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Why Is Overhead Expected in the For-Profit Sector, but a Punishable Offense for Nonprofits?

How the perception of overhead is hurting the causes we love

Somewhere along the way, our society decided to think differently about overhead in the nonprofit and for-profit sectors. This decision did not consider the consequences and how it can negatively affect the organizations that could change the world. Why is it that we consider helping people to be worth less compensation, and that a career that helps no one should be worth over double the salary? How can nonprofits scale, and therefore expand their causes, when they are expected to forego investment? Wouldn’t we prefer that a cure for cancer be found, or every person on Earth have clean water, no matter how much the organization spends on administration?

First, what is overhead?

Overhead expenses are budget items that include rent, administration costs, salaries, and bills required in order to operate. A nonprofit’s overhead ratio often comes into consideration when donors determine their contributions and refers to the money spent by the nonprofit on overhead, versus the amount spent on the mission.

Both nonprofits and for-profits have overhead expenses. However, if a nonprofit is spending less on overhead, does that make it more worthy of our donation?

The consequences of avoiding investment

Dan Pallotta summarizes five issues nonprofits face when they can’t invest in their business in his Ted Talk titled, “The Way We Think About Charity Is Dead Wrong.” With the current stigma around overhead, nonprofits are unable to:

  1. Lure top talent away from the for-profit sector
  2. Advertise on the same scale as the for-profit sector
  3. Take risks in pursuit of new customers
  4. Have the same amount of time to find customers as the for-profit sector
  5. Access the stock market to fund their businesses

As Pallotta states in his talk, the social issues we face, whether they be homelessness or human rights, are large-scale issues, and our organizations are tiny in comparison. Unfortunately, our beliefs around overhead keep them tiny, and result in two separate rulebooks for the nonprofit and for-profit sectors.

Nonprofits face the imbalance

Lyda Salatian, the founder and executive director of Green Teams of Canada, a nonprofit based in Vancouver, BC, has experienced this problem first-hand as her organization struggles to receive funding. Green Teams is devoted to gathering young Canadians outdoors, providing gloves, shovels, and loppers along with opportunities to restore ecosystems and increase biodiversity. However, with a large volunteer base of more than 6,000 volunteers, people often assume that Green Teams is solely volunteer run.

“Charities conjure up images of people devoting themselves to helping a cause without asking for anything in return,” Salatian explains. “Over the years, we’ve been asked: ‘What do you do as a day job?’ ‘Why don’t you get a volunteer to run your activities?’ ‘Can we pay you in plants and trees?’ and ‘What will the volunteers think if they hear you get paid for this work?’ It sends a message that, while they love the work we do and want us to keep doing it, we don’t deserve to get paid for it.”

Why Is Overhead Expected in the For-Profit Sector, but a Punishable Offense for Nonprofits?

Green Teams of Canada volunteers, organized by the Green Teams staff, gather to remove invasive
plants and plant native species in their community. Image from Green Teams of Canada.

Compensation is key

Compensation appears to be at the heart of the issue when it comes to our perception of overhead. A CEO of a cancer agency making a comparable salary to an executive whose company makes violent video games for children appears nearly parasitic, as opposed to adding greater value to the world. In his TedTalk, Palotta references a survey by Businessweek that looked at the compensation packages for MBAs 10 years out of business school. The median compensation for a Stanford MBA, with bonus, at the age of 38, was $400,000. Meanwhile, they found the average salary for the CEO of a $5 million-plus medical charity in the United States was $232,000, and $84,000 for a hunger charity. It seems unlikely that many talented people will be willing to sacrifice $316,000 every year to become the CEO of a hunger charity.

This problem isn’t reserved for multi-million dollar charities; it trickles down to grassroots organizations, as well. Rather than being concerned with attracting top talent or mass marketing, they are more concerned about keeping the lights on. Without donations, they struggle to receive sufficient grants to remain operational, and their limited staffs struggle to manage data, monitor finances and administration, and manage their offices. Without dedicated, qualified people, effective programs wouldn’t exist.

“We have made a significant impact in our communities because we are skilled, passionate and dedicated to the work we do,” Salatian notes. “We are just as professional, fast-paced and disciplined as for-profits.”

About 62 percent of Americans think that nonprofits spend more than is reasonable on overhead.

