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

Published: Friday, Oct. 12 2012 11:46 p.m. MDT

Lindsey Zizumbo, right, of the Hinckley Institute of Politics, and Lisa Watts, mayor pro-tem of North Salt Lake, talk during a public leadership training session for women this past January at Salt Lake Community College.

Scott G Winterton, Deseret News

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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."

The unprecedented growth at the Komen Foundation, a Dallas-based nonprofit dedicated to finding a cure for breast cancer, is a good case study in the positive impact of well-spent overhead.

Between 1997 and 2007, the Komen Foundation grew its annual fundraising from $47 million to $324 million. It did it by investing in a long-term fundraising strategy. The crown jewel in that strategy is the Komen Foundation's Race for the Cure events which, though expensive to put on, increase the organization's visibility and bring in huge donations.

Another example of the big returns that come to nonprofits by investing in the organization comes from the Boys and Girls Clubs of America. During her 34-year tenure as CEO, Roxanne Spillett more than tripled the club's network-wide revenue from $480 million to $1.5 billion. With those funds she increased the number of clubs from 1,500 to 4,000, considerably expanding the organization's reach.

Spillett's $1.18 million salary raised eyebrows, but according to auditors at PricewaterhouseCoopers LLC, her compensation was "in line with industry standards and appropriate." In order to attract highly qualified candidates like Spillett, nonprofit organizations need to provide competitive salaries. "Would it have been better to find someone who would do the job for less?" said Larry Checco. "Would they have been as effective?"

Donors' demands

It's not entirely clear why overhead has become the metric for determining how effective an organization is. The fact that there aren't agreed upon standards for measuring the success of nonprofits is certainly a factor, according to Gregory Goggins of Bridgespan. "Businesses have profitability and returns to shareholders to show their effectiveness," she said, "but it is much harder to understand if a nonprofit organization is working." Part of the reason donors use overhead, said Gregory Goggins, "is that it is a metric they can understand."

Others suggest that the preoccupation with overhead may be a function of the Puritan values upon which America was founded. "The Puritans were aggressive capitalists but frowned on self-interest," Polletta said. "Giving to charity was a way to do penance for making money." Donations used to pay for overhead don't have the same atoning quality as donations that directly help people.

The fixation on overhead may also be a function of suspicion people have about how nonprofit organizations use their funds, said Gail Perry, a fundraising consultant based in North Carolina. "Beating the drum for low overhead is result of not trusting nonprofits to use their money responsibly," said Perry. Gregory Goggins agrees that lack of trust is a major problem. Funders demand low overhead because without such restrictions, they "don't believe that nonprofits will wisely use the stewardship given to them," she said.

Making it worse

Unrealistic expectations about overhead are perpetuated by charities themselves, according to Gregory Goggins. When Haiti was struck by a series of devastating tropical storms in 2008, NGO's raised funds by advertising that 92 cents on every dollar collected went directly to the people affected. "It set up an expectation that that (low overhead) is what is appropriate," said Gregory Goggins.

In a climate where low overhead determines where people give, nonprofits feel pressure to misrepresent to keep overhead low. Often this means misrepresenting the cost of running their organizations. The numbers nonprofits report for overhead on their financial statements "defy plausibility," according to the Nonprofit Overhead Cost Project, an ongoing study by the Urban Institute, a liberal think-tank based in Washington, D.C.

Examining 220,000 nonprofit organizations, researchers found that more than one-third of nonprofits report no fundraising costs whatsoever, while one in eight report no management or general expenses. But distorting the cost of running a nonprofit only perpetuates unrealistic expectations about overhead. "I kind of scratch my head when people say we should run nonprofits more like businesses," said Gregory Goggins. "In business you don't look at overhead to measure success."

Without accurate data, funders will never know what overhead rates should be. The power dynamics between funders and grantees, however, make it difficult for nonprofits to address the issue of overhead directly. "An organization that decides — on its own — to buck the trend and report its true overhead risks losing major funding," said Gregory Goggins. Getting all nonprofits to stand up together may not solve the problem either. "Even if they all act together, there is still a huge power in balance between funders and nonprofits. There's a risk people with the money will just find other avenues for giving," Goggins said.

email: mwhite@desnews.com

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