The Overhead Myth: What’s All The Fuss About?

The nonprofit world has been abuzz with talk about the “overhead myth.” What is it, how does it affect us, and why should we care?

1. Understanding The Overhead Myth

Recently, GuideStar, Charity Navigator, and the Better Business Bureau Wise Giving Alliance started a collaborative campaign to change the way people measure a nonprofits’ success. Their campaign, called The Overhead Myth Campaign, is aimed at “denouncing the ‘overhead ratio’ as a valid indicator of nonprofit performance .”

For those unfamiliar with the term, “overhead ratio” refers to the amount of money a nonprofit spends on its mission versus money spent on overhead costs. Overhead costs include things like rent, employee salaries, administrative costs, and bills. Donors often expect charities to maintain a very low overhead — some watchdog groups maintain that overhead costs should only account for as little as 25% of total expenditures — and are criticized for high overhead costs.

The organizations’ letter asserts that evaluating nonprofits’ effectiveness by their overhead ratios is a dangerous practice that leads to something they refer to as the Nonprofit Starvation Cycle. In the cycle, nonprofits are so concerned with limiting their overhead that they lack the resources to work effectively. Because they are unable to work effectively, they make too little money to boost their fundraising efforts and bring in more donations. The campaign also notes that unrealistic expectations about overhead costs result in increased pressure for nonprofits to manipulate cost reports and tax documents.

Sounds bad, right? The writers of the Overhead Myth letter think so, anyway. Although they’re not saying that people should stop evaluating a nonprofit’s overhead ratio entirely, they are saying that donors should also look at metrics like “transparency, governance, leadership, and results.”

2. Why Now?

The issue of nonprofit overhead has been around for a long time. But a couple of notable recent events have brought the topic to the forefront of the nonprofit world’s conversation.

First, one could reasonably argue that the recession and the state of the economy has contributed to the use of overhead ratios as a way to evaluate nonprofits. As increasingly cash-strapped donors trim back their own expenses, they want to feel like their charitable donations are being used effectively. Those donors, despite their good intentions, perpetuate the “nonprofit starvation cycle” with their expectations. This is all purely speculation on the author’s part, of course, but current economic circumstances could definitely explain the increased scrutiny of charities’ spending.

The conversation really heated up when Dan Pallotta presented his now-famous TED Talk called “The way we think about charity is dead wrong.” The video is absolutely worth a watch: Pallotta “calls out the double standard that drives our broken relationship to charities” and proposes that nonprofits be rewarded for their effectiveness instead of what they spend. Pallotta’s TED Talk quickly circulated through the nonprofit world and has sparked lively debate about the relationship between nonprofit organizations and the public. While I doubt that Pallotta’s Talk directly influenced the decision to start the Overhead Myth Campaign, it did set the stage for a pointed conversation about the use of overhead ratios in the nonprofit world.

3. Want to Learn More?

There’s an astonishing number of blog posts, news articles, videos, and discussions about overhead ratios. Here are some of my favorites:

• Six Reasons Non-Profits Fail, Reason #4: Obsession with Percentages: Although this article is from February of 2012, the author candidly points out how some nonprofits respond to the pressure of maintaining low overhead.
• What Do Good Outcomes Cost?: Nonprofit advisor Ann Goggins Gregory discusses different ways nonprofits can address the overhead myth.
• Nonprofit Emaciation: Confessions of a Do-Gooder Who Starved an Organization: A blunt, thoughtful look at one nonprofit’s struggle with overhead costs.
• Overhead Ratios are Essential for Informed Giving: CharityWatch asserts that overhead ratios are an important way to judge a nonprofit’s effectiveness.