Overemphasis on Overhead Spending Undermines Impact

IS LESS REALLY MORE_QUOTE2

Like any good business leader, as the CEO of PYXERA Global, I am always seeking ways to improve our organization. And like any good business leader, I look to learn from others what has worked in their companies. In Fast Company, Inc., Harvard Business Review, and across a dozen LinkedIn groups I’ve joined, I’m awash in news of achieving and maintaining an effective organization, the best ways to obtain and retain talent, the importance of employee engagement, and how new technology is improving the way businesses operate. Each author raises valid points about the financial and time investments necessary, the management skills that must be cultivated, and the equipment that must be procured in order to follow best practices and maximize effectiveness. Forward-thinking companies all over the world endorse these approaches and report that they are rewarded with high-performing employees, streamlined operations, improved financials, and better results—be those profit, innovation, service delivery, or production targets. Shouldn’t it make perfect sense, then, for PYXERA Global to make some of these same types of investments?

The obvious answer to this question should be ‘yes,’ but there is one simple fact that makes such investments problematic—PYXERA Global is a not-for-profit business. That fact alone should have no bearing on our decision to invest in order to maximize effectiveness—like any business, we have a duty to do so. The challenge is that, like any not-for-profit, we are far too often judged by our ‘overhead rate’ or ‘administrative costs,’ not by the quality of our work or the results we deliver nor, oddly, by the total cost of a project or program.

Potential funders of 501(c)3 organizations often seek information on sites like Charity Navigator, which do provide a valuable service in helping people avoid charity scams. At the same time, Charity Navigator defines administrative costs as any dollars not spent on program expenses and gives a financial management score of zero to any non-profit with overhead costs of 30 percent or more and a top score of 10 to organizations that have less than 15 percent overhead, stating specifically that “lower is better.”

While I certainly understand why funders want to see the maximum funds possible invested directly in the effort they wish to support, assessing the financial management of a not-for-profit on the “lower is better” scale makes no sense if the funder is seeking the most effective organization. An organization with zero percent administrative costs presumably has no paid accountants or executive leadership, no IT infrastructure, and no compliance or monitoring and evaluation functions. Such an organization cannot pay for an independent audit. In fact, it cannot even hold a general staff meeting or provide training to its staff, as these would be non-program expenses.

Of course, every organization’s administrative needs are different. A charity that works strictly as a pass-through for humanitarian goods and services can be expected to have lower administrative costs, though is likely to have higher fundraising costs—also not direct program expenses. A not-for-profit that runs complex health, economic growth, or food security programs should have notably higher administrative costs, allowing them the in-house expertise needed to design and monitor these types of programs in order to provide maximum impact. An organization that has international offices and programs necessarily has even more complex requirements regarding accounting and compliance, without which a funder’s resources are almost sure to be misused.

In my perusal of various websites that catalog non-profits, I found “top-rated charities” that claimed administrative costs of as low as 0.9 percent. Before you get out your checkbooks to support such an apparently efficient organization, consider the following:

Who is staffing such an organization? Does it have quality leadership and employees paid a competitive wage at which they can afford to stay in their jobs? Does it train and continue to raise the qualifications of those staff? Does it have a team of people dedicated to identifying new funding sources for sustainability? Does it have accounting software and qualified financial staff to track your funds? Does it have insurance? Does it have reasonable technology and communications infrastructure? In short, can this organization, in fact, do the job which you wish to fund, and do it well and in a sustainable manner?

The answer is, based on an overhead cost percentage, you have no idea, but with administrative costs that low, you should probably be concerned. To put it another way, take the straightforward example Saundra Shimmelpfenning provides in her Lies, White Lies, and Accounting Practices:

IS LESS REALLY MORE_QUOTE

Ultimately, it is not the funder that deals with the consequences of underspending on administrative costs—they are not offered the inedible raw meat patty on stale bread—rather it is the very people they are attempting to serve. No wonder we see more and more situations where those we seek to assist say “thanks, but no thanks” to donor funds.

In discussions with my colleagues that run other not-for-profit organizations, we find that we often agree with a potential funder on a reasonable overall cost of a program, only to later dig down into budget detail and be told we must limit administrative costs to the “gold standard”: 15 percent or less. I have never understood this; if the total cost for the services delivered is deemed to be fair and appropriate, then why should the funder be concerned about how those funds break down internally? At that point, a not-for-profit with necessarily higher administrative costs has just three choices, all unpalatable: 1) dip into their meager reserve funds to subsidize the work of the funder; 2) walk away from a good project that would provide needed services; or 3) deliver a sub-par result.

A growing number of individuals and institutions—chief among them Dan Pallotta and the Guidestar initiative, The Overhead Myth—are beginning to turn the tide on this important issue, but much more remains to be done. As we begin the new year and new funding cycles, my resolution is to do a better job educating our clients and potential clients and funders about the importance of non-program costs to delivering results and long-term impact. I fervently hope that other not-for-profit leaders will take on this same charge and that together we can work to break this cycle and ensure that we are willing to pay the appropriate price to offer the highest quality ‘burgers.’

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