News and analysis
May 19, 2013

Overhead Costs Pose Dilemma for Charities

The International Rescue Committee's eight-page newsletter to supporters in the fall of 2012 emphasized how the humanitarian charity spends its money.

Last fall, the International Rescue Committee mailed an eight-page newsletter to supporters that highlighted the work it was doing to help people displaced by famine, drought, and conflict in Africa’s Sahel region.

It included photos, articles, interviews, and statistics—and a prominent pie chart labeled: “IRC efficiency.”

The chart broke down how the humanitarian charity spends its money, showing that 93 percent goes to programs and services and just 7 percent to management and fundraising.

“More than 90 cents of every dollar we spend goes to our programs for refugees in over 40 countries and 22 U.S. cities,” an accompanying fundraising letter states.

Such high spending on programs has helped the IRC win high marks from charity watchdogs—four stars from Charity Navigator and an A+ from CharityWatch.

But its emphasis on efficiency is in some ways running against the tide.

A growing number of nonprofit experts have been trying to woo charities away from emphasizing their overhead costs, urging them instead to tout what they say donors should really care about—whether their work is making any difference.

'Destructive’ Efficiency

That notion has gained fresh currency thanks to buzz surrounding a talk by Dan Pallotta, an author and consultant, at a TED (Technology, Entertainment, Design) Conference in March titled “The Way We Think About Charity Is Dead Wrong.”

In a speech that has been viewed online more than 1.6 million times, Mr. Pallotta said: “The next time you look at a charity, don’t ask about the rate of their overhead, ask about the scale of their dreams.”

When a charity emphasizes how much it spends on programs, it “does a real disservice to the nonprofit itself and to the nonprofit sector as a whole,” says Nell Edgington, president of Social Velocity, a nonprofit-consulting firm.

All charities need to spend money on things like staff, technology, and office space, she says: “If you didn’t have those pieces, you wouldn’t be able to have a program. It’s meaningless at best and destructive at worst.”

But nonprofit managers say not all donors see it that way: They might be interested in a charity’s dreams, but they also want to be sure that the bulk of their money is paying for actual services, not exorbitant fundraising or administrative costs.

“Our major donors, people who give five- and six-figure gifts annually, tell it to our fundraisers, that they consider this very important,” says Edward Bligh, vice president at the International Rescue Committee.

He says the group’s high “efficiency” ratio is also highlighted in lists of big charities that appear in publications like Forbes and the Christian Science Monitor.

“Donors are more carefully scrutinizing the charities they want to make an investment in,” says Daniel Nisbet, vice president for development at Feeding America, which told recipients of a recent fundraising letter that “97 percent of operating expenses go to programs designed to advance our mission of a hunger-free America.”

That percentage comes up regularly when his group calls to thank donors who have made gifts of at least $500, Mr. Nisbet says.

“They often cite that they know about our efficiency, how far their money is going,” he says.

Counting Donations

However, that kind of pressure also prompts charities to seek ways to make their program costs look as big as possible, sometimes using questionable accounting techniques that attract the attention of regulators and journalists. For example, the Internal Revenue Service has said it is reviewing how groups value donated goods, which constitute a big chunk of program costs for some charities.

Just last month, following a Chronicle investigation, World Help, a Christian relief nonprofit, said its revenues were only 7 percent of what it had previously reported to the IRS because it had overvalued donated medicines that it said it provided to other charities.

But even under less-controversial circumstances, the definition of program costs can be elastic. Take United Service Organizations, which provides entertainment and other programs for military troops and their families. Toward the end of last year, it sent a holiday fundraising letter that included a pie chart stating that “90 percent of USO’s expenses are directed to support our troops and their families.”

But its 2011 Form 990 tax document tells a different story: 71.5 percent spending on programs, 11.7 percent on management and general expenses, and 16.8 percent on fundraising.

USO gets to 90 percent by adding more than $200-million in donated facilities, celebrity performances, and public-service advertising—items it is not allowed to count on its Form 990 but that it reports on its financial statements. This is required by generally accepted accounting practices because it would otherwise have to pay for them.

It makes sense to count those donations as program costs since accepting them frees up money for programs, says Kelli Seely, the organization’s senior vice president for development.

Daniel Borochoff, president of CharityWatch, a watchdog that calculated USO’s program at 63 percent when awarding it a grade of C+, says including services like those don’t tell donors how their cash is being spent. “When somebody gives money to USO, they’re not paying for those PSAs,” he says.

Nevertheless, USO officials say the “efficiency” pie chart is an important fundraising tool. Gena Fitzgerald, USO’s vice president for communications, says results are 5 to 10 percent higher when the chart is included in letters seeking new donors.

Inconsistent Accounting

Even when the accounting methods are more straightforward, the way charities calculate program costs is inconsistent, nonprofit experts say. Organizations can include as “program-service costs” on their tax forms a portion of their spending on items like salaries and benefits, rent, information technology, lobbying, travel, and conferences. They may divide an executive director’s salary, for example, among programs, administration, and fundraising, according to how much time he or she spends on each activity.

But those breakdowns are “close to meaningless” because accounting standards offer little guidance about how to calculate them, says Murray Covens, a grant-seeking consultant at North Texas Nonprofit Resources. “You could talk to five accountants about the same organization’s books and find five different answers about how to allocate expenses between programs, administration, and fundraising.”

Some nonprofit experts wish charities would drop the talk about program spending altogether because it fosters an atmosphere that could deter groups from making needed investments for fear of increasing their overhead costs.

“The more you focus on how high your percentage is, the more you suggest to the donating public that’s what the donating public should be paying attention to,” says Bennett Weiner, chief operating officer at BBB Wise Giving Alliance, a nonprofit watchdog.

Tom Ahern, a donor-communications consultant, faults United Way of Rhode Island for telling donors that 100 percent of their gifts support community programs. That is only possible because an industrialist, Royal Little, set up a trust fund in the 1930s to pay for the charity’s administrative and fundraising costs, he says. “It implies that the United Way is so super-duper efficient that somehow they’re able to have a nice building with a lot of staff, everybody gets paid well, and yet, magically, the donor dollar is not tapped for that.”

Chris Medici, a United Way spokesman, says his group tells donors that 100 percent of their donation “goes back out into the community” but regularly repeats the story about Mr. Little’s gift, for example when it makes presentations to companies about workplace giving. “It’s a part of who we are, a part of our DNA,” he says.

Donors’ Expectations

One reason the public judges charities by their spending is that it is hard to find other ways to evaluate them.

In response to criticism about overemphasizing finances, the watchdog Charity Navigator has been expanding the criteria it uses to rate charities. It began in 2011 to consider how open and accountable groups are and this year announced a project to rate the quality of results that they report publicly.

But it could be a tough haul weaning donors away from caring how much of their money goes to directly help a charity’s beneficiaries.

“Most donors would like to have 100 percent of their money going to the thing they’re trying to support,” says Soledad Gompf, vice president for new business development at Finca International. The charity, which provides loans and other financial help to the world’s lowest-income entrepreneurs told recipients of a recent mailing that 93 percent of their donation would support its programs. “I meet with all of our major donors,” she says. “When they look at the annual report, for example, when they look at the material they get, or look at proposals, they’re looking at that piece of information.”

Send an e-mail to Suzanne Perry.