The Overhead Myth

Many people, my acquaintances included, believe that a nonprofit can be judged outright as good or bad based on one metric. One metric! Think about that for a minute. What if your worth as a person was defined by your debt to income ratio? What if Dragon Corp was valued on the NYSE based solely on its CEO to staff pay ratio (1:1 at the moment ;)? This is clearly ridiculous. You are a good person, regardless of whether you have a large mortgage! Dragon Corp is a fantastically profitable company that has a huge earnings multiplier (okay, not right now, but you get the point).

We don’t evaluate people or businesses on a single metric. We shouldn’t evaluate nonprofits that way either.

What is overhead, anyway?

Overhead is the amount of money a company spends on activities or resources that do not directly benefit their bottom line. This includes office rentals, computers and software, telephones, airfare, professional registrations, the coffee machine, etc. Depending upon the business, it includes salaries for support staff (HR, accountants, etc.) and sometimes staff that work directly on projects. For the most part, nonprofits consider all salaries in the overhead category. (I am presuming there are IRS rules about this, although I have not researched them). For nonprofits, overhead also includes fundraising.

Ok, great. All businesses and nonprofits need those things to function.

Why do we hate it so much?

I have theories.

The first is that history has provided us, the general public, with some spectacular examples of overhead spending failures. (I will resist linking to specific events here in an effort to avoid slandering organizations that have turned the corner on this.) Needless to say, it has happened regularly enough that it has become a common reason to avoid giving to ALL organizations. Bummer.

Luckily, the advent of websites such as Charity Navigator helped to moderate this excess spend through radical transparency. Yay! Go mandatory regulatory reporting and the internet!

But wait, that hasn’t solved the problem. It has merely shifted it. By publishing the overhead metric, alongside very few others, these charity comparison sites have established a bar that nonprofits now feel obligated to be under. We have shifted from “you’re spending too much on non-essential items” to “if it’s not less than 20% I will not invest in this organization.” Hm.

The second reason that overhead is disrespected is that donors believe that money spent on overhead is not spent on the core philanthropic mission. If an organization feeds the homeless then it seems self-evident that every dollar spent on phone service is a dollar not spent on a meal. I get this, even though it isn’t necessarily true as I will explain below.

The third reason is that most donors are confused by the plethora of nonprofits out there. We only have limited time to spend investigating each one. Using a crude cut-off for overhead allows us to immediately eliminate quite a few organizations; it is a mental short cut. Now, there are many reasons we don’t give, and the mental energy associated with finding a cause to support is big one. So if it’s between not giving and giving to an organization that meets your overhead threshold, I say go for it! But if you want to grow AND give your hoard, and you want to give in line with your values, then I’m not in favor of this approach.

Why?

Because crude overhead metrics mask efficiencies and also encourage rule bending.

Impact Matters

Let’s say the soup kitchen above needs a program manager. They have the choice between hiring a fresh out of school, excitable 22 year old for $23k/year or a highly organized, former administrator for the chamber of commerce for $35k/year. Which would you choose? Do you have enough information to choose? Of course not. It’s not just about pay, or even about personality. It’s about skills and the ability to leverage them in service of the nonprofit. And it is highly probable that the additional networking, management and business experience of the older worker will offset the pay gap. If the older worker can provide $12k/year in value to the nonprofit through increasing capacity, adding services and coordinating with community partners then they are the better choice. But you, the donor, cannot make this decision based on overhead spend alone.

Of course, you could make the argument that if the more expensive worker adds $12k/year in efficiencies PLUS raises an additional $60k in donations ($12k/20%) then they will have no net impact on the overhead percentage. But seriously, no one is doing this math.

Or at least, they shouldn’t be.

But actually, they are.

Because donors can’t easily see that the more experienced hire allowed the organization to serve an additional 4,000 meals. They can only see that overhead expenses went up. And that makes donations go down, for the reasons set out above. So the nonprofit (especially an un-savvy one) will choose the cheaper staff member. This is ridiculous. No for profit business would operate in this way.

Viewing Nonprofits as a Business

If Dragon Corp can hire someone that produces an extra 200 widgets a week they will rationally evaluate the extra salary against the extra revenue. If the return on investment is greater for the more experienced widget maker, the business will hire them in a heartbeat! They do not have to justify the salary cost to their investors. Why don’t we view nonprofits the same way? For a soup kitchen, the number of meals served is the equivalent of revenue (in that it is the organizational driver), but even the business minded among us rejects this.

Nonprofits know this is happening and they do their best to manage their numbers, because they have to. Managing numbers, frequently, can include rule-bending (I’m not talking about rule breaking, or illegal accounting here, just shifting numbers around). Anyone who has worked for a private business knows how this works. Being incentivized to meet a specific metric often leads to leaks in other areas; it is a management truism that all incentives have unintended consequences. Not all of them are beneficial to getting your hoard deployed in the most effective manner.

Why does the Overhead Myth exist?

Possibly it is because we feel that nonprofit workers should not be paid very much. But more likely it is because:

  • We do not take the time to evaluate our charities
  • Charities are terrible at helping us understand their effectiveness.

I will write more about both topics in the future. But for now, I will leave you with these closing questions:

If you ran a nonprofit, how would you balance your overhead with your mission? How much overhead would you consider to be “too much”? Have you ever considered a similar question for your business?

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