Non-profit organizations provide much needed services and programs in social services, the environment, the arts, and so much more. Their work benefits everyone in our communities, and is only possible with the public’s support. Most of the money non-profits raise goes to program delivery, but some also must go towards administrative costs. Should non-profits operating expenses be supported by a portion of our donations? How have your or your friends’ perspective on the issue of administrative costs changed over the years? Have you ever declined donating to an organization because of reported excessive administrative costs?

We invite you to comment on our blog, as well as suggest topics for future discussion.

February 8, 2010

Author: Kelvin Lui, University of Toronto B.A.Sc. Engineering Science Student and Endeavour Consultant

My thoughts to those suffering in Haiti.

As we watch the aftermath of the destruction on TV, many of us have responded by donating to various charities. However, I saw something on CBC News a week ago which bothered me. A person being interviewed cautioned viewers to be careful when donating to charities.Based on her research, she felt that some charities/non-profits incur high administrative costs. Her underlying logic was that a charity with high administrative cost is less worthy of public support.

I would like to provide a much-needed counterargument to this manner of thinking. It pains to use the Haitian disaster as a starting point, but when else does the subject of donating to a non-profit organization cross our minds on a daily basis? In my opinion, we should appreciate the fact that a portion of our donation is spent on administrative costs, whether it is for the Haiti disaster or for local charities, because these “costs” are what enable the non-profit organizations (NPOs) to deliver their services.

We should not base our donation decisions on the percentage of administrative costs an organization incurs, but rather on the magnitude of the positive impact that it achieves. By considering whether or not to donate to a NPO implies that we trust the service it provides. If this trust has been established, should we not also trust their management to best allocate our donations to maximize the impact of their services?

To understand “administrative costs”, we must first look at NPOs’ role in the bigger picture.

1. The Non-Profit Role in Society

In the Western world, NPOs take on a unique position at the crossroads between government and businesses. Often referred to as the “third sector”, NPOs deliver goods and services that:

• The government considers outside their scope of services to provide (nonessential services)
• Are not cost-efficient to be provided by a government agency
• The business sector considers unprofitable

NPOs exist because someone has recognized a social “need” within their community and realized that if they don’t do something, the need will not be addressed.

Due to the particular space that NPOs occupy in our society, they are supported by this unusual administrative cost structure. Some NPOs rely on corporate sponsorships and individual donations to fund their organization; in addition, some are partially supported by government funding[iii]. They are not largely supported by tax revenues, like the government, nor are they sustained through the sales of goods and services.

2. Breakdown of “Administrative Costs”

The interviewee quoted that up to 10% of a charity’s budget is spent on “administrative costs”, although different sources suggest the figure is actually higher, around 16%[iv]. But what are these “administrative costs”?

Based on my experience and research, the term “administrative cost” is really a misnomer. An NPO typically incurs three major types of expenses[v]:

• Program Delivery (what the public views as the NPO’s “work”. E.g., sending disaster response teams, or delivering afterschool programs to disadvantaged youths)
• Fundraising
• Management and General Expenses (E.g., staff[vi] salary, IT infrastructure, training, etc)

When the public refers to “administrative cost”, they are usually referring to the last two costs: Fundraising, and Management and General Expenses (M&G); essentially, what “keeps the lights on” for these charities.

Using this definition, Canadian non-profits spend on average, below 35% of their budget on these two categories[vii]. (From here on, these categories will be referred to as “administrative costs”). Before we go up in arms on this seemingly high percentage, we need to understand: Why are these costs incurred in the first place?

3. Why Do Non-Profits have Administrative Costs?

If we compare most NPOs against their business counterparts, Small and Medium Enterprises (SMEs), they share many similarities in structure. Like SMEs, NPOs deliver a good or service to society. In addition, while SMEs earn a profit for their shareholders, NPOs produce a “social profit” for society. The main difference is how they support this delivery of goods and services.

While SMEs can sustain their operations from the sale of their products/services and earn a profit, NPOs rely on government, corporate and individual support (in addition to the sales of their services3) for their revenue. Due to increasing competition for limited funding, NPOs use the services of grant-writers and professional fundraisers to pursue foundational and corporate funding opportunities, as well as organize sophisticated fundraising drives to solicit public donations.

As for the cost of operation, NPOs, like all other businesses, are required to pay expenses such as rent, utility bills, salaries, and accounting and legal costs. Since the services they provide are not profitable, they must recover their operating costs by taking a portion from our donations to support their daily existence.

Essentially, NPOs are using these “Administrative Costs”, to earn the funding required to deliver their services, and invest it back into their organizations.

In contrast, a typical company spends much higher than 35% of their revenue to sustain their day-to-day operations. The average Canadian SME spent 81% of their total revenue on cost of sales and operations in 2006[viii]. Even a large Canadian corporation such as TELUS spent 60% of their revenue in operation expenses in 2008 (revenue of 9.6 billion, operations expenses of 5.9 billion[ix]).

4. The Hidden Value of Non-Profit Organizations

That still doesn’t address the question of: Should NPOs use a portion of our donations to cover administrative costs? The answer is yes, because they provide vital services demanded by our society.

To answer this question, again we have to consider why NPOs exist in the first place?

Statistics Canada’s Cornerstones of Community Report[x] succinctly sums up their presence with this:

“…These organizations are, in many ways, the cornerstones of Canadian communities, enabling Canadians to come together to address needs that they believe to be important. Non-profit and voluntary organizations are an expression of our Canadian values and the capacity of these organizations to serve Canadians helps to shape the quality of our lives and our communities.”

