Happy Birthday Overhead Myth. Please Die Now.

Can you believe that 10 years have passed since Charity Navigator and Guidestar declared war on the Overhead Myth? 

And that 10 years have passed since Dan Palatta’s presentation damning the Overhead Myth became the most popular nonprofit TED talk of all time?

If you know anyone looking for a poster child for zombie beliefs, tell them we’ve found one for them!

This myth:

• Limits the ability of nonprofits to do good in the world

• Incentivizes illegal and unethical behavior

• Feeds a penny-wise, pound-foolish culture

Therefore, I hope you’ll join me in working for its speed demise.

What is the Overhead Myth?

The Overhead Myth states, in a nutshell, that the percentage of expenses a nonprofit spends on administration and fundraising can tell you how much good they do in the world. 

Too frequently, donors and grant makers see a nonprofit that spends 20% or even, gasp(!), 25% on overhead and choose not to fund them because of that.  They hold rigidly to the myth rather than asking deeper questions like “how much impact will my gift to this organization have?”

The myth gets reinforced by grantors and donors who restrict their donations to programs … as if the programs could do their work without good administration to make sure the lights come on, technology functions, and staff get paid.

Where did it come from?

We can trace elements of the Overhead Myth back 400 years to Plymouth Rock and the Puritan settlers.  Their culture punished joy and leisure, valued extreme self-sacrifice, and dealt harsh punishment to anyone who didn’t adhere to their rigid beliefs.

These days, just like a swamp will breed mosquitos, IRS Form 990 creates fertile ground for the Overhead Myth.  This form, completed by just about every nonprofit in America, provides the only universal set of data that allows us to compare nonprofits.  Unfortunately, that data says very little about actual lives saved, trees planted, or other impact measures.  The closest the 990 comes is the allocation of expenses across programs, fundraising, and administration.  That’s how it has become a proxy for impact.

A few nonprofits even cultivate the myth.  They have independent funding, like an endowment, that covers administrative costs.  So they promote themselves to donors by saying that 100% of the donation will go into programs.  These organizations, whether through ignorance or indifference, do serious harm to nonprofits as a whole.

Harm #1:  Bad incentives corrupt people

The overhead myth tempts otherwise honest people to game the system.  And once someone stretches the truth a bit, it become easier to stretch it a bit more, and a bit more until they ultimately become quite comfortable lying and with other forms of corruption.

Where does this temptation lie?

The overhead ratio depends on how a nonprofit’s expenses get allocated.  Who allocates the expenses?  Staff do.

The Overhead myth incentivizes staff to allocate spending and staff time more generously to programs than they might otherwise.  When the consequences a big overhead ratio include losing key funding, layoffs, and closing a nonprofit entirely, “generous” allocations of spending can easily become complete fabrications.

But what about auditors?  Wouldn’t they catch that?

Maybe.  Sometimes.  Some auditors. 

However, auditors get the records that they audit from staff and they only scrutinize a small percentage of all transactions.  If staff have made generous allocations in the accounting, many can escape the notice of even a diligent auditor.

And we need to remember that auditors also have incentives.  Auditors typically get paid by the nonprofit, not by the donor, and they want to keep their customers year over year.  So they have incentives to ignore a little exaggeration here and there. 

Harm #2:  Cheap over frugal

We would never actively encourage anyone to be penny wise and pound foolish, but that’s exactly what the Overhead Myth does.  It creates a mentality of scarcity and starvation so strong that too many nonprofits take it for granted that they must spend the least amount possible in the short-term (cheapness) rather than looking at what is cost effective in the long-term (frugality).

Case in point:  Once upon a time, I got to work with a great nonprofit.  It had smart, dedicated staff; a blue-ribbon board; lots of respect in the community; and they made a big difference for those they served.

Then I got a look at their computers.  Everyone was using a laptop they’d received second hand from a grant maker that had decided they were too worn down and obsolete for their own staff.  Many wouldn’t hold a charge while others needed constant tech support.  All moved slowly and needed frequent rebooting.  On top of that, this equipment created morale problems because of the message they sent about the value of staff’s time.

I pointed this all out to the executive director, who by all accounts was a smart, business-savvy person.  My initial communication plan, “this is so obviously bad,” fell on deaf ears.

So I crunched the numbers to paint the picture. Using conservative estimates, I demonstrated that those old laptops cost the nonprofit $1,500/year per employee in lost productivity.  Meanwhile, good, new laptops might cost only $700 and can last 2-5 years.  That led to that nonprofit making more and more frugal decisions (rather than cheap ones).

Harm #3 and beyond

How else does the zombie hurt the nonprofit sector?  How about:

• Staff Recruiting and Retention.  Many nonprofits pay their staff below market rates.  And, money represents a serious incentive for people, especially if they have dependents like kids, or have student loans, or don’t have a million dollar nest egg.

• Misdirected charitable giving.   Can we all agree that actual impact, and being effective, is more important than the overhead spent on overhead?  If so, we should want funders to nonprofits that have a high impact per dollar donated and not to nonprofits that have low overhead but also low impact?

• Innovation.  When nonprofits have to scrimp on nickels and dimes, and barely have enough staff and resources to cover their day-to-day operations, how can they possibly take a risk on trying something new?  

Well how much should nonprofits spend on overhead? 

Recent research suggests that the most impactful nonprofits spend around 35% on overhead.  That’s a big difference from the 10-20% that some nonprofits find themselves locked into. 

Ultimately, the overhead percentage is the wrong question

What’s the right question, then? 

Impact. 

For example, for every dollar spent:

• How many children got to eat a nutritious meal?

• How many acres got reforested?

• How many addicts have stayed clean and sober?

• How many lives got saved?

And doesn’t measuring impact make more sense anyway?

Measuring impact puts our focus on how well an organization delivers on their mission.

Have you ever seen a successful nonprofit that had “low overhead expenses” as their mission?

So please join me in this fight against the overhead zombie.  We can’t let its birthday cake get another 10 candles!