Nonprofits often receive funding for providing a specific service to a community, but not for the organizational infrastructure that supports the service. Running a food bank or crisis hotline is crucial work, but who is going to pay the rent, phone bill, and liability insurance for such organizations?
Donors have historically avoided funding “overhead.” Understandably, they want as much of their money going to serve the community. The problem comes in not acknowledging all the costs that contribute to providing service.
How we price and pay for goods and services is a core marketing activity. The right pricing approach makes your product or service available to the widest possible audience. Beyond that, the right pricing approach helps ensure the sustainability of your organization and gives you the resources to scale.
Part of the problem with nonprofit funding is the term “overhead.” It sounds extraneous, superfluous. I think that “infrastructure” is a better term. There’s a certain amount of organizational infrastructure that goes into delivering a service, and it must be accounted for.
Imagine if you could tell your water company that you were going to pay for water but not “overhead.” How will you feel when the company turns off the web site and customer service phone lines because those were “overhead”?
This attitude is starting to change. For instance, in 2014 the federal government began requiring federal grants to pay for infrastructure (the announcement refers to “indirect” costs).
Discussion in the nonprofit sector is shifting towards understanding, and funding, the full cost of services. Full costs are defined in this article from Nonprofit Quarterly as
Day-to-day operating expenses + working capital + reserves + fixed asset additions + debt principal repayment
A recent Stanford Social Innovation Research article distinguishes between funding day-to-day operations with ongoing revenues and funding capital, reserves, fixed assets and other expenses through donations, grants, etc. This is one way that nonprofits can move closer to financial sustainability.
Granted, many nonprofits won’t ever be able to cover all their infrastructure costs through ongoing revenues. For instance, a crisis hotline needs to be a free and anonymous service. Such an organization won’t ever generate enough funds from its ongoing activities to pay all its infrastructure costs. Still, better accounting of all costs and efforts to meet those costs through appropriate funding streams helps build sustainable nonprofits.
Many nonprofits aren’t fully aware of all their day-to-day infrastructure costs. As a guideline, here are guidelines for expenses of a professional service organizations adapted from a blog post by SPI Research:
- Direct labor expense (40 to 50 percent): Direct labor cost as a percent of total revenue.
- Fringe benefit expense (6 to 10 percent): Fringe benefit expense as a percent of total revenue.
- Subcontractor expense (7 to 15 percent): Subcontractor cost as a percent of total revenue.
- Fundraising (2 to 20 percent): Includes all direct development headcount and fringe benefits plus business development travel and expense, commissions, incentives, and sales training.
- Program development (1 to 2 percent): This includes all research, design and product costs for improving current offerings and creating new offerings; fringe benefits; and expenses such as labs, tools, delivery training and project reviews.
- Marketing (1 to 2 percent): This encompasses all marketing headcount and marketing expenses, such as Web, PR, collateral, advertising, trade shows, sales training, and customer satisfaction surveys
- IT (1 to 2 percent): Comprises all IT capital expense, depreciation and headcount costs.
- General and administrative (5 to 20 percent): This includes PS corporate management, facilities, additions to working capital and reserves, and debt repayment.
Use these guidelines to check your organization’s budget, pricing, and spending. You can adjust your spending to fit all these expenses into your current revenues, increase your revenues from operations and donations to match your current level of spending, or combine revenue and spending adjustments to reach a new level of sustainability.