The other day a very thoughtful friend told me he’d like to pull together a list of recommended nonprofits for his co-workers as a way of raising visibility and funds, and he wanted my suggestions.  We were talking about what the list should look like in terms of geographic focus, issue area, etc., and he said, almost as a throwaway line, “…and we should make sure none of them spends more than 10% on fundraising.”

He didn’t mean it this way, but it could have sounded like, “Let’s make sure none of them spend too much money doing what you do.”

So let’s dig a little deeper.  What he’s essentially saying is, “let’s make sure the organizations aren’t wasting money,” and unfortunately “overhead spend” is the unbelievably blunt approximation we have of wasting money.

A great comment on my blog last week, in another post where I riffed on the overhead ratio test, put this point very well, concluding:

There are horror stories of huge sums burned by inefficient organisations. It isn’t bad guys, frauds or scammers. It’s just organisations that don’t do as good a job…In some cases almost all of the money donated goes into running the bureaucracy of the organization itself. In some cases, fundraising itself costs more then the activities it funds.

…How do you avoid donating to companies like this? Well, you might find that most great organizations have a 20/80 overhead/programs ratio…The problem with this is that it is incredibly crude. If all else is equal, a lower overhead is certainly good but all else is never equal…

I understand what you are saying. I agree. You’re right.

But what is the alternative?

It turns out that a number of “rating agencies” in the nonprofit space have banded together to answer this question, with the goal of creating a quick and easy way to rate the effectiveness of nonprofits.  Tim Ogden, Editor-in-Chief of Philanthropy Action, recently issued a press release titled “The Worst (and Best) Way to Pick a Charity,” and the release was signed by the CEO’s of Guidestar and Charity Navigator, the two organizations that have arguably done the most to create the “10% overhead” rule of thumb in the nonprofit sector.  Hats off to Tim for kicking this off, and to Bob Ottenhoff (CEO of Guidestar) and Ken Berger (CEO of Charity Navigator) for signing on to the release and for helping push this conversation forward.

Some thoughts on how this might play out:

1. Changing perceptions about this will be hard. Convincing someone that your new idea (product, story) is better than the one they currently believe in (purchased) is harder than selling them on a brand new idea (this is part of the reason the iPhone still beats the pants off of the Palm Pre – iPhone created the category, and the Pre is trying to be improvement on the iPhone).  So getting people to let go of the overhead ratio myth will actually be harder than it was to convince them of the myth in the first place.  For any real traction, this thing needs a breakthrough idea, message, and advocate.  In fact, I bet you most people don’t even know where they first heard the overhead ratio number.

2. Effectiveness is the right goal, but will we ever get there? The push to replace the overhead rule of thumb with an effectiveness rating feels right, though I worry that executing on that promise will be elusive.  There are lots of players pushing this forward, but I’d feel a lot more comfortable if the push were towards “here are the questions we want to ask” rather than “here are the answers.”  I know the world wants a star rating for everything (including the food we buy at the supermarket), but can’t we do better?

3. The endgame is creating better stakeholders. Let’s learn from the field of socially responsible investing.  A lot has gone into ratings of public companies, and the track record is decidedly mixed: attempts to make ratings more sophisticated have generally resulted in less transparency and objectivity.

The real power of these ratings comes not from the ratings themselves (with retail shareholders and consumers somehow knowing if companies are good or bad), it comes from shareholder activism – as information becomes more available, passionate followers create a dialogue with companies that can turn the dial on accountability.  If ratings can create real dialogue (hopefully with much less acrimony than exists with public companies) we’ll make more real progress (and for this to happen, the raters have to be held accountable too…)

4. If you must talk about overhead ratios, ask about efficiency. Since I doubt that the myth of overhead spend is dying any time soon, why not in the meantime promote a marginally better measure: measure fundraising efficiency (how much does it cost to raise $1) rather than how much fundraising is done (fundraising as a % of total spend).  I’m not sure I care if a nonprofit with a great mission spends 8% or 18% of its budget on raising funds – assuming they can spend the funds they raise wisely.  But I do care if a nonprofit spends 4 cents to raise a dollar or 40 cents.  While neither of these numbers tells me anything about the effectiveness of the nonprofit as a whole, all in all I’d rather make a bet on the one that’s more efficient.

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