Charity Overhead

April 17th, 2013 by Potato

Here is a recent TED talk on philanthropy and advertising you should go watch.

This is an interesting perspective. As someone who is currently “overhead” I can, to a certain extent, agree. Besides my current day job, I also recently picked up an interesting freelance gig. A donor hired me to rewrite and revamp a fundraising brochure for a local hospital. Because I’m being paid directly by the philanthropist and not the foundation, my fees will not appear in their books as overhead, though I hope that the work that I’ve done indeed helps multiply the donations they eventually receive regardless. (You can see a PDF of the brochure here.)[Update: I did a second related one.]

To some extent there is a need for scale in philanthropy. A charity attempting to say fund research looking for a cure for cancer is not going to be able to make much of a dent with an annual budget of $100k — that’s barely one research grant (and even then the lab has to have some other source of core funding). It takes millions to be able to have enough to get together a panel of peer reviewers to examine grant proposals, or to buy expensive pieces of infrastructure such as PET scanners. And that takes some kind of investment to scale up — whether resources for advertising, or the volunteer effort to go viral on the internet.

But there’s a limit. At some point you could just be raising money to pay people to try to raise more money. In the talk he mentions that charitable giving has been stuck at 2% of GDP for decades. If there is some sort of mechanistic reason for that — it’s the amount people are capable of giving, or some sort of unconscious philanthropy budget in the population as a whole — then pushing for more overhead is just shifting the charity spending around, and in fact a net negative due to the overhead. It is possible that, by being able to tackle large challenges smaller organizations could not, we would be better off with one (or a few) massive billion-dollar charities spending a total of $240B than with a bunch of smaller million-dollar charities spending $275B with lower overhead costs. But if outcomes are directly related to dollars spent, more overhead would indeed simply mean more waste.

Consider a parallel with investing: you could pay a brilliant manager some percentage of your funds under management, and they might be able to beat the market for you. But there’s only so much return out there to be had: if everyone else hires an investment manager then everyone is on an even footing and is back to getting basically average returns… less the overhead to the managers.

There were three other points of his I want to discuss.

The first was on compensation. The big unanswered question for me was whether you would get value for that extra $300k spent on talent in his hypothetical. Perhaps everyone is better off if the MBAs pursue for-profit $400k salaries and donate $100k to the charity, who can then hire an $87k/year executive. If the charity tried to hire someone for $400k, would they get more than the ~$300k difference back in value? Charities, after all, don’t have all the things to manage that for-profit businesses do: maybe the extra money buys you advertising and capital markets experience, which you just don’t need as a non-profit. And why doesn’t that logic apply all down the chain? We pay grad students and post-docs a disgraceful pittance for trying to find the cures to our modern medical ailments, but brilliant technically-minded and driven people can make far more in the private sector. Would we have long since solved this pesky cancer problem if we were only willing to retain top talent in the research enterprise by setting post-doc starting salaries at $400k, and grad student stipends at $75k?

The second was on the whole comparison of the for-profit and not-for-profit sectors. You see, the two are very different fundamentally. When I give my money to Coca-Cola for a beverage, or to Amazon for a book, I am transacting with them for something. I don’t care how much they spend on overhead, because I am making my decision on whether or not to give them money based on what they are giving me in return at that moment. I need to only extend a small amount of trust to them (trust that Coca-Cola hasn’t diluted my Coke Zero, trust that my book from Amazon will arrive undamaged in a under a week), and I have recourse if my trust is violated: I can demand my money back, sue for breach of contract, etc. But once I send my money to them and receive my item, it is no longer my money. It’s their money, they can do with it as they wish.

Giving money to a charity is a completely different thing. I’m not getting a thing or a service, I’m giving my money to the charity to make the world a better place. I am trusting them to put my money to good use. Though the money is out of my hands and I have no recourse to get it back once I give, at no point do I consider it “their money” to do with as they please. Maybe they could give me a better “product” if they spent three times as much on overhead as I had reasonably expected — but that is a lot of trust for me to give. While only people donating staggering amounts of money expect to be able to direct their donations precisely, I still expect that, in general, my donation will be used for the stated purpose — ultimately mostly directed towards some kind of program spending rather than churning overhead or as risk capital. Their use and governance of the money will continue to be the concern of the donors, and so there is a very real reason for spending on overhead and risky activities to be perceived differently than in the for-profit sector.

In an analogy to investing, let’s say that there was a company that raised $100M in a stock offering to pursue a business idea. They went out the first few years and spent $90M of the money doing what had to be done (hiring people, renting office space, advertising etc.). After a few years of losing money they discover that the business model is just not viable. To continue is to throw good money after bad so they wind up operations. As a shareholder, through the first few years you would have been obliged to let management take the risk and pursue the business, spending your capital on whatever “overhead” was needed to do so. After it failed, you would expect that any residual money ($10M in this example) would be returned to you as the business was shuttered, and promptly. If they dragged their feet in the wind-up, paying salaries for years, burning through your capital with no purpose you would rightly be pissed at that loss.

In the not-for-profit sector, overhead spending that is going to have a multiplicative effect is difficult to discern from the telemarketer full employment program. How do you know whether you’re in the phase of risk capital spending that is pursuing the innovative business model with lots of potential, versus the phase that is basically the insiders stealing from the other contributors of capital? The risk-reward equation is not the same in the not-for-profit and for-profit examples, and the governance is different: profits are much easier to measure than “impact” or “do-goodery”. And as unethical and despicable as it was for the executives in the hypothetical example to burn the remaining shareholder capital after it was clear nothing would come from it, it is even more morally repugnant to live large off people’s charitable donations — hence the aversion to overhead spending.

And the last point I wanted to discuss was that of spending more overhead as a percentage to scale up. In the presentation he just kind of implicitly assumes that to scale up an organization might have to spend a larger percentage on overhead. But should this be so? Shouldn’t scaling up offer economies of scale? If instead of spending $100 to raise $1000 at a bake sale, a charity should spend $100M on organizers for a massive event and TV air time, then shouldn’t that investment be expected to pull in $1B for program spending, rather than just $250M as his 40% figure would indicate? Now again, maybe the efficiencies come on the spending side (perhaps spending $250M in one organized way with a unifying strategy does more cumulative good than spending $1B in separate $1M chunks).

So while I can see some of his points about needing large-scale charities to tackle large-scale problems, and that sometimes investments have to be made (to train people, to build infrastructure, etc.) and sometimes more overhead has to be spent (for strategy, for advertising), I do not fully agree. Sometimes overhead is just money not going to program spending, and I would hope that scaling up would bring about more efficiency rather than less. The not-for-profit and for-profit sectors are have larger fundamental differences than he suggests. And when you come right down to it, I want to be able to know that my charitable donation is going towards the stated purpose and not to the Canada Foundation for Telemarketer Employment. Maybe looking at the percentage of spending on overhead is not the best way to choose where to donate — perhaps we need some impossible measure of impact per dollar donated — but we will naturally gravitate towards metrics that are easily enumerated.

3 Responses to “Charity Overhead”

  1. wayfare Says:

    “If they dragged their feet in the wind-up, paying salaries for years, burning through your capital with no purpose you would rightly be pissed at that loss.”

    Nope… not bitter at all.

  2. gabor Says:

    The link to the pdf gives a 404 error. There is a missing quotation mark at the beginning of the A tag’s href attribute. Or an extra at the end… depends how you look at it :)

  3. Potato Says:

    Thanks gabor, I fixed the link, and also added one to a second related brochure.

    Note that the fancy font effects don’t show up properly in the built-in Firefox browser reader for PDFs, but if you opt to open in Acrobat reader it should display fine.