I recently had a frustrating experience. It all started during a casual conversation with one of my mother’s friends. After hearing a bit about my role as CFO of the World Resources Institute, my mother’s friend informed me that she regularly contributes to charities. In fact, she stated proudly, she only donates to organizations with “low overhead”-- that is, to groups that spend the lion’s share of their funding on program expenses and only a small amount on fundraising and administrative costs. I couldn’t help but shake my head--not only because I disagreed with her, but because it’s a sentiment we hear all too often in the non-profit world.
Activist and fundraiser Dan Pallotta articulated this problem well in his March TED Talk, “The way we think about charity is dead wrong.” Pallotta explained that there are separate rulebooks for for-profit and non-profit companies in the United States. For-profits are judged on their growth and the quality of their products—which have the cost of necessary infrastructure or overhead baked into the cost of each product. Non-profits are evaluated on how little they invest in infrastructure rather than the quality of their work.
At WRI—and at all non-profits, for that matter—scrimping on essential infrastructure is short-sighted. This practice negatively impacts our work, our growth, and ultimately, our ability to change the world.
Dan Pallotta: The way we think about charity is dead wrong
The Problem with Focusing on Overhead
Non-profits organize their costs into “programmatic expenses” and “overhead.” Overhead is also commonly referred to as “administrative” or “indirect” costs. In the case of WRI, programmatic expenses refers to the amount of money we spend creating our research products and generating real-world outcomes. Funding for all other organizational activities falls under overhead.
Charity watchdog groups (e.g. Charity Navigator, Charity Watch, Guidestar, Wise Giving Alliance, etc.) historically have overemphasized simplistic performance metrics, such as administrative costs as a percent of total expenses, known as the “overhead ratio.” Groups with a “high” overhead ratio have been judged as ineffective or untrustworthy. Many of these same watchdog groups are now charting impact instead, measuring a non-profit’s successes rather than focusing on overhead ratios. However, many donors remain stuck on the previous metric, putting ceilings, aka “caps,” on the portion of their donation that can be used to support overhead.
This metric/approach is penny wise and pound foolish. An organization’s overhead fees are used to support activities at the program level. One is used to complement the other. Trying to report what percent is spent on programs vs. administration or development, then, is a somewhat arbitrary metric. Overhead is not bad, it’s necessary.
Overhead Ensures Program Success
At WRI, our overhead costs pay for items such as rent, utilities, software, computers, recruiting, training, and web site maintenance and hosting. All of these undertakings contribute to our ability to create solid research products, develop solutions, grow as an organization, and generate impact.
When a donor caps how much of their donation can go toward supporting overhead, we're forced to use unrestricted funds to cover these real and essential costs. Unrestricted funds are given to us by donors that know us well and trust us to use the funds as we see fit, rather than restricting them to a specific project. These funds are very precious and limited for all non-profits--and they’re a very small fraction of the overall funding we acquire.
As an example, consider our External Relations department: Most of these staff members and their activities are paid for with unrestricted funds. Our communications staff works hand-in-hand with our researchers to develop clear messaging, interface with the media, build our web presence, and ensure that our work is properly positioned for targeted audiences. They also create key communications materials to spread the word about WRI’s research, such as press releases, op-eds, blog posts, videos, and infographics. Ideas need to be communicated before action or behavior can be changed. Making up for overhead caps with unrestricted money draws funds away from the communications budget. Limit communications, and you directly limit the power that our research has to create impact.
Fixing the Perception of Overhead
We need to change the measuring stick by which we evaluate non-profits. Investing in skilled talent at competitive market rates, sophisticated systems to monitor progress, and reliable infrastructure should be rewarded. These practices are smart business.
So I’d like to propose a new benchmark for donors and prospective donors: Let’s make 25 percent a “safe harbor” for the amount of funding an organization like WRI spends on overhead. This figure should be the starting point of the donor-organization relationship. Amounts that exceed or fall under 25 percent can then be explained by the organization, with sufficient transparency to support its particular business model. This flexibility allows donors and organizations to develop a trusting, working relationship--one based on an organization’s individual model, not a one-size-fits-all metric.
We have a duty to responsibly spend every dollar we receive. Our programs and our donors should understand our costs and hold us accountable. If donors are not satisfied with the level of overhead, it’s probably due to under-investment in infrastructure, not over-investment. If donors believe in the organization’s mission, they should add resources to help the organization progress, rather than putting them deeper in the red financially and capacity-wise.
We have a choice: Continue to quibble over how costs are allocated between overhead and programs, or start talking about the most effective ways to change the world. My money’s on the latter.