When I explain what Kinder does I usually get great responses. People are enthusiastic about the fact that there is a company that evaluates charities, ensuring donations go to reliable development projects. Although most people don’t have extensive knowledge about the charitable sector, most of them have heard of the most popular ones — i.e. WWF, Oxfam, Doctors without borders (MSF) — and have donated to one or two charities in their lifetime.
Most people I speak to are happy to share some of their wealth, I have never met anyone who didn’t want to donate out of greed. I have, however, met a couple of people who have decided not to donate because of uncertainty, scepticism, and myths that have engulfed the charitable sector.
The myth: charities’ high overhead costs waste money
In the years of conversations about the benefits of people ‘making sure donations have the most impact’, I’ve noticed a recurring theme. Namely, that people don’t want their donations to be ‘wasted’ on overhead costs — things like administrative tasks, operations, internal infrastructure, and salaries.
Many people feel strongly about their donation going straight to the end beneficiary: that it shouldn’t be used for anything ‘wasteful’ within the charity. To them, transparency is being able to see exactly how their donation reaches the end beneficiary.
I will be completely honest — before learning anything about international development and the charitable sector, I used to think the exact same way. Why would a director's salary be so incredibly high when that money could go straight to a vulnerable family? Why would you ‘waste’ money on overhead costs when that money could be used to buy 15 cows for a community?
Interestingly, research reflects what I noticed during the above conversations. A study from the Texas A&M University found that firstly, “many donors report relying heavily on overhead cost metrics when choosing a charity” and secondly, “donors exhibit a strong distaste for charities that report high overhead coast, even when there is no relationship with the charity’s effectiveness”
Busting the myth: low overhead costs do not equal effectiveness
To someone without knowledge about the charitable sector, I can see why low overhead costs might seem like a desirable goal. It’s reasonable to assume that the less charities spend on overhead costs, the more they can use for projects, and the more effective their work is.
In reality, this is rarely the case. While it’s a reasonable deduction, assessing a charity’s effectiveness on overhead costs alone is quite misleading — and can cause more harm than good. Measuring the effectiveness or impact of a charity is a very complex process, and using overhead cost as the main indicator conceals other crucial factors.
The Starvation Cycle
The vicious cycle of overhead underfunding — fuelled by the overhead myth — was exposed in a 5-year research project by the Stanford Social Innovation Review. They named this The Nonprofit Starvation Cycle.
There are three stages to this cycle. In the first stage, funders have unrealistic expectations of how much it costs to run a nonprofit organisation. During the second stage, nonprofits, who heavily rely on funders, feel the pressure to conform to their expectations.
This results in the third stage, where nonprofits respond to the pressure in two ways. Firstly, they are pressured into spending too little on overhead costs. Secondly they underreport their expenditure. The underspending and underreporting results in more unrealistic expectations from funders. Over time, as the stages of the cycle repeat themselves, funders believe that nonprofits can do more with less and less. Ultimately, the nonprofit ends up starving itself trying to live up to the expectations of funders.
A major factor in the success of any organisation is its employees. No company can become sustainably successful without having experienced, motivated, reliable, and creative employees. The same goes for non-profits.
Staff wages generally make up a large chunk of overhead costs. When these are kept as low as possible, charities have to decide between paying their employees’ below-market salaries, (and forgo experience and highly skilled employees for high positions), and cutting employee numbers, which risks overworking them.
The pressure of keeping overhead costs as low as possible can result in charities finding it hard to compete for skilled labourers. A third option is taking on volunteers, but I think we can agree that no organisation can effectively run on volunteer staff alone, especially over a long period of time.
Infrastructure and Implementation
The same goes for any necessary infrastructure within the charity. Funder pressure can force charities to underinvest in necessary infrastructure — automatically decreasing the quality of their projects.
Funders want to see projects with positive impact. This ultimately means that any successful planning, monitoring, and completion of a charitable project will need high-quality resources that might fall under ‘overhead costs’. Charities that have fallen into the starvation cycle, and are attempting to do more with less, will end up having to cut costs for overhead resources — resources that might have been useful in the delivery of the project.
Although it may not seem reasonable to the donor, spending money on certain overhead costs can improve project impact enormously. For example, using donations to fundraise further and spread awareness might not yield immediate results, but it could prove to be incredibly effective in the long run.
Charities that build robust infrastructure, like a sturdy IT system, financial systems, employee skill training, fundraising processes, etc, are much more likely to plan and deliver successful projects. And that is essentially what both charities and donors want.
I think we can all agree that a charity should use funds to be as impactful as possible. But at times funders can hold too much power, and put too much pressure on charities. In fact, charities themselves know best how to spend their money. Sometimes that might mean high salaries for an executive with a decade of experience, or extra costs to infrastructure that can maximise project delivery in the future.
Overhead costs should definitely not be ignored, but it’s important to understand that they don’t paint the whole picture, and can’t serve as the main metric of evaluating effectiveness. Alternative and more complex measures are much more useful, which is one of the reasons our charity evaluations are more holistic.
Check out how we evaluate charities here.