: Well, I had a different read of that data. It is absolutely true that the Money for Good research showed that most donors don’t give based on nonprofit results. But it also showed that a significant portion—about 15%, depending on how you cut the data—do. That may not seem like much, but that represents 30 million people responsible for close to $40 billion in annual giving. So there’s already a huge unserved market, even if it represents a small portion of the entire system of philanthropy.

And at GuideStar we see this every day. We have 7 million unique users a year. And that’s just on our website, our data was used another 22 million times on other platforms last year through just one of our distribution mechanisms. So people want data. And as we get more and more programmatic data—data that is oriented towards results against mission—I’m absolutely confident that we’re going to unlock new behaviors among donors, nonprofit executives, journalists, and others. The nonprofit sector is about to enter a new phase, and I think it’s going to be remarkable.

Photo Credit: GuideStar

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Debunking the Nonprofit Overhead Myth: An Interview with Laura Zumdahl

Laura ZumdahlIn this month’s Social Velocity blog interview, I’m talking with Laura Zumdahl, Vice President of Nonprofit Services at Donors Forum. Donors Forum provides networking, education, leadership and advocacy for philanthropists and nonprofits in Illinois. Laura provides leadership to Donors Forum’s efforts to strengthen nonprofits. I wanted to talk to Laura and Donors Forum primarily because of their innovative work bringing nonprofits and philanthropists together to talk about the real costs (including administrative costs) of creating social change through their Real Talk about Real Costs effort I highlighted earlier this year.

You can read past interviews in the Social Innovation Interview Series here.

Nell: What was the impetus for Real Talk about Real Costs and what is your ultimate goal with the project?

Laura: We’ve long known “overhead” has been a challenge in the nonprofit sector. Over the past few years, we’ve been engaged in some conversations and education about overhead and the “starvation cycle” that encumbers nonprofits, but it had been in fits and spurts.

In 2012 Donors Forum decided we needed to do more to directly address the issue with our membership and see what kind of change we could make locally on this tough issue. So we launched a “Community of Practice” focused on bringing together a group of dedicated funders and nonprofit leaders to tackle the issue over the course of a year through education, sharing of stories, and collective action to move the needle on funding nonprofit overhead.

Ultimately, we want to see change in the sector related to funding the full cost of service delivery. We want nonprofits to be able to understand and articulate their true costs of delivering their missions, and we want funders to understand those costs and fund organizations accordingly. We want funders to invest in the impact they can have with their dollars, not just a limited portion of a program that doesn’t include the real costs. For nonprofits to have a greater impact, they need to have their mission fully-funded.

Nell: The underlying assumption behind Real Talk about Real Costs is that it is possible to get nonprofits and funders to talk openly and honestly with each other. But that is something that rarely occurs in the sector because of the power imbalance between grantor and grantee. How do you overcome that imbalance and get to open, honest, productive conversation?

Laura: The power dynamic you articulated is often a huge barrier for authentic, productive conversations between grantors and grantees. We recognize that as part of the challenge of this work and know that we are only going to make change by helping people to shift that in their own work and experience so they can understand the perspective of the “other”.

When we first started this effort we formed a community of practice comprised of about 30 leaders – half grantors and half grantees. This community spent a year coming together every six weeks or so to learn more about overhead cost issues, hear each others’ stories about the challenges related to their work, and develop relationships. We intentionally focused on helping them to create a trusting and safe space where they could understand and learn from each other. It’s not easy to get to open and honest conversation when power dynamics are at play, but we saw this happen when we were deliberate about getting a commitment from participants to engage in this way and create a space for them to develop relationships and trust to allow these conversations to take place.

Nell: What are your plans, or do you have any plans, to take these conversations to a national level? How do we encourage these conversations beyond Illinois?

Laura: We do! We are continuing to work with our national partner, The Bridgespan Group, on the ongoing conversations at the local level in Illinois. We plan to launch another community of practice later this year, which will continue this work that has evolved over the past few years. We also are working with other great national partners, such as Guidestar and Grantmakers for Effective Organizations (GEO), to take the conversations to a national level and encourage change in other locations, not just Illinois.

We need to encourage these conversations across the country – and that happens when people take the risk to build relationships that enable authentic conversations so stories can be shared and nonprofits and funders can work together to make change on how we address the issue of overhead costs in the sector.

Nell: What do you make of Guidestar, Charity Navigator and BBB Wise Giving Alliance’s recent Pledge Against the Overhead Myth? How do you think their efforts will affect donor actions?

Laura: We were thrilled to see Guidestar, Charity Navigator, and BBB Wise Giving Alliance make such a strong statement to the donors of America. Their recognition of how overhead rates can be wrongly used as a measure of effectiveness helps to raise awareness about this misconception and the importance of donors investing in impact.

Their leadership on this issue and the pledge that they’ve asked donors to commit to is an important step in helping to clarify the myths that have long surrounded overhead costs. They are looked to by many donors for signs of what to consider when selecting nonprofits to invest in, and their plea to donors to consider the real cost of outcomes and impact of an organization – not just a ratio that doesn’t tell the whole story – is a clear directive that we hope will affect both individual and institutional donors substantially.

Nell: What do you think it will take to really move the needle and get a majority of donors to recognize and invest in real nonprofit costs?

Laura: Change is hard when you are trying to affect behavior in a whole sector, so it’s not going to happen overnight. It’s a long process of affecting change in some areas that can build and eventually influence others to reconsider how they invest in real costs. We believe that if we can take the lead on making change in Illinois and share that experience with others, it’ll eventually help to influence behavior in other geographic areas across the country – hopefully leading to a wide-spread sector shift somewhere.

Several years ago nonprofits and funders weren’t talking about this issue together – and now, in some small pockets – they are. That’s a step in the right direction. And those of us in the sector need to support this work by making a personal commitment to address the myths around overhead whenever we can so we are part of making change happen.

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Getting Real About Nonprofit Overhead Costs

Getting Real About Nonprofit Overhead CostsThere is something pretty interesting going on in Illinois around nonprofit overhead costs. I have written many times (here and here for example) about how the distinction between “overhead” and “program” costs in the nonprofit sector is meaningless at best, and destructive at worst.

I’m really excited to see that the Donors Forum in Illinois is starting to host real conversations between nonprofits and philanthropists about the Real Costs (including administrative costs) necessary to create effective social change.

With the help of the Bridgespan Group, in March the Donors Forum brought nonprofits and philanthropists together for a one-day discussion about real costs in the nonprofit sector. They want funders to understand that it is not enough to fund only nonprofit programs. In order to create effective social change, nonprofits must also be able to fund the infrastructure, staffing, space, tools, and research costs of their work.

The image above is a graphic facilitation of the March session. The Donors Forum has also developed a great website with resources for nonprofits and philanthropists about real costs, including Ann Goggins Gregory and Don Howard’s seminal article in the 2009 Stanford Social Innovation Review “The Nonprofit Starvation Cycle,” reports and resources about nonprofit fiscal fitness, Grantmakers for Effective Organization’s study on how philanthropy is changing, and much more.

As part of their efforts, the Donors Forum has also put together this video that helps to explain, in very clear terms, the critical importance of funding ALL of a nonprofit’s costs:

I’m excited to see where this conversation goes and whether more nonprofits and philanthropists start having open, honest conversations about what it really takes to create lasting social change. I’m hoping to interview Valerie Lies, President and CEO of the Donors Forum, later this year about this initiative and where they hope to go from here. So stay tuned.

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