The Vicious Cycle of Low Overhead

(Sept. 1, 2009) As if making the case for overhead for the long-term health of your organization wasn’t difficult enough … now there is additional pressure to cut costs. Nonprofit leaders say it’s time to break the cycle of unrealistic expectations for overhead spending.

In the Fall 2009 issue of the Stanford Social Innovation Review, authors Ann Goggins Gregory and Don Howard of The Bridgespan Group describe the “nonprofit starvation cycle.” They write that a vicious cycle fuels the persistent underfunding of overhead and describe the cycle of inadequate funding in three stages.

The first stage in the cycle is “funders’ unrealistic expectations about how much it costs to run a nonprofit.” Funders demand extremely low overhead expenditures in proportion to direct program expenditures. At the second stage, “nonprofits feel pressure to conform to funders’ unrealistic expectations.” Organizations are afraid to lose critical funding, essentially feeling caught between a rock and a hard place. And at the third stage, “nonprofits respond to this pressure in two ways: They spend too little on overhead, and they underreport their expenditures on tax forms and in fundraising materials.” This underspending and underreporting in turn perpetuates funders’ unrealistic expectations.

Over time, the article says, funders expect grantees to do more and more with less and less—a cycle that slowly starves nonprofits.

If you are feeling the pressure to fund programs at the expense of critical overhead—such as technology systems to work better and more efficiently (and save money!), skills training and fundraising infrastructure—now may be the time to grab the wheel and steer funder and donor expectations back on course. Urge them to focus on the end results—the impact of your organization’s programs—and not simply overhead to program spending ratios.

Proof Is in the Pudding

Blogger Kate Barr of Balancing the Mission Checkbook goes so far as to say that she simply doesn’t care about overhead ratios and explains why in her blog post. “I care that they are effective nonprofits that can tell donors what they do and why it matters,” she writes. She explains that she is concerned about impact, not ratios, when she donates to charities.

However, steering outside expectations will require a larger movement among nonprofits, say Gregory and Howard. “Although several factors drive the cycle of nonprofit starvation, our research suggests that taking action at the first stage—funders’ unrealistic expectations—could be the best way to slow or even stop the cycle,” they write. “Changing funders’ expectations, however, will require a coordinated, sector-wide effort. At a time when people need nonprofit services more than ever and when government is increasingly turning to nonprofits to solve social problems, this effort is necessary to keep nonprofits healthy and functioning.”

Refocusing Attention

“Funders need to refocus their attention on impact by asking ‘What are we trying to achieve?’ and ‘What would define success?’” explain Gregory and Howard. “In so doing, they will signal to their grantees that impact matters more than anything else. Even focusing on approximate or crude indicators (for example, ‘Are we getting an A or a C on our impact goals?’) is better than looking at cost efficiencies, as focusing on the latter may lead to narrow decisions that undermine program results.”

Funders must also clearly communicate their program goals to their grantees, they say. Having established that funders and grantees share the same goals, funders should then insist on honest answers to the question “What will it take to deliver these outcomes consistently, or to deliver these outcomes at an even higher level of quality or quantity?” The answer to this question, in short, is adequately funded infrastructure—otherwise known as overhead!

Click here to read the full Stanford Social Innovation Review (SSIR) article, “The Nonprofit Starvation Cycle.”