Is Overhead a Good Yardstick for Nonprofits?

Yard Stick

April 30, 2012; Source: Los Angeles Times

Outspoken and direct, Jack Shakely, the president emeritus of the California Community Foundation, says in no uncertain terms that administrative costs—the measurement people most often use to determine a nonprofit organization’s worth—is a poor means of evaluation. In this LA Times editorial, Shakely writes that it doesn’t help that charity raters with their “top 20 lists” propagate this notion, as do nonprofits that perpetuate it by brandishing their administrative overhead costs on their websites or promotional material. For nonprofits trying to create social change or to solve large problems in society, why would a simple number—the percentage of an organization’s budget dedicated to administrative costs—determine how effective it is?

According to Shakely, using administrative costs as means of measurement is “hogwash” because “there is absolutely no way of telling that an organization with 5% administrative costs is superior to one with 20% costs based on that criterion alone. In fact, the exact opposite may be true.”

To explain the widespread use of what he considers a poor metric, Shakely refers to Nobel Prize-winning economist Daniel Kahneman’s book, Thinking Fast and Slow, which describes the two ways in which we think: the intuitive system for quick decisions and a rational system which uses evidence. Shakely summarizes some of Kahneman’s points to note that the intuitive system tries to easily compartmentalize what seems complicated, sometimes subconsciously, while the rational system is “lazy, and it will defer to the intuitive system whenever it can, especially if the intuitive answer comes cloaked in seemingly scientific justification.”

This theory could be used to explain a great deal of “research-based” pap many blindly adopt all the time. And yes, in the nonprofit sector too. As Shakely writes, “Low administrative costs could indicate prudence and sound judgment at a charity, but they could just as easily indicate inadequate staffing, insufficient salaries or, shall we say, fudging.” –Kristin Barrali

  • Putnam Barber

    Ira Kaminow, of Tzedakah ([LINK=http://www.just-tzedakah.org][/LINK]) poses this thought experiment: “Would you feel comfortable giving to an organization that told you, completely truthfully, that it spends [U]nothing[/U] on administration? No money, no volunteer time, nothing at all.” For me the answer is easy. Of course not. Sound administration requires care that can’t be bought on the cheap. Of course, as well, administrative expenses can be “too high”. But judging whether that is true or not requires detailed knowledge of the inner workings of the organization in question — more data and more attention than outsiders are likely to give, even if they could. A focus on administrative costs harks back to a model based on :”the rich” giving money to intermediaries to help “the poor.” Naturally, both “the rich” and “the poor” want the intermediary’s share to be small. That model simply doesn’t fit the work of tens of thousands of perfectly respectable nonprofits. If they slight administration to look good by some outsider’s measure, they are slighting their mission. If they misrepresent their costs in pursuit of that goal, something much worse and much more dangerous to the quality of community life is going on. Good for Jack Shakely for making his point so forcefully and well!

  • Mazarine Treyz

    Everyone knows where to find a nonprofit’s 990. It’s on Guidestar, right?
    And everyone knows that you can cook the numbers to get them to look like whatever you want them to look like.
    Overhead is a red herring.
    I’ve written about this before, when I talked about some of the key concepts from Dan Pallotta’s book, uncharitable.
    for example, there’s the No Life, no Liberty, Just Pursuit of Wealthy donors concept, which says that we shouldn’t want to be compensated fairly for working in charity, that we are lucky to get $10 an hour
    http://www.wildwomanfundraising.com/life-liberty-pursuit-wealthy-donors/

    When you just look at overhead, you encourage a culture of destitution.
    http://www.wildwomanfundraising.com/uncharitable-culture-of-destitution/

    People getting paid less and then jumping to another job as soon as they can. How will this help fulfill the mission?
    Instead of asking, “what is your overhead percentage” we should be asking, “how well are you accomplishing your mission?” Because that’s the more difficult and the more interesting question.

    Sincerely,

    Mazarine
    http;//wildwomanfundraising.com

  • Richard Taylor

    Great point made by Mr. Shakley. As a beancounter, I have to add that the computation of administrative rates are as subject to manipulation as Fannie’s profits were….

  • Saras Chung

    This practice reminds me of how Charity Navigator grades nonprofits. Their completely formulaic approach to determining the worth of a nonprofit is a dangerous practice as donors trust and use these ratings as a guide for their charitable givings without much thought. The focus should be on outcomes. Are they achieving their mission? Some organizations may look good on paper in regards to their administrative percentages but may not have much impact on the mission they are working to achieve.

  • Elizabeth Rosen

    I agree with Shakely — he provides a great illustration of why we need to look beyond financial metrics when deciding which nonprofits deserve our time, money, and public support!

    In fact, I intern at GreatNonprofits.org (www.greatnonprofits.org), which is a site that shares his perspective. It’s the largest online database of user-generated reviews of nonprofits. On the site, donors can see a new dimension of the impact of the nonprofit – through the eyes of a parent whose child received tutoring, or the ex-felon who got job training, or the volunteer who helped write advocacy newsletters. These first-hand experiences help donors see the on-the-ground work of the nonprofit.

    Don’t hesitate to contact me – elizabeth@greatnonprofits.org – if you have any questions about the site, or just want to talk more!