We have been gratified by the tremendous amount of support we received for our Stanford Social Innovation Review article, “Pay-What-It-Takes Philanthropy,” but we’ve also gotten some pushback. In fact, if we were writing the article today, we’d do some things differently to reflect how our thinking has evolved. No doubt our thinking will continue to evolve as we push toward new solutions.
Nonprofit leaders across the United States and abroad have let us know that the article really hit home. They like it because the article clearly establishes that indirect costs are real and that the typical 15 percent funder reimbursement rate is too low. We have been told that the article is being circulated among nonprofit boards as a must-read. For those nonprofits with business models that rely on a higher mix of indirect costs, the article is particularly valuable because it helps to validate their costs and has been used in making their case to funders.
The pushback has come from some funders who disagree with our emphasis on the need for nonprofit segmentation and benchmarking. They fear that segmenting nonprofits by activity and benchmarking expenditures will lead to replacing today’s low caps on indirect costs with new caps that are just as misguided. In the critics’ view, the sector should scrap indirect costs altogether and focus instead on providing general operating support.
They have a point. We acknowledge that we gave general operating support short shrift in the article. We’d argue today that funders ought to supply flexible, multiyear funding to grantees they trust, accompanied by open and honest conversation about the nonprofits’ true needs, encouraging nonprofits to make investments in innovation, impact, and efficiency that “but for” this capital they would not make. Unrestricted funds are the most valuable type of capital for nonprofits because they allow them to grow stronger.
But general operating support by itself is unlikely to solve this problem of underfunding indirect costs—dubbed the nonprofit starvation cycle—given that US foundations, the US government, and many global funders give the vast majority of their funds through project- and program-specific grants. It’s unrealistic to think that all funders would ever go to providing 100 percent general operating support. In a world where billions of dollars are being awarded as project support grants, nonprofits should not have to re-set expectations of indirect cost levels—which are inherent to their business models—one by one, funder by funder, or grant by grant. That’s why we believe that segmentation and benchmarking have an important role to play in solving the current problem with project grantmaking.
In the corporate world, we have learned that CEOs and leadership teams really value segmentation and benchmarking for what it tells them about their own cost structure, how they compare to peers, and how to allocate scarce resources to the highest and best use. That’s what segmentation and benchmarking can tell you. It’s extremely valuable information. Not to pursue segmentation and benchmarking in the nonprofit arena out of fear that the information might be misused is shortsighted. Every nonprofit leader should want to know this information.
Our commitment to better understanding segmentation and benchmarking continues as we carefully examine the expenditures of a greater number of nonprofits. Beyond our ongoing research, we see a need for sector leaders to come together to craft shared language and definitions. Today, terms like overhead and indirect costs mean different things to different people.
We also will work with nonprofits and funders to coalesce around a common point of view about how best to fully fund nonprofits. We’ll never solve this problem if key stakeholders get stuck on planting the flag on their own turf. We need shared, scalable solutions.
Finally, we understand that the conversation about indirect costs is just a piece of a much larger conversation about funding and how nonprofits achieve impact and scale. That larger conversation includes the need for nonprofits to understand their full costs, the role of general operating support and multiyear funding, and the importance of capacity building.
Make no mistake. This is hard work. But it’s important work for the social sector to embrace and advance. We’re eager to join with others on this journey and to contribute what we can.