Why nonprofits need overhead: Focus on overhead can hurt charity's bottom line

SALT LAKE CITY — Heifer International has a big problem: overhead. The Arkansas-based nonprofit, which is dedicated to helping small dairy farmers, spends more than 20 percent of its budget on fundraising and another 8 percent on administrative expenses, according to Charity Navigator, an independent charity monitor.

Overhead has become a key metric for donors deciding where to invest their philanthropic dollars. An organization with such high administrative and fundraising costs can struggle to attract donors. So it is a bit unusual that Heifer International has received $43 million from one of the most discriminating donors in the business, the Gates Foundation.

Bill and Melinda Gates have pledged 95 percent of their $60 billion fortune to charity. Yet despite their deep pockets, they aren't throwing money at problems. To get a nod from the Gates Foundation, organizations need to make financial disclosures and strategic proposals.

If the Gateses are primarily concerned with return on investment, giving to an organization that spends almost 30 percent of its budget on overhead seems like a colossal waste. So is their investment in Heifer International a mistake? "Unlikely," according to Larry Checco, a nonprofit branding consultant based in Maryland. "Bill Gates isn't running a charity," said Checco. "He's running a philanthropic organization interested in outcomes." As a successful entrepreneur, Bill Gates may have some unique insight into indicators of success, and overhead doesn't seem to be his priority.

While the Gates Foundation may not be obsessed with overhead, plenty of other organizations and private donors are. In the wake of the 2008 financial meltdown, sensitivity to financial waste is especially acute. Polls show that Americans believe charities should spend no more than about 23 percent of their funding on overhead, according to a 2012 survey by Phoenix-based Grey Matter Research & Consulting.

Overhead, which may include spending on fundraising, administration and employee salaries, has become one of the primary ways that people decide which organizations are ethically meeting their objectives, but consultants warn against the danger of conflating efficiency and effectiveness. "There isn't a correlation between what is spent on overhead and outcomes," said Ann Gregory Goggins, senior director at the Bridgespan Group, a nonprofit organization that provides consulting services for other nonprofits. "At the crux of this argument is the fixation on a number that isn't meaningful."

The framework that nonprofits should not use their money on overhead is "so powerful not even Dick Cheney and Nancy Pelosi disagree on it," said Dan Polletta, an expert in nonprofit sector innovation. But what if skimping on overhead makes it impossible for organizations to fulfill their missions? "It's always presented as a zero-sum game, where any money (for overhead) is money wrenched from the hands of kids rather than money that is invested … to potentially dramatically enlarge the money available to the kids," Polletta said.

But breaking free from unreasonable expectations about how much nonprofits should spend on overhead may be difficult. Funders' ideas about the meaning of overhead are deeply ingrained. This creates an incentive for nonprofits to perpetuate the notion that they can run their organizations on next to nothing by underreporting their expenses. Speaking out against this cycle, which starves nonprofits and limits their effectiveness, is essential, according to Gregory Goggins.

Overhead is necessary

Organizations that build robust infrastructure for information technology, accounting and fundraising strategies are more likely to succeed, said Gregory Goggins. "That's true in every industry, and nonprofits are no exception to the rule." The effects of limited investment in an organization are felt well beyond the office. "Non-functioning computers cannot track program outcomes and show what is working and what is not," she said. Likewise, "poorly trained staff cannot deliver quality services to beneficiaries."