It is nice that the authors of “Pay-What-It-Takes Philanthropy” mention my critique of the idea that foundations should fully fund all indirect costs: I believe that is a losing battle. However, it feels strange for the authors to mention the critique one page into the article and then spend the rest of the article arguing for the full funding of indirect costs.
There is a powerful reason that funders cap the reimbursement of overhead or indirect costs at a low level. It is because the characterization of these costs (as “overhead” or “indirect”) establishes them as not relevant to the object of the funders’ investment. The grantees willingly collude with the funders to create two classes of costs—relevant and compelling “program costs” and irrelevant and useless-sounding overhead/indirect costs. The funders want a particular program to happen, so they fund the program. Then they are brought a bill for costs that sounds like something they shouldn’t want and, because of that, they don’t particularly want—overhead/indirect costs—and are asked to pay for it. They don’t want it because it is characterized as something completely distinct from their desired thing—the program.
It is like asking a restaurant guest to pay for the meal and then in addition pay an administrative fee of 40 percent for the restaurant furniture, fixtures, taxes, utility bills, location, and view. Obviously the guests would balk when the two pieces are characterized that way. Instead, the restaurant defines the “program” to include the infrastructure and ambiance, not just the food, and it structures its prices accordingly.
I have shown elsewhere (“Rethinking the Decision Factory,” Harvard Business Review, October 2013) that the entire world of business is shifting from direct costs to indirect costs. In business, the former are costs of goods sold—purchased inputs, direct labor, etc.—and the latter are sales, general, and administrative expenses, which include items like R&D, marketing, and talent development. Over the past 30 years, SG&A has nearly doubled from 13 percent to 24 percent as a percentage of revenues of the 30 companies comprising the Dow Jones Industrial Average. Is this a bad thing? No, it is a reflection of the ability of these companies to make their offerings more compelling by adding value to the direct costs—for example, by doing more R&D to produce a more advanced product, or doing more advertising to build a stronger brand.
When selling their products, America’s best companies don’t tell customers that the product costs $76, but they would also like them to pay a $24 indirect cost premium. They say, "That will be $100, take it or leave it." And they don’t attempt to pacify investors by keeping sales costs, R&D spending, and advertising costs at a bare minimum. Their job is to figure out a productive way of producing a high-quality product that customers adore. And the answer as to how to do that, from America’s most prominent and successful companies, has been to dramatically increase investment in what foundations would call “non-program costs.”
This is not a semantic question—it is a strategy question. Currently, funders and grantees are following a losing strategy of suppressing investment in what the most successful organizations in the country are expanding. The only folks who are suffering are the people they are both attempting to help. It is always thus: Customers are hurt the most by flawed strategy.