“Like a Business:” Toward a Deeper Discussion of “Overhead”

The advice is as ubiquitous as it is nonsensical: “Run your nonprofit like a business” or “like a start-up.” What does that even mean?

It’s not at all clear, and when it comes to spending on “overhead,” it seems to mean either “spend a lot less” or “spend a lot more” – depending on which self-appointed business-knows-best guru is doing the talking.

It’s confusing. But more on overhead in a minute.

First, let me observe (again) that the counsel about operating a nonprofit “like a business” has been dispensed by many who should be smart enough to know better. I have taken issue with it many, many times over the years – most recently in my new Chronicle of Philanthropy column.

Those working in the nonprofit sector – what I like to think of as “the People’s Sector” – are working on the toughest challenges. While there is much to be learned across sectors, there is also much that is distinct about running a nonprofit. Further, as Jim Collins has famously pointed out, most businesses are mediocre.

Simply put, “business” is not a synonym for “effectiveness.”

In my Chronicle column, I take issue with CodeNow CEO Ryan Seashore, who declared earlier this month on TechCrunch.com that, “The nonprofit model is broken.” He goes on to paint nonprofits with a broad brush, writing, “Unless you’re part of a unicorn nonprofit like Charity: Water then your organization likely has too much overhead, too much bureaucracy, and a lack of focus on impact. Everything feels slow,” and not enough like “a for-profit start-up.”

Huh? How could a smart person write this? In my column, I explore the root causes of this kind of ignorance, focusing on the media, institutions of higher education, and the nonprofit sector’s own self-confidence problems.

But here I want to note the oddity of the fact that while some, like Seashore, equate being “like a business” with low overhead, others equate it with more overhead. In a Boston Globe article last week, Sacha Pfeiffer writes about fundraiser and author Dan Pallotta’s efforts to argue against “overhead” ratios as a metric by which nonprofits are judged. Pallotta says that nonprofits should be freed from the constraints we place upon them and should be encouraged – like a business, he says – to invest more in overhead.

I am confused.

At least Pallotta has part of it right. There is a need for many organizations to invest more in themselves: in their technology infrastructure, in their systems, and in their people. But, unfortunately, Pallotta’s focus is on fundraising in particular, and he has been quick to defend those whose fundraising practices result in the bulk of donations going to for-profit fundraisers – all too often without donors even knowing. This is unfortunate because, as I note in this 2013 blog post, there are different kinds of “overhead.”

When we lump together fundraising costs that too often are, in fact, questionable, with investment in professional development or performance measurement, we do the cause of reducing the emphasis on overhead a disservice. Donors have a right to know what proportion of their dollars ends up in the hands of for-profit fundraising professionals.

Indeed it is a concern about this on the part of donors that apparently contributed to the closing of Pallotta TeamWorks – Pallotta’s defunct company – a dozen years ago.

Pfeiffer’s otherwise balanced and well-reported Globe piece underplays this distinction between overhead to strengthen nonprofit capacity and “overhead” in the form of payment to for-profit fundraisers.

[An aside: the article also credits Pallotta with “gaining allies,” citing, for example, a 2009 Bridgespan article.  But, in fact, Bridgespan (which I doubt would consider Pallotta an ally) – and CEP for that matter – have been making an argument against an over-emphasis on administrative cost or “overhead” ratios long before Pallotta took up the cause. And both CEP and Bridgespan have been preceded by many others in the sector, such as Clara Miller, formerly of Nonprofit Finance Fund and currently President of the F.B. Heron Foundation.]

Given Pallotta’s defense of fundraising practices that often leave donors feeling burned, it’s not surprising that the overwhelming bulk of the more than 100 comments on Pfeiffer’s piece are strongly negative in their views of him and his cause. Unfortunately, it seems Pallotta’s entry into this discussion has set reasoned debate back rather than advancing it.

This is due in part to his own history at Pallotta TeamWorks and in part to the fact that his views are extreme and his grasp on the facts poor. (For examples of what I mean, see this review of his most recent book that I wrote for the Chronicle of Philanthropy in 2012.)

That’s too bad, especially given the thoughtful leaders in the sector, like those behind the “Overhead Myth” campaign, who are pushing for progress on this issue.

What we need to focus on, of course, is not just de-emphasizing overhead ratios as a performance metric. We also need improvements in approaches to performance measurement. The reality is that donors often gravitate to overhead ratios when they can’t get their hands around anything else. But we also should recognize that what is invested in “overhead” isn’t necessarily irrelevant, either.

Which brings me back to the point about business. Is it a “business” approach to invest little in overhead, as Seashore argues? Or is it a “business” approach to invest a lot in overhead, as Pallotta argues?

Ask the owner of your local dry cleaner (or the owner of a chain of dry cleaners, for that matter) whether he wants high or low overhead, and I am pretty sure he’ll tell you low. Ask the CEO of a technology company (Pallotta’s favorite example is Apple) – and if you define overhead as including investment in innovation and R&D (and definitions are of course a huge part of the problem here) – then surely you’ll get a different answer about what will lead to the greatest success.

Like so much in life, it all depends: on the work being done, on the context, on the industry (or field), on the competitors (or other players), and on the stage of evolution of the business (or nonprofit).

For funders, whether individual donors or foundations, the primary focus should be on results: what has been achieved – and will be achieved – by a program or organization relative to its costs. There should be a recognition that assessing what has been achieved is sometimes challenging, and will result in interpreting a mix of qualitative and quantitative data. It’s not as straightforward, by a long shot, as evaluating a business investment.

But there are surely contexts in which getting into the details of a nonprofit’s budget will be important for a donor. It’s reasonable to want to understand, if you’re making a major contribution to an organization, how it is allocating its budget – and to raise questions. As Vice President Joe Biden, quoting his father, has said, “Don’t tell me what you value. Show me your budget, and I’ll tell you what you value.”

In that vein, a donor might even worry that a nonprofit isn’t investing enough in “overhead” activities such as professional development or technology. (You chuckle, thinking, that never happens. But it does. I have been asked about this by thoughtful program officers wanting to ensure CEP’s long-term health.)

Or a donor, looking at two nonprofits generating similar donations and similar programmatic results, might very wisely decide to support the one that is able to raise money more efficiently – rather than the one that is allowing a for-profit fundraiser to keep 40, 50, or even 86, cents on each dollar raised – assuming they could obtain that information, which isn’t always easy. (And, yes, this happens: for-profit fundraisers sometimes do take that big a slice of a dollar raised, both in Pallota’s day at Pallota TeamWorks and today.)

Nonprofit Finance Fund CEO Antony Bugg-Levine put it this way in an email to me. “In the end, a budget (with whatever overhead it calls for spending) should be a manifestation of an organization’s strategy and plans, not an end in itself. Funders/donors/Board members often focus on whether the nonprofit ‘made its budget’ as a proxy for being run well without asking the more foundational question of whether the budget embodies the priorities the organization has set out to achieve programmatically.”

So what makes sense in terms of an approach to “overhead?” Just as approaches to overhead vary between the dry cleaner and the technology company, so too do they vary across different types of nonprofits.

I have spent a lot of time in recent years – some might argue too much – critiquing those who blather on about the sector being more “like a business.” I have criticized them for their lack of understanding of nonprofits.

But I have started to wonder if, perhaps, they also lack an understanding of business.

Phil Buchanan is president of CEP and a columnist at the Chronicle of Philanthropy. Follow him on Twitter at @philCEP.

nonprofit sector, nonprofits, overhead, role of business, strategy
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