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.
I too believe that not being able to include administrative overhead in funding requests is the elephant in the middle of the room. Why not question us NPO’s as to our overhead right along with our program and fundraising costs? Perhaps it’s another burden funders, already inundated with requests and applications and perhaps isn’t necessarily the person best equipped to measure a NPO’s spending? Maybe there aren’t enough resources out there to help funders learn industry-standards they can then hold the applicant-NPO to work towards?
My belief is that many NPO’s simply adjust their proposals to show funds going towards programs but, in reality they are disbursed quite differently once the check is in hand. We’re still relatively tiny and haven’t had this issue arise but, I’ve seen NPO’s where this is simply the way things are done. The grantees believe it’s justifiable to cross that boundary. It seems to be the elephant in the center of the room and few people are talking about it.
If outcome-reports are diluted because the NPO spent money on administrative costs then funders are essentially missing out on huge opportunities to more accurately see the effectiveness of their program-spent dollars. Also, wouldn’t this be a great opportunity for funders, the ones who take the time and effort to address this issue, help a NPO streamline its overhead costs; ultimately providing valuable opportunities for NPO’s to lean their operations to more effectively serve their constituents. In our current economic climate this issue will be more critical than ever so it’s a great discussion and will hopefully be addressed by innovative funders and NPO’s alike.
Jerry,
Thanks for writing and bringing up these interesting points. I agree that overhead costs is a huge issue not usually discussed in the nonprofit sector. But I think there is also a misunderstanding among funders and some nonprofits about overhead costs. Overhead costs are somehow seen as bad and we need to limit them as much as possible. Why is there even a distinction between overhead and program costs? If a nonprofit has a clear mission and a clear strategy to achieve that mission then isn’t everything in the organization, and everyone, working towards that mission? I think the bigger issue, and perhaps the one that funders and others are trying to address, is misalignment and inefficiency that can sometimes occur in the sector. Whenever these things are present additional funding will be spent that didn’t need to be spent.
I am hopeful with the new direction older nonprofit rating systems are taking and the emergence of new rating systems that this overhead debate will be better understood and the anti-overhead sentiment will go away.