This is problematic, considering nonprofits still need to pay for office space, computers, marketing, and staff. So how was this perception created? The idea that overhead ratios are a sufficient ranking system for effectiveness comes from a variety of sources:

  • Charity Navigator, which is now updating its ranking system to be less focused on overhead.
  • Journalists, who often report on overhead.
  • Nonprofits themselves, which include figures regarding the dollars spent on services in their marketing efforts or under-report their overhead.
  • Donors, who have few other metrics with which to evaluate nonprofits.

As a result, a vicious cycle begins, as those desperate for solid infrastructure are eventually unable to function as organizations – let alone serve their missions. Ann Goggins Gregory, COO of Habitat for Humanity, Greater San Francisco, emphasizes the importance of nonprofit leaders living by an important philosophy: “Organizations that build a strong infrastructure and invest in maintaining that foundation are more likely to succeed than those who do not.”

Where do we start in countering the ingrained perception of overhead?

In order to work against it, we first need to identify the origins of the issue. This can be tricky, as the dysfunction is a succession of problems that act in tandem. In a Stanford Social Innovation Review article coauthored with Don Howard, “The Nonprofit Starvation Cycle,” Goggins breaks it down into three problems that create a vicious cycle:

  • Donors’ unrealistic expectations about how much it costs to run a nonprofit.
  • Nonprofits awareness of these unrealistic expectations, and their attempts to adhere to them.
  • Nonprofits response to this pressure, which takes two forms:
  1. They lower their overhead.
  2. They underreport their operational costs on tax forms and in marketing.

Because of this underspending and underreporting, donors’ unrealistic expectations are maintained and nonprofits struggle to do more with less to keep up. Ultimately, this cycle starves nonprofits and prevents them from funding their missions.

While several factors contribute to this perception, Goggins’s research suggests that tackling donors’ unrealistic expectations may be the most effective place to start. This would need to begin with honest and open communication between donors or grantmakers and the nonprofit, to better understand the true amounts that go into operational costs. Additionally, without proper data, funders do not know what realistic overhead rates should actually be. Organizations like GuideStar are committed to providing donors with relevant and reliable data that enables donors and nonprofits to make more informed decisions that are not solely based on overhead figures. 

Without overhead metrics, what should donors consider?

Donors should focus on results and plans for the future that will elevate and scale the organization and their cause.

“Next time you're looking at a charity, don't ask about the rate of their overhead. Ask about the scale of their dreams, their Apple-, Google-, Amazon-scale dreams, how they measure their progress toward those dreams, and what resources they need to make them come true, regardless of what the overhead is,” recommends Pallotta. “Who cares what the overhead is if these problems are actually getting solved?” This puts the value on the organization’s ability to invest, rather than stifling such investment.

Meanwhile, GuideStar, BBB Wise Giving Alliance, and Independent Sector developed  five Charting Impact questions that , that nonprofits allow nonprofits to share results:

  1. What is your organization aiming to accomplish?
  2. What are your strategies for making this happen?
  3. What are your organization’s capabilities for doing this?
  4. How will your organization know if you are making progress?
  5. What have you accomplished so far and what’s next?

GuideStar also offers nonprofits the opportunity to provide metrics showing their progress toward their missions. Organizations provide this information by updating their GuideStar Nonprofit Profiles. Updating is free.

Closing Thoughts

Ultimately, public perception of overhead creates a vicious cycle that negatively affects nonprofits. It is not an issue that can be solved with ease. Resolving the problem, or even just slowing this cycle, requires a sector-wide effort to change donor expectations, establish open and honest communication, and manage and accurately report costs. In 2013, GuideStar, BBB Wise Giving Alliance, and Charity Navigator launched the Overhead Myth campaign to do just that. (Read more about this effort on the Overhead Myth website and in this blog.) But the need to change public perceptions persists.

While monitoring and understanding nonprofit costs is important to catch fraud and ensure funds are reaching the intended causes, establishing dialogue creates transparency and encourages nonprofits to measure their impact, and then adapt. Allowing organizations to make investments and scale can ultimately result in real change. However, this will never occur unless we can abandon demoralizing the causes that make valuable contributions to our communities, health, and global well-being through the expectation of low overhead.

Why Is Overhead Expected in the For-Profit Sector, but a Punishable Offense for Nonprofits?Katie Tatham is a content marketing specialist at iATS Payments. Katie has been part of the Customer Care, Onboarding, and Marketing teams at iATS, giving her the unique opportunity to work with nonprofits and understand the challenges they encounter. She enjoys helping nonprofits tell their inspiring stories and sharing them within the nonprofit and technology sectors. When she is not writing, she spends her time cooking, or outside hiking and playing field hockey.

Topics: Overhead Myth Overhead Ratio