Guest post – Unintended consequence: the pressure for ‘good’ overhead ratios creates pressure to get GIK

The following guest post was submitted to me by a reader. As with other guest posts, this is his/her opinion and does not represent the opinion or experiences of his/her employer. It also does not represent my opinion.

I wrote the headline. I hope it captures the tone of the post.

For your consideration:

The more and more that I hear about the “controversy” over pharma values, the more and more it shows the completely unnecessary overreliance on overhead rates as a mean of valuing charities. Think about some of the issues that arise from the use of overhead rates:

  1. Charities feel pressure to increase revenue (Charity Navigator expects 10% a year growth in addition to low overhead and high net assets)
  2. Charities may get into a donation that can quickly boost revenue without adding fundraising cost (like GIK, or dewormers)
  3. Charities forgo donations when they no longer provide high enough revenue (charities now are using far less dewormers because they no longer have high revenue value)

What does this mean?

When I first started working with NFP’s after working solely with for-profits, one way I kept my focus straight was to remind myself that these are expense companies, not profit. What I mean by that, is the point of a NFP is to produce “good expenses.” The expenses of a NFP are their core, their programs, the good they are doing for the better of our world, the fulfillment of their mission and exempt purpose. A NFP should be doing everything they can to make they expenses do the most good possible.

With the increasing focus on overhead rates (I don’t have enough history to know if the focus has increased or decreased over time, but it seems overly high now), the focus has then shifted to revenue value. Admin costs are what they are, it takes a certain amount to run an organization, and even more to run it well (see TED video in early post). So an organization is left in a bind with these options:

  1. Raise admin costs and have a more effective organization, but get killed by media/watchdogs and lose donations.
  2. Lower admin cost and have a less effective organization, but get praised by media/watchdogs.
  3. Keep admin costs the same but raise revenue and get praised by media/watchdogs.

Most, if not all, NFPs want to do the most good the most effectively. They want to help people.

Option 1 is tempting, but the fallout is considered to be unbearable. Option 2 is equally unbearable because NFPs want to do their work well. So, as long as the focus is solely on overhead rates, Option 3 remains. How then does an organization raise revenue without investing any fundraising costs?

The focus on overhead rates has caused the shift for these orgs from being “good expense” companies, to “maximum revenue” companies. The key to getting the praise from the media/watchdogs has been GIK.

Look at the highest rated charities on Charity Navigator (http://www.charitynavigator.org/index.cfm?bay=topten.detail&listid=113).  All are GIK-based orgs.

With that pressure, what would you expect?

With GIK being the magic bullet, can we condemn organizations for seeking GIK that maximize revenue? Aren’t people getting what they asked for when they pushed overhead rates as the best measure of charities?

With focus now on revenue, the unintended consequence is when a particular GIK no longer provides the needed revenue value (i.e. pharma) charities are then encouraged to no longer use that GIK in their programs, having possibly a profound effect on the people they are trying to serve.

It’s true that charities are wrong for manipulating revenue in this way, if any charities are doing so. But we asked for it when we pushed overhead rates. The whole controversy around pharma valuations is based solely on overhead rates. If that was a not a measure of charities, then pharma values would not matter.

More voices like Dan Pallotta need to speak up about the real correlations between efficiency and effectiveness, and we should all encourage watchdogs to move toward reporting on effectiveness.

Jim’s comments: Many thanks to the author for this guest post.

What do you think? Do we need a better measure for NPOs than overhead ratios?

What could that tool look like?

3 Responses to Guest post – Unintended consequence: the pressure for ‘good’ overhead ratios creates pressure to get GIK

  1. DJ says:

    This is a far more worthy discussion to have (as it addresses the underlying issues) than digging down into accounting minutia in an attempt to standardize accounting practices and asking questions that have no clear answer.

    Excellent post.

  2. David says:

    “It’s true that charities are wrong for manipulating revenue in this way, if any charities are doing so. But we asked for it when we pushed overhead rates. The whole controversy around pharma valuations is based solely on overhead rates. If that was a not a measure of charities, then pharma values would not matter.”

    This is the one spot within an otherwise outstanding post that i have to disagree with. If charities are willfully manipulating revenue, inaccurately booking purchases as GIK, revenue booking when they are not involved in the supply chain in a meaningful capacity, etc. then this is wrong. I can not absolve a charity simply because the environment forced them into it.

    The thief who steals a loaf of bread for starvation may have mitigating circumstances but they still stole. Their circumstances give rise to understanding but not to excusation.

    having been said, the solution to the starvation does not come in the form of harsh punishment but in addressing the underlying causes and remedying them. as is the point of this post.

    charities need to be ranked and graded on the success of their programs or on how well they deliver on their charitable mandate.

    “…if you judge a fish by its ability to climb a tree, it will live its whole life believing that it is stupid.”

    • Jim Ulvog says:

      David:

      I think we can distinguish between two behaviors. There are several caveats in each of these examples. If I’ve not drawn them extreme enough I can rewrite them.

      First, a charity that seeks out GIK, is involved in obtaining them from a donor, gets them to the ultimate user and thus books it as GIK revenue.

      Second, a charity that has no involvement but gets “pretty words on paper” (Don’t remember who first used that phrase and don’t want to be bothered to look it up) and thus books it as GIK revenue.

      The first charity is working within the accounting rules, even if the med isn’t related to their overall purpose. The second charity is outside the accounting rules.

      How you characterize each organization depends on your own ethical framework. My guess is most people would see a big distinction between those two organizations. On the other hand, they may both be responding to the pressures identified in the post.

      You can use the word ‘manipulating revenue’ for one, both, or neither of the two examples I just gave, depending on your definition of words and your ethical values.

      Jim

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