Tuesday, January 27, 2015

"Overhead" Aversion - Is it the Head or the Heart?

Donors' reliance on accounting measures of efficiency and the frustration it creates among nonprofit leaders seem to permeate most discussions about how to improve the nonprofit sector.  Now over a year old, the Overhead Myth campaign continues to provide hope to those in the sector seeking to convince donors to happily fund administrative and fundraising costs.  Despite the optimism, recent evidence seems to confirm that the attention donors pay to so-called "overhead" costs isn't going anywhere.

Notably, a study recently published in Science showed that a simple way of increasing donations is to ensure and communicate that overhead costs have already been paid by another donor so that any donations the solicitation recipient makes are "overhead-free".  In fact, the study showed that this approach boosts giving even more than securing a matching gift.  The study underscores the emphasis that donors place on assurances that they are funding programs, not overhead. Yet, many have viewed this study as painting a picture of donors being driven by the heart instead of the head, showing that donors don't care about how much overhead a charity has but rather only care about a feeling that their donation counts.  As examples, Vox reports the study as providing evidence donors don't view overhead as inefficient but just want want the "warm, fuzzy feeling" that their donation went to services, and Brady Josephson's Huffington Post blog post declares it as evidence that donors "care more about how they feel when they give than how organizations spend their money."

To me, the evidence is not necessarily that donors are irrationally following their heart, but rather could indicate donors are being particularly rational.  To elaborate, if one thinks in terms of costs of making a new product or product line, Econ 101 tells us that that the relevant cost to pay attention to is the marginal cost of production, not the average cost.  It is no secret that accounting reports provide average cost information, not marginal cost, so a savvy decision-maker needs to consider if and how those numbers may differ.  The same holds with nonprofit accounting.  Accounting estimates of the percentage of expenses going toward programs may give donors a sense of the average use of donations, but again the relevant calculation to a savvy donor is instead one of the marginal use of a donation.  In this case, the fact that donors highly value a nonprofit who can ensure that the marginal use of a donation is 100% on programs may simply indicate that donors who find overhead distasteful are being entirely rational.

In other words, while it seems to have become the norm to assume that donors make poor and irrational decisions based on accounting reports, perhaps it is worth considering the possibility that donors are more savvy than many are willing to admit.

Wednesday, January 14, 2015

Reconciling Claims About Spending by the Red Cross

As part of their examination of the American Red Cross' response to Superstorm Sandy and Hurricane Isaac, NPR and ProPublica noted a discrepancy between claims by the organization about its spending and what the financial statements bear out. In particular, it was noted that even though it incurs substantial fundraising costs, the Red Cross often repeats the claim that "91 cents of every dollar that's donated goes to our services." Of all the criticisms of the organization, this one seems to have gained the most traction, even leading to calls for additional oversight and demands for answers from Sen. Chuck Grassley. In what follows, I seek to provide a simple reconciliation that supports the view that the claims made by the Red Cross are true but at the same time inaccurate. To do so, I make use of the 2013 fiscal year financial statements for the organization.