Overhead Costs: The Obsession Must Stop

When it comes to charitable giving, there will always be skeptics who question where the money really goes—and donors who object to a charity using their gifts to cover overhead. This skepticism is misplaced. Nonprofits are businesses and, as they grow, they must invest in their infrastructure to survive, retain employees, and, ultimately, succeed at their mission.

Families in Schools, a Los Angeles-based nonprofit, came to this realization just a few years ago and proved it can be done. Kaci Patterson, the organization’s vice president of programs and administration, noted that as the organization grew, “it became apparent that we would need to have more balance between our external and internal priorities, and that our fundraising needed to reflect that.” After talking with a few major donors about its budget plans and getting the approval of its board, Families in Schools “restructured its indirect cost rate, making it 10 percent of all expenses (except pass-through funds).” It also decided to add more jobs focused on supporting its “internal sustainability.”

Directing donations to help fund a nonprofit’s operations has long been controversial. Earlier this year, three of the country’s top nonprofit associations publicly challenged the perception that well-managed nonprofits have the lowest administrative and fundraising expenses. In an open online letter to all US donors, BBB Wise Giving Alliance, Charity Navigator, and GuideStar joined forces to denounce the “overhead ratio”—that is, the percentage of nonprofit expenses that go to administrative and fundraising costs—as a useful measure of a charity’s overall performance.

Arguing that the overhead ratio is “imprecise and inaccurate,” the authors encouraged donors to stop obsessing over a nonprofit’s administrative costs when deciding which charity to support, and to instead focus on the big picture and what it will take for a nonprofit to achieve the best outcomes.

Under the assumption that minimal administrative and fundraising costs mean a more effective nonprofit, donors frequently seek out organizations that spend the bulk of their funding on program expenses and only a small amount on overhead. But here’s the issue: We can’t separate a program from the people who develop and deliver it. To ensure that a program can achieve maximum impact, we must actively invest in the staff who are supporting the program and make sure we have the best people on the job.

Let’s say you’re running a nonprofit that offers after-school programs for at-risk youth. Donors are happily investing in your programs as long as your organization uses the money solely for expanding and building out the initiatives. Now, your organization can serve 30 percent more youth than before, but what if your staff isn’t trained to manage the operations and services required to support the increased program capacity? How will you help your people successfully oversee this larger initiative? Without training and development in place for your team of staff and volunteers, you severely minimize the opportunities to make the most of your program.

Ultimately, every organization—for-profit or nonprofit—hopes to reach its goals and provide meaningful results. At our organization, Cornerstone OnDemand, a global talent management company that works with both the private and nonprofit sectors, we have seen firsthand the importance of giving all organizations the ability to invest in people and infrastructure to ensure their organization’s performance.

As with most companies, we have a fiduciary responsibility to the company’s employees and shareholders to spend capital wisely. Our chief executive must ensure the overall profitability of the company, and therefore has the flexibility to decide how much to invest in people, technology, finance, and internal systems to optimize growth. Why do we expect nonprofit leaders to operate under a different set of rules?

Nonprofits are driven by mission, but they too have financial targets and other performance metrics to meet. In the private sector, we see that companies with high-quality training and development programs generate 26 percent more revenue per employee and realize 40 percent less voluntary turnover than their peers. What if we translated this to the nonprofit sector? If we invested in the training and developing staff who deliver these critical programs, would we see 26 percent or more impact per staff member? Would nonprofits achieve greater success because they could focus their people, time, and money on mission-driven activities rather than covering the cost of turnover?

The belief that nonprofits that minimize investments in overhead deliver higher-quality services or better results has deprived many organizations of the resources they need to serve their communities. Leaders of nonprofits need flexibility to invest in recruiting and sustaining the best talent, training and developing employees properly, and building a strong pipeline for succession. Expenses like this are not frivolous; they’re smart.

A Bersin by Deloitte case study examining how United Way of the Bay Area manages talent explains: “In the nonprofit world, as in the for-profit world, effective talent management serves as a critical source of mid- and long-term organizational efficiency and effectiveness. In other words, money is simply better spent, and services have more impact, when talent is well-developed and well-equipped.”

We must challenge the myth of nonprofit overhead. Donors need to focus on evaluating charities based on leadership, transparency, governance, and results. With this potential paradigm shift, we recognize that there will be heightened pressure on nonprofits to better define and deliver outcomes to their funders. But that’s a good thing. All organizations are better off if they’re held to a higher standard—just not a double standard.

Read more stories by Julie Brandt.