Getting Clear About Overhead, Part 1

To many donors, the percentage a nonprofit spends on “overhead” is important in their decision about which organizations to support—too important, in my view. What matters most is not the way a budget is divided, but the results an organization produces relative to the total budget.

It’s performance that should most powerfully influence donors.

So I was thrilled last week that the leaders of GuideStar, Charity Navigator, and BBB Wise Giving Alliance came together to call for an end to the overemphasis on overhead as a measure of nonprofit effectiveness. This “Overhead Myth” campaign is an important, and welcome, step.

The three CEOs—Jacob Harold, Ken Berger, and Art Taylor—launched the campaign to change public perceptions on this issue. This is something of an evolution for Charity Navigator and BBB Wise Giving Alliance, which have historically relied on overhead ratios as a key metric in their assessments of charities and, based on my review of their websites last weekend, seem to continue to do so.

In their letter, the CEOs write that rather than seeking to minimize overhead, “many charities should spend more on overhead. Overhead costs include important investments charities make to improve their work: investments in training, planning, evaluation, and internal systems—as well as their efforts to raise money so they can operate their programs. These expenses allow a charity to sustain itself.”

I could not agree more. (Note: I believe it is also the case that some of the above can often legitimately be counted as “program expense,” but part of the problem is the difficulty of understanding what can and can’t and the variation across organizations in how things are accounted for.)

Also important, though, was that the CEOs did not take an extremist position and argue that overhead ratios never matter. Indeed, they said: “At the extremes the overhead ratio can offer insight: it can be a valid data point for rooting out fraud and poor financial management.” This is a crucial point and distinguishes this effort in a fundamental way from Dan Pallotta’s fledgling and ill-conceived “Charity Defense Council.”

More on that in my next post on this topic.

But, first, it’s important to understand that the concern about an overreliance on overhead as a performance measure is not new. In CEP’s first publication, Toward a Common Language: Listening to Foundation CEOs and Other Experts Talk About Performance Measurement in Philanthropy, released in 2002, we noted the widespread concern among the foundation leaders on this issue: “virtually every interviewee cautioned against the simplistic notion that higher proportional administrative costs necessarily indicate poor performance,” we wrote, because administrative costs are defined differently across organizations, because contexts differ, and, most important, because it is performance and outcomes that matter.

And, of course, many others in the sector had been making these arguments long, long before we heard them expressed in our initial research effort. Yet, as I have said in almost every talk I have given on performance assessment in the past decade, people continue to gravitate toward administrative cost ratios—because they are the most easily available, seemingly (although not really) standardized data that nonprofits must report.

This is something that GuideStar and its CEO Jacob Harold have been working on for the better part of a decade (during much of which he was a program officer overseeing the William and Flora Hewlett Foundation’s philanthropy program). Many others have made the case over recent years, including Nonprofit Finance Fund, Bridgespan, and Mario Morino and Venture Philanthropy Partners. In the UK, Caroline Fiennes, whose excellent book I blogged about last year, is an especially eloquent destroyer of the overhead myth, arguing forcefully for a focus on performance.

As CEP’s report, Room for Improvement: Foundations Support for Nonprofit Performance Assessment, makes clear, nonprofits care about performance assessment and are looking for more support—financial and non-financial—to do that difficult work. But, today, they are generally not getting it from foundations, arguably the donors who are best positioned to do it because of their ability to make larger, longer-term grants than the typical individual donor. Some foundations may be demurring in part because they don’t want to support “overhead.”

This is a vicious cycle, of course, in which the lack of investment in performance assessment contributes to a lack of good performance data that would help nonprofits make a stronger case against the use of administrative cost ratios to judge them.

So, if the fight against an overreliance on overhead is to be successful, foundations must play a crucial role. Among the steps they can take:

  • Support nonprofit performance assessment efforts by investing in organizations to help them develop the capacity to do the work required to gauge performance. Nonprofits want this help from their foundation funders and, today, they are generally not getting it.
  • Provide flexible, general operating support that is multi-year and six figures or more to those organizations whose goals are well-aligned with their foundations’ goals. Our research has shown that this kind of support, which gives grantees flexibility to invest in their infrastructure, is positively correlated with grantees’ views that foundations are making a positive impact on their organizations. But it remains much more the exception than the rule.
  • Review their own policies on overhead to ensure that what they’re asking of those they fund is realistic. Are they effectively forcing nonprofits to re-categorize expenses in order to meet their funding criteria, and therefore contributing to what Melinda Tuan has called the “dance of deceit” between funders and grantees?
  • Look at their own performance measurement and the degree to which their foundationsand boardsare overly reliant on administrative expense ratios to judge their own performance.  Many foundation boards fixate on administrative cost ratios in the absence of a broader understanding of what is being accomplished through administrative spending; this can undermine performance for foundations, just as it does for nonprofits.

Foundations may see the debate about overhead and think it pertains primarily to the world of individual donors. But, in fact, foundations have a vitally important role to play.

In my next post on this topic, why we need to be clear about different types of overhead.


Phil Buchanan is president of CEP and a regular columnist for the Chronicle of Philanthropy. You can find him on Twitter @PhilCEP.

administrative cost ratios, effective philanthropy, leadership, nonprofit sector, performance measurement, role of philanthropy
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Getting Clear About Overhead, Part 2: Questionable Fundraising Costs

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