In this month’s edition of Nonprofit Management and Leadership, Jason Coupet, an assistant professor of Public Administration at North Carolina State University, finds that lower overhead rates do not equate to efficiency. In fact, the exact opposite is true—they correlate negatively:
The overhead ratio doesn’t actually measure efficiency, for two reasons. First, the overhead ratio doesn’t account for what organizations are actually doing with their resources. And second, the ratio doesn’t account for what organizations are accomplishing with their non-overhead spending.”
“Some nonprofit researchers have raised concerns about the accuracy of overhead ratios as a means of assessing efficiency,” says Coupet, who may or may not know that the sector finally revolted against the measure a few years ago after bowing to its rule for four or more decades, “but our work is the first to approach it using efficiency theory—and we were able to demonstrate the problem using real-world data.”
The study gathers data from 666 Habitat for Humanity affiliates around the country and assesses efficiency using two different tools, looking at overhead ratio against number of houses produced. Both tools produced a finding of a negative correlation. “In short,” Coupet says, “this demonstrates that not only is the overhead ratio bad at assessing efficiency, but also that using it to assess efficiency may actively mislead donors. We argue that nonprofit scholars, managers, and donors should move away from concepts and measures of efficiency based on financial ratios, and toward ones that embrace maximizing what nonprofits are able to make and do.”
Let’s take this a bit further: The focus on overhead has been a significant thorn in the side of the nonprofit sector for more than a generation, but it has not stood alone as a cultural backdrop to the way the public views our work. The idea that nonprofits can be measured for their effectiveness using the proxy of frugality is deeply ingrained in public attitudes. The pressure to reduce (or “report differently”) on expenditures is both frustrating and discouraging to nonprofits, be they those on the ground trying to keep the food bank doors open or sector leaders busily promoting transparency and sustainability instead of manipulation and scarcity.
The rise of the pervasive narrative that “overhead is waste” seemed to start down a more extreme path with the growth of charity rating services like GuideStar, Charity Navigator, and the BBB Wise Giving Alliance more than a decade ago. Despite many efforts to generate a more reasoned dialogue, there is a continuing and powerful mindset that charities are routinely “wasting money on overhead.”
Perhaps most frustrating of all, the ratings services that opened this Pandora’s box don’t seem to have made much progress in reversing the negative attitudes created by overhead mythology. This, despite the three rating services mentioned above having taken already the extreme step—perhaps even counter to their own financial interests—of directly addressing the “overhead myth” in a historic letter:
When we focus solely or predominantly on overhead, we can create what the Stanford Social Innovation Review has called The Nonprofit Starvation Cycle. We starve charities of the freedom they need to best serve the people and communities they are trying to serve.
That letter was more than five years ago, and their “we take it back” effort clearly didn’t work.
Writing about Canadian donor attitudes in The Lens earlier this year, I discussed the results of the “Talking About Charities” report that showed 73 percent of survey respondents agreed with the statement that “Charities spend too much on salaries and overhead.” NPQ has an ample supply of relevant articles to offer the American experience. One, a conversation between Jon Pratt and Paul Light, revealed some similarly alarming attitudes. For example, Light found that some 40 percent of Americans believe that employees of charitable organizations should take a discount or pay cut “because they’ve signed on to help others.” Such attitudes, when combined with occasional extreme attention by media and government about nonprofit salaries, makes for a powerful combination that helps sustain the waste mythology. As Light observed, “It’s a frustrating paradox that Congress doesn’t care very much about how much private CEOs—corporate CEOs—make. Basically, if it’s in the private sector, we’re not going to worry too much about it. But if it’s in government or nonprofit-land, it’s fair game.”
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Generocity contributor and sometime NPQ writer Tivoni Devor seeks to change that conversation by taking it head-on, encouraging more interest in CEO-to-average-employee ratios (noting that comparisons to the private sector show that even the biggest of nonprofits are much more reasonable) as well reminding us that nonprofit employees can hardly help others if they are not earning reasonable wages.
These are the types of arguments that even the most casual of NPQ readers have likely heard before and that most are anxious to consume. Last week, readers flocked to read Claire Knowlton’s 2015 article about the need to go beyond addressing overhead as an isolated issue. Knowlton instead makes the case to cover what she calls “full costs.”
We’ve been so distracted by the discussion of whether nonprofits should just be able to pay their day-to-day operating expenses (and how)—including overhead—that we’ve mostly ignored the need for nonprofits to generate enough surplus to reinvest in the organization’s immediate and future health.
There’s even a formula provided for defining full costs: day-to-day operating expenses + working capital + reserves + fixed asset additions + debt principal repayment = full costs. This is of course a very reasonable formula—but one that would nevertheless call for a radical shift in the entire nonprofit-donor-funder relationship.
While we ponder the various ways to make that change happen, Devor is calling for an additional shift, one that hits right at the heart of the most difficult of nonprofit choices: Should we stop looking for cost savings that benefit our bottom line but lead to purchasing that harms the greater community? In other words, should nonprofits be considering (and be supported to pursue) their own “buy local” policies?
Nonprofits should be shouting about how much of their spending happens at locally owned, minority-owned, women-owned, veteran-owned or disabled-owned businesses. There is a multiplier effect in spending locally that shows that for every $100 spent at a locally owned business, $45 of that is re-spent locally, while national chains only spend $14 of that sale locally.
This is an intriguing idea that has this author (a nonprofit executive who manages purchasing) feeling the financial pinch of a cogent ethical argument: If buying local supports healthy communities, and the mission and values of my organizations are tied to relevant healthy community outcomes, why am I doing my shopping at big box (including online) retailers?
Devor argues that donors and funders are becoming more sophisticated, and that they are ready to appreciate transparent decisions about expenditures that represent healthy investments in staff, as well as locally sourced products and services. My own research on the subject indicates that while attitudes are evolving in that direction, they are still by far in the minority. But nonprofits must not be subservient to regressive thinking, and maybe that’s why we’ve been failing in our efforts to overcome the overhead myth—too much defending and not enough leading.
Perhaps the time is right to more strongly assert our role as leaders in driving and supporting healthy communities, and for those who are ready for the journey, both Knowlton and Devor have laid down some interesting roads to follow.
With contributions from Ruth McCambridge.