OPINION How not to choose a charity: the folly of overhead ratios

publication date: Sep 27, 2013
author/source: Alexandra Tzannidakis

To the ongoing despair of the nonprofit sector, the number one criterion that potential donors use in selecting a charity continues to be the ominous “overhead ratio.” In the face of all the information available to them about their options, donors tend to zero in on a charity’s overhead expenses as shorthand for its effectiveness. See, for example, Hope Consulting’s very thorough 2010 report entitled Money for Good

After all, every donor wants the most bang for their donated dollar. More’s the pity, this fixation on overhead is encouraged by the Canada Revenue Agency via its guidelines and forms.

Downright deceptive

The problem is that the overhead ratio is simply not the definitive metric of efficiency that people think it is. In fact, it is often downright deceptive. Spending money on a solid administrative structure can be vital to the success of a charity’s efforts. Indeed, the demonization of overhead costs has led to a situation where many charities are really under-spending in that area and doing themselves, their beneficiaries, and their donors a disservice in the process.

The emotional nature of charitable giving can perhaps blind people to the reality that charities are still very much businesses - as they must, and should, be. The difference is essentially in their goal: they have donors who want program results, instead of shareholders who want profit results. But just because the destination of the money generated is different, it doesn’t mean the internal mechanisms for generating it are necessarily different.

Measure impact, not overhead

Like any for-profit business, the administrative costs of a charity can be crucial to maximizing its output. The question should not be how much an organization is spending on overhead, but whether its output metrics show that its internal expenses are efficient at producing program results. A charity that thoughtfully spends 20% on overhead may well be making a much bigger impact through its programs than one that haphazardly spends 10%.

The takeaway here is not that more overhead directly equals better programs, but rather that the overhead ratio is not a useful or informative measure of a charity’s worthiness when considered alone. Comparison research conducted in the UK on 265 charities from 2008 to 2011by Giving Evidence and Givewell shows that low administrative costs do in fact tend to correlate with poor performance.

Donors not mission experts

The root of the trouble seems to be the simple fact that a donor is not in the best position to determine how their donation should be spent. That information is in the hands of the people who organize and direct the charity, and understand its needs and functions.

Different types of charities require greatly differing amounts of overhead: for example, a group home will have much more overhead than an organization that exists simply to funnel money to other charities through a website. Any endeavour that is operating offshore will immediately create more overhead due to Canada Revenue Agency requirements about retaining control over foreign activities. One well-compensated professional may bring far greater success to a group’s mission than ten well-meaning but clueless volunteers. Saving up for a large project next year may synergistically multiply the value of every dollar that goes toward it.

You can’t sell coffee without a roof

This intensification of resources is the very value of a business structure, and people recognize the truth of this in their daily lives. They know that you need to spend money to make money. They know that opening a chain of cafés is much more expensive and potentially much more profitable than running a coffee stand from your front yard. Shareholders do not complain that money is going toward rent rather than coffee beans. So why does this logic not transfer to the nonprofit sector? 

Donors want emotional payback

The notion of altruism is a funny one, in that the more selfless a gesture is, the more likely its maker is to want a specific kind of payment for it. Donors want the emotional pay-off of seeing the impact of their hard-earned money. If I were to donate $100 to a disaster relief effort, I may feel personally affronted by the idea of that money going to the charity’s infrastructure rather than being traded directly for food and blankets for the victims. I am robbed of my hit of emotional pay-off. If my donation were ten times that amount, my irritation would no doubt increase correspondingly.

A lack of emotional payoff may make donors feel used. The crux of this problem is, of course, that charitable giving is emotionally motivated. This is paradoxically also its strength, as without emotional motivation people might just think, “I pay my taxes. That should be enough.” Something extra is required to motivate voluntary actions, and that “something” is feelings.

Nonprofit professionals struggle eternally with this paradox: how to make the necessary emotional appeal to draw in donations, without trading off control over how the money is to be spent. In a recent open letter to the donors of America, the heads of GuideStar, Charity Navigator and the Wise Giving Alliance implore people to stop using administrative and fundraising costs as a measure of effectiveness.

Genuine altruism sets feelings aside

And yet, donors remain fixated on the overhead ratio as an indicator of how good they will be able to feel about their donation. The true altruism would be to forsake personal feelings and rely on a sound examination of a charity’s output metrics, so that your donation will actually make the biggest impact - regardless of where exactly in the large puzzle of a charity it is spent.

Alexandra Tzannidakis is an associate at Drache Aptowitzer LLP, where she practices tax, corporate and charity law. After earning her undergraduate degree from McGill University, she studied law at the University of Leicester in the United Kingdom. Alexandra frequently writes on topics of interest to charities and nonprofit organizations. Her work has appeared in various publications, including The Canadian Taxpayer, Canadian Not-For-Profit News, Hilborn Charity eNEWS, and Thomson Reuters’ Taxnet Pro.

Contact her by email.

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