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Seeking Solution to Nonprofit Starvation Cycle, Leaders Call for New Sector Financing Models

June, 2016

The Bridgespan Group has issued a new study that advocates for re-thinking the typical 15 percent cap on nonprofit overhead reimbursement. Citing the need to end the “widespread, vexing starvation cycle” of underfunding and underinvesting that prevents nonprofits from maximizing their impact, Bridgespan is calling for an approach grounded in the real costs of providing a given type of service, what they call “pay what it takes” philanthropy.

Understanding real costs: To  gain a better understanding of what nonprofits actually spend on indirect costs—those not attributed to a specific program or service—the researchers examined the financial records of 20 well-known, high performing nonprofits and reported that their real indirect costs comprised between 21 percent and 89 percent of direct costs. According to the study’s co-author and Bridgespan Partner Jeri Eckhart Queenan, “We now have proof that we are systematically and chronically underfunding nonprofit organizations and this evidence should inform foundation and government policy on the reimbursement of indirect costs.”

There is no one-size-fits-all-financing model: The authors found that nonprofits can be segmented based on what they do and how they do it. This research on cost structure identified four distinct segments: US-based direct service; policy and advocacy; international networks, and research organizations. For example, the study reported that nonprofit research labs have a median indirect cost rate of 63 percent because of the nature of their work not because they are inefficient, but it is nearly two and a half times the 25 percent median rate of direct service organizations covered in the Bridgespan survey.

According to Bridgespan Manager Michael Etzel, one of Eckhart Queenan’s co-authors, “This research offers a path forward, one by which we have cost data by segment, and can benchmark nonprofits by type, and nonprofits against similar for profits.”

Etzel continued, “This variance in indirect cost rate mirrors the industry segmentation long recognized in the private sector, which if adapted could be a great learning benefit in the nonprofit sector.” Among companies in the S&P, for example, consumer staple companies have a median indirect cost rate of 34 percent, while information technology companies reach 78 percent. The paper’s third co-author, Bridgespan Consultant Sridhar Prasad said, “These costs drive value and impact in both the private and nonprofit sectors. Flat indirect cost or overhead rates are wrong and 15 percent is too low.”
Change is underway: Some foundations are beginning to change this practice. Ford Foundation President Darren Walker is among funders most outspoken in calling for a new grantmaking approach. Beginning in January 2016, Ford doubled its overhead rate to 20 percent. In doing so, Walker said he “hoped to encourage more honest dialogue about the actual operating costs of nonprofit organizations.”
Added Etzel, “If nonprofits would commit to understanding their true cost of operations and if funders would shift to paying grantees what it takes to get the job done, the starvation cycle would end. The grantmaking conversation would shift from an emphasis on what it takes to fund a program to what it takes to build strong organizations and achieve impact.”
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