Report: Focus on Low Overhead Hurts Nonprofits

When it comes to nonprofits, mission is paramount. But overhead is still a necessary part of the equation, and charitable groups are often encouraged to keep their spending very low.

A new study from the Bridgespan Group, however, has a fresh take on the issue: Nonprofits shouldn’t have to starve their infrastructure spending in the name of keeping overhead low. Instead, the study argues, foundations should “pay what it takes” to build out that infrastructure.

The argument already has some fans among major philanthropic firms.

“All of us in the nonprofit ecosystem are party to a charade with terrible consequences—what we might call the ‘overhead fiction,’” noted Ford Foundation President Darren Walker in comments to the Stanford Social Innovation Review  (opens in a new tab). “The data included in this article along with comparable data for our grantees convinced us that we had to make a change.”

Walker’s group doubled its investment in overhead as part of its most recent funding round, based on the study’s research. What’s in the study that inspired such a dramatic change? Well, here are a few of the key points:

Indirect costs are higher than budgeted. The study, which analyzed 20 high-performing nonprofits in a variety of sectors, found that indirect costs (the study’s more inclusive term for “overhead”) made up an average of 40 percent of the organization’s total costs—in some cases, far beyond the 15 percent overhead rate allotted by most foundations.

Different types of nonprofits have different needs. A research lab and a global NGO with a wide network of affiliates tend not to have a lot in common, other than the fact that they’re both in the nonprofit space. Because these organizations are so different, they often have different spending needs, with network and field management the most important cost for the NGO, and equipment the biggest cost for the research lab. By putting a firm cap on indirect spending by each organization, it can limit how well these organizations conduct their respective missions. The study showed that one of the research organizations analyzed had indirect costs that teetered near 89 percent, with physical costs the biggest point of pressure.

The focus on low overhead hurts charitable efforts. One group cited by the study, the head of a girls’ mentoring organization, said that the philosophical focus on keeping overhead low has led to disinterest in the real picture by foundations. “They don’t want to listen,” the CEO said. “So we have to have two budgets: one that has the real numbers, and another that shows the funders what they want to see. If you don’t give them what they want, they won’t give you any money.”

By making the point in the study, Bridgespan hopes to encourage a rethinking of how overhead is perceived by foundations and other donors.

“If nonprofits would commit to understanding their true cost of operations and if funders would shift to paying grantees what it takes to get the job done, the starvation cycle would end,” Bridgespan Manager Michael Etzel, a study coauthor, said in a news release  (opens in a new tab). “The grantmaking conversation would shift from an emphasis on what it takes to fund a program to what it takes to build strong organizations and achieve impact.”

The full study can be read on the Stanford Social Innovation Review  (opens in a new tab) website.