The Nonprofit FAQ

I always get lost in these discussions of 'administrative' and 'fundraising' 'costs'. I'm not quite sure what the issues are.

First. Rich Steinberg (of Indiana U) makes a persuasive case that donors should not be concerned about average costs (ratios) in evaluating the performance of organizations which seek donations as one of the ways they raise the money they need to operate. You can read the technical argument (which I found quite difficult) at pp 347 ff of Susan
Rose-Ackerman, ed., The Economics of Nonprofit Organizations (Oxford, 1986 -- now [2001] out of print).

You can also see some less formal discussion of the topic online by reading other sections of the Information for Nonprofits website (see especially http://www.idealist.org/if/i/en/faq/142-154/74-89).

The nontechnical argument goes like this. If I am a donor who wants to see a goal accomplished, I should be happy if my donation leads to more progress toward that goal. Only when the marginal return from fundraising efforts is negative -- ie, the last dollar spent results in less than a dollar of contributions -- does the fundraising effort impede my interests as a donor. Steinberg points out forcefully that it is a serious mistake to confuse average costs -- say over a year -- with marginal costs. In fundraising as in other economic activities, one theoretically optimal situation (except in perverse cases which economists delight in defining but real-world folks can usually ignore) is the point where marginal costs equal marginal revenues -- other
optimal points are likely to result in less total production.

Of course (A) it is very hard to manage in terms of marginal costs, so managers use other strategies to try reach their goals. Arbitrary caps on certain classes of expenses are a bad strategy. They lead to inefficient forms of resource substitution and morally destructive prevarication in accounting. I think you can observe the ill-consequences of both if you survey the nonprofit scene in America today.

And (B) there are all sorts of efficiency and comparative arguments that need to be considered when the donor has a choice among "competing" organizations committed to overlapping but not identical strategies for accomplishing the desired goal and using different resource and management combinations in their work.

But, consider two organizations -- each with a budget of $1,000,001 -- to make my point by an extreme example.

One plans to pay a genius $1 to solve the problem completely after spending $1 million to raise that dollar and find that genius (it will have only $1 of 'program' expenses!).

The other plans to spend $250,000 on fundraising, $100,000 on
administration, and $650,001 on paying many less talented people lesser amounts of money to work on, worry about, but not solve the problem.

They both need just one more dollar to complete their fundraising and implement their plan.

Which would you rather donate to?

(Of course, of course, most of the problems people in the nonprofit sector address don't fit that example as they are not the sorts of things that can be 'solved' once and for all, but rather require continued, dedicated and often thankless work to be dealt with as best we know how. But the issue about the effectiveness of a donation doesn't go away for all of that, it just makes it even harder to think about.)

Donors should be encouraged to think about these kinds of questions. Not to look for arbitrary (and easily manipulated) statistics.

Second. Whose interests are we concerned with here?

Large organizations, with well-recognized names, face very different challenges in raising money when contrasted with start-ups.

Some services and programs predictably tug at the heartstrings of donors. Others are hard to explain and difficult to understand. One sort of service will have different fund-raising strategies (and goals) from the other.

Some services are difficult and dangerous to administer, imposing significant risks and burdens on their leadership staff and volunteers. Others are slam dunks (not really, I know!.... but comparatively).

Again, their cost experiences are likely to be different.

Arbitrary caps on fund-raising and administrative costs will favor organizations which engage in relatively risk-free activities that are easy to explain to prospective donors and have achieved a relatively high level of public recognition.

If our goal is to protect donors from dishonest organizations that present themselves as charities but which are in fact fronts for fund-raising as an end in itself, then we should insist on greater clarity and comparability in the reporting of outcomes and efficiency in services, not on nuances of cost-accounting in the non-service part of their work.

If our goal is to promote overall efficiency in the provision of public goods -- to encourage organizations that use the least possible resources (whether cash donations, volunteered time and talent, in-kind support, or user fees and payments) to produce the maximum amount of benefit for the community -- then again we should be looking at outcomes, though we might attend more to cost accounting practices in order to avoid being misled by focusing just on the resources that are easy to account for.

Third. The American Institute of CPAs has been working for some time on guidelines which will significantly alter the way costs are allocated by charities among "program", "fundraising" and "administration." As I read the draft, few well-known organizations will be able to follow these new guidelines honorably and report program expenses equaling 75% or more of their total annual budgets. (For a discussion of AICPA SOP 98-2, see http://www.idealist.org/if/i/en/faq/225-211/28-64.) This change will follow close on the heels of the new FASB standards (116 and 117) which have pushed most organizations in the direction of reporting higher revenues and more substantial assets than appeared in their books under the previous standards. (Note 10/17/97: These new standards have been issued since this paragraph was written. They are discussed in http://www.idealist.org/if/i/en/faq/501-39.)

If donors (1) pay attention to the "real" financial statements of organizations and (2) have been educated to take rule-of-thumb ratios as strong indicators of performance, then we can expect a serious communications and public-relations problem as these new rules begin to take effect.

To conclude....

To my taste, the challenges facing the nonprofit/fundraising community at the moment are