The Starvation Cycle and the Problem with Program-Based Funding
At root, restricted funding stems from a lack of trust in nonprofit organizations. Whether the concern is inefficiency, mismanagement, or even fraud, the result is the same. Program costs are deemed virtuous, while overhead expenses are all but stigmatized. Unfortunately, rather than making nonprofits and their programs more efficient and effective, this line of thinking shoots them in the foot. That’s because even the leanest, most streamlined social impact organization has overhead costs. Those costs are a necessary part of the package. And they aren’t going anywhere.
To put the perpetual underfunding in perspective, consider this: Major foundations traditionally put a 15 percent cap on overhead reimbursement. Yet a recent study of twenty nonprofits found that indirect costs make up between 21 and 89 percent of direct program costs. Even the organizations with the lowest overhead costs had expenses totaling more than 15 percent of direct costs. And the median rate found in the study — 40 percent — is nearly three times the typical 15 percent cap.
The study also found that different types of nonprofits have different overhead costs. For example, research laboratories were found to have consistently higher overhead costs than direct services agencies (primarily because of the high cost of research equipment). Among for-profit businesses, this sort of industry-by-industry variation is expected and understood. But the same can’t be said for segments in the nonprofit sector. The takeaway? One size doesn’t fit all. A flat-rate overhead reimbursement of any amount doesn’t make sense.
The current funding practices mean that nonprofit organizations are almost always running their operations on a serious deficit. With the ever-present specter of empty coffers, nonprofits operate in starvation cycles and with a scarcity mindset. They are unable to compete for the best talent, retain staff, build capacity, and ultimately achieve the impact they aim to create.
For many nonprofits, true cost funding is a critical component to breaking the starvation cycle.