Recently, the leaders of the three leading sources of information on nonprofits in the US – GuideStar, Charity Navigator and BBB Wise Giving Alliance – penned an open letter to the donors of America denouncing the “overhead ratio” as a valid indicator of nonprofit performance. Their effort included a new website, a social media campaign and a petition to encourage others to pledge an "end to the overhead myth."
The announcement caused no small amount of amusement and some consternation. As Trevor Neilson said recently in the Huffington Post, the announcement sounded to many who read it a bit like "donut shops denouncing donuts." The fact is that while these rating organizations have played an important role strengthening charity accountability, they have also helped create the very obsession with overhead rates they are now endeavoring to dispel. But their announcement was big news. Private philanthropy in this country exceeds $300 billion a year (American individuals, corporations and foundations gave $316.23 billion to charity in 2012, according to the latest edition of Giving USA). And philanthropists in the US rely on the ratings from these three organizations to help guide their giving.
What prompted the announcement? Looking at overhead rates does make intuitive sense: presumably, the less an organization spends on administration the more it spends helping people. And the more money goes to the people you are trying to help the more good your dollars do, right?
Measuring EffectivenessA relatively new e-publication by Saundra Schimmelpfennig on the subject is highly instructive about the pitfalls of this measure. Schimmelpfennig’s core message is very clear throughout the publication:
"While there is waste and fraud in the nonprofit world, these problems are not uncovered by looking at an organization’s administration ratio. In fact little can be learned by the administration ratio as it’s often more a reflection of the organization’s accounting practices than anything else."Overheads do contain some useful information. The problem arises because this metric has become the leading measure of effectiveness and efficiency - and to some the only measure. Overhead ratios can be manipulated and the undue emphasis on overhead ratios as measures of effectiveness and efficiency has ended up making nonprofits less of both. A 2010 US Government Accountability Office (GAO) report put it well: “A vicious cycle is leaving nonprofits so hungry for decent infrastructure that they can barely function as organizations—let alone serve their beneficiaries." (Read the full report).
Nonprofit spending on training and IT, two areas that I would argue require constant renewal and improvement, is a fraction of what for-profits spend in these two areas. Is it because nonprofits do not need as sophisticated an investment in these and other related areas as for-profits? Of course not. It is because of the misguided belief that a low overhead is somehow virtuous and a high overhead is a sign of waste. Getting as much of the donor dollar to the field is imperative but it cannot be at the expense of needed investments in organizational effectiveness.
Look at our own organization. As a relatively large nonprofit with thousands of donors across the country, we need a sophisticated management information platform. When I came on board as the CEO a bit over 2 years ago, we were still using a system built from scratch 15 years ago, on a computer code no one could remember. Fifteen years! Given the speed of innovation in IT, it might as well be 150 in human years. The system met our needs at the time it was developed. But we failed to invest regularly on information systems upgrades and over time the system was less relevant to our changing needs and more expensive to adapt and update. By 2011 operating and maintaining this system was painful and unaffordable. We finally bit the bullet and embarked on an overdue information system modernization initiative that year. We have also begun investing in staff training across the board. We need to come up to the 21st century. Without these investments, our efficiency (which without a doubt had been dropping - even as our overhead ratio held steady), would continue to drop.
Robert Kaplan at Harvard wrote a decade ago:
"success for nonprofits should be measured by how effectively and efficiently they meet the needs of their constituencies. Financial considerations can play an enabling or constraining role but...do not relate to overall organizational mission and objectives."In other words, financial measures (including operational ratios) capture important elements of organizational success, but these need to be complemented with measures that try to capture progress towards the mission. This includes measures of program quality and impact (“Are we doing the right things?” Are we doing things right?” “Are we making a difference, i.e. are children and their communities better off now than before Plan partnered with them?”) and sustainability (how does the organization think about sustaining results and initiatives beyond the life of the funding and if we go back ten years later to communities where Plan worked, are the positive changes still present? Have they grown?). And good measurement without good learning is not very valuable. How well an organization learns and feeds back the learning into capacity development and activity design and execution also matters, particularly in terms of its future viability and success.