Underspending on Overheads

In 2013, Dan Pallotta made a mess of the assumed function of charities by suggesting that society sets rules to disincentivize performance, to the detriment of all.  One of his issues is executive compensation, which is constrained in the charitable world.  It is virtually impossible for charities to attract, motivate, and keep the talent necessary to produce the outcomes we so badly need and want, as governments and corporations hand over responsibility for programs and services they can’t or won’t deliver anymore.

The case is made again, from a different perspective by Hector Mujica and Narinder Dhami in an editorial about the retarded pace of innovation in the non-profit sector.  Their point is that donors and funders put such a premium on financial efficiency that there is no margin for experimentation and improvement in non-profit organizations.  While the other two sectors have made innovation a central objective, with varying degrees of success, most non-profits compete to do more with less every year, with no opportunity to convert accumulated and acquired insights into innovative change.

Given their obvious resource challenges, our non-profits should be equipped to become aggressive learning organizations.  But, with the way donors and funders evaluate them, many are kept in the corner with dunce caps on, while the other sectors have budgets for risk, innovation, and improvement.  While there are many exceptions to this rule, the existence of this pressure, and its cumulative effect over decades, is undeniable.

It’s a hard thesis to accept for those in the field.  There was a time in the 70s and 80s when non-profits were seen as innovators with something to teach corporations about creativity in areas like strategy formulation and solution design.  Business leaders sent their managers into arts organizations to learn skills like collaboration and innovation.  However, creativity in non-profits’ programming and service didn’t always translate into creativity in the generation of new resources, in their management of assets, in their financing of new ventures, or in their cultivation of talent.  It simply wasn’t affordable.

This is a theme NetGain has raised before and is one that is timely now for a different reason.  Our clients often come to us on the precipice of accomplishment or disaster.  Either they are faced with a great opportunity to accomplish something new or are faced with a challenge that could end their existence.  In both scenarios, the moment is fraught with peril because of their marginality.  In the same way that talent and innovation are underdeveloped because we systematically reward the groups with the leanest budgets, we also thwart growth or tip organizations into decline by prioritizing false efficiencies.

These are false efficiencies because we all know that learning organizations become more efficient, prosperous, and self-reliant than dumb organizations that scrape by repeating past behaviours while the world changes around them.  As Pallotta points out, we get uncomfortable when a non-profit succeeds too well.  When they start to register budget surpluses, tax officials and many supporters become suspicious.  Instead of incentivizing success and the enhanced capacity and quality of community service it enables, the tendency is to limit support, restrict their latitude, and hinder them with copious amounts of reporting.

Unlike the great majority of valued and respected organizations in other sectors, our clients and their peers have been established and have grown without access to capital.  They were founded by volunteers with a bit of money and have financed their accomplishments through a combination of sweat equity and donations until they’ve attained a sufficient degree of legitimacy with donors and funders to operate in a stable but marginal way.  There they languish, straining to stay solvent, trying to grow and change, while comforting their supporters that they remain suitably marginal.  A kind of desperation sets in, compounded by limited access to executive and managerial talent, until a critical moment when they’re confronted by risky propositions with acute consequences.  It is often in those “grow or die” moments that they acquaint themselves with consultants like us.

Imagine if new business startups didn’t have any capital to risk on the years of operation required to achieve profitability, or if a new government agency, like an academic institute, was expected to have an immediate impact with no guarantee of sufficient or sustainable funding.  We’d all still be farmers, lumberjacks, and fishermen.  Yet that is the condition in which we keep our third sector, despite the rising importance of non-profits in our communities and economies.

The specific mechanism, which has repeated in annual funding cycles for decades, is the tracking of overhead costs.  We have a societal mistrust of non-profits that pay too much for the people who do the work, yet we criticize the limited skills and competence of the sector when problems occur.  There is also a general mistrust of non-profits that invest too much in facilities, except when they are facilities named after, and enjoyed by, their charitable donors.  Opera Halls can raise tens of millions in capital and bear the names of their donors, for example, but for food banks, this is not so easy.

Facilities and real estate are becoming a major focus for NetGain and its urban clients because these are often the second largest category of overhead cost after staffing (see our posts here, here, and here, for instance).  As land prices skyrocket and affordable space, in good condition and practical locations, consumes more of the non-profit’s budget, they must either shrink or grow.  They can economize by reducing expenses in other critical areas, such as wages or program delivery, but this is ultimately fatal.  Or they have to solve their real estate problem by increasing revenue.  The problem is that funding agencies and donors, guided by indices, like Charity Intelligence Canada and MoneySense, rank their efficiency according to overhead costs and space costs that are beyond their control.

There are solutions to the real estate problem.  There has to be because attitudes aren’t changing fast enough in response to people like Pallotta, Mujica, Dhami, and others who have noted the inadvertent ways in which our tax rules and funding habits have hamstrung charities and hampered their maturation into strong, sustainable corporations.

In our view, the space shortage is much less acute than it seems.  It’s wrong for so many underhoused non-profits to be spending so much on badly located and maintained space, especially when a portion of their public and private sector subsidies are diverted from programming or staff remuneration to cover rising real estate and associated costs.  Although this is only one aspect of the problems arising from a 19th century attitude to charitable corporations in 21st century societies, it’s an urgent problem because it is growing fast in hot real estate markets, and because it is, in our view, soluble.

More to come...

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