NPOs do not exist because they are legally required to; they are not mandated to provide their services like the government[xi], nor do they exist to make a profit for their shareholders. The existence of NPO is voluntary, non-money-related[xii] and often driven by the values we, as a society, hold dear.

Everyday, we encounter NPOs’ services, whether it is World Vision enabling us to sponsor a child overseas, “green” organizations offering tips to reduce our environmental footprint, or NPOs working with disadvantaged kids to reduce youth crime rates.

In aggregate, the value and impact these organizations bring to the Canadian society is stunning.In purely economical terms, core-NPOs (defined as all NPOs excluding hospitals, universities/colleges) accounted for $36 billion of Canada’s GDP in 2007. This number is nearly six times that of the Canadian motor vehicle manufacturing industry[xiii]! Even then, this $36 billion figure does not take into account the immeasurable economic value of volunteer hours or the vast social benefits and community well-being contributed by this sector.

In addition, the demand for non-profit organizations is rising. With government services withdrawing over the past two decades and the population aging, the demand for NPO services, especially those in health care and social services, will continue to grow[xiii].

Ultimately, the services NPOs provide help to reduce the financial burden on our governments(Caveat[xiv]). Our donations to the Haiti disaster means that private money can augment what countries are providing through governmental foreign aid. Our donations to the Salvation Army and other NPOs means that the government can spend less to address social issues in the city such as homelessness and addiction[xv].

Since these organizations provide such vital services to our community, and serve to uphold the values we hold dear; then should we not support the paid staff, and the administration costs required for their existence? We cannot take these organizations for granted.

5. Can Non-profits Lower their Administrative Costs?

The next logical question is, can administrative costs be reduced? Maybe, but we should consider what the trade off would be?

Having interacted with the management of a few NPOs, I have noticed that their biggest burden is a lack of organizational capacity. They seldom have the time or money to invest back into their organization, which impact things such as the quality of their volunteer/staff training, IT infrastructure to support their donor communications and the ability to retain full-time staff members to take care of administrative tasks. If we ask these NPOs to further reduce their fundraising, and management and general costs (and divert the savings to program delivery), this internal investment will suffer more, reducing the effectiveness of their services in the long run.

Since salary is typically the largest portion of administrative costs, the public sometimes asks: Why can we not reduce the pay of NPO?The reality is that most of those working within the non-profit sector already experience lower pay and basic benefit packages compared to their for-profit counterpart [xii]. Noncompetitive salary often means that talent cannot be retained for a significant period of time, resulting in higher turnover and increased administrative costs. In addition, those who are actively trying to improve their communities should be competitively compensated for their efforts.

Why can NPOs not rely on volunteers more to reduce their overhead costs?Despite the noble intentions of many volunteers, they are a fickle bunch. Here are a few reasons I have noticed on why charities cannot depend entirely on volunteers:

• Volunteers often have high turn-over rate due to changing work and family commitments
• Volunteers are not obligated to perform (it is difficult to “make” a volunteer do their job)/li>
• Volunteers expect tasks to be “fun” (a reasonable expectation).Unfortunately, the most important tasks are often administrative in nature [e.g., entering hundreds of donor names into a database], which is not appealing to many volunteers
• Many NPOs simply do not have the time to develop and implement a thorough volunteer program.

This is why NPOs must have a balance of paid staff and volunteers.My advisor from a previous consulting engagement suggested that NPOs have approximately one full-time staff member for every $100k in operating budget.

This is not to say that NPOs cannot improve their fundraising practices or operating efficiency (and hence reduce their overhead costs). Many can benefit from some process improvements. The challenge is that under such a shoestring budget, most NPO managers would rather dedicate their time and resources to meet their program delivery target or funding deliverables[xvi]. In addition, as most NPOs already practice very thrifty spending habits, it is questionable how much more they can save.

Of course, there are definitely organizations with questionable “administrative costs” which may need to be addressed. For example Mothers Against Drinking and Driving had a public fall-out in 2007 when it was revealed that about 70% of their operating budget was spent on fundraising. But in the perspective of the everyday, well-intentioned NPOs, reducing their “administrative costs” can prove to be difficult, and maybe even detrimental to their long-term sustainability.

As Seija Suutari, Executive Director of the United Way of Greater Simcoe County addresses this challenge:

“There are administrative costs associated with doing [program delivery],” she said, citing rent, insurance, photocopying and other expenses. “We do everything to mitigate those costs. I think the (private sector) can learn from our ability to get things done with minimal resources.”[xvii]

6. An Appreciation of their Value

I have attempted to present the issue of administrative costs from the perspectives of the non-profit sector. This is not to say that all NPO administrative costs should be accepted at face value; it is good civic engagement for us to understanding where organizations are using our donations. However, let’s not allow this scrutiny of expenses to undermine the essential services that the non-profit sector brings to our community and economy. We should balance our vigilance of organizational spending with an appreciation of the NPOs’ ingenuity in driving social impact with such limited resources.

In the end, the final decision on whether or not to donate to an NPO returns to the question of trust. Do we trust the managers and executive directors of these organizations to best allocate our donations to deliver a vital service or program that we value as Canadians?

The next time we donate, let’s take a quick moment to appreciate the fact that these administrative costs exist, which enables trained staff to be quickly deployed to disaster zones, after school programs to be delivered to at-risk youths, or public advocacy which ultimately is trying to save our environment.

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7. Thoughts

Disclaimer

I am not an expert on the non-profit sector. Most of this piece is based on my experience and some background research. If there are any errors in the data or other views on this topic, I will love to hear them.

Thank you

Many thanks to Jaclyn Chiang, Debbie Kelsall, Lisa Romkey, Andrea Wong, and Stella Woo for their edits and insight. Thank you!

Endnotes/References

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