The Next Generation Research Report 2020, Disruption with Impact dived deep into how the development sector is changing. Some of the most significant pressures that organisations face is the demand to become more professional and business-like in their operations. This in turns put greater emphasis on adopting cutting-edge evaluation, incorporating innovative technology and putting in place structures to scale-up quickly and cost-effectively.
Our report acknowledges that increasingly investors and funders are recognising that to effect change and deliver on the ambitious Sustainable Development Goals requires that Non-Government Organsiations (NGOs) are well-resourced and effective organisations. But despite this recognition for many the age-old habits of funding remain in place with funders paying for project costs and limited funding of operational costs.
How does NGO funding work?
Most NGOs receive funding from grant makers, foundation, private philanthropists or corporate social investors that is directed to supporting direct project costs (called restricted funding), with funders paying a small percentage towards the NGO’s indirect costs or overheads.
Indirect costs are expenses not directly tied to a specific project but shared across multiple projects. Indirect costs are essential and directly tied to a non-profit’s ability to accomplish its goals. Typically indirect costs are capped and can range from 0 – 15% of the direct cost, depending on the funder.
This approach is largely informed by the belief that high overhead costs are a maker of inefficiency in NGOs.
Why is this problematic?
The biggest problem with this approach is that these flat rate policies vastly underestimate the real indirect costs required to implement successful programmes. In 2015 Bridgespan conducted research and found that indirect-cost rates varied significantly between different types of NGOs and almost always exceeded 20 percent—often by a sizable margin. For example research organisations often see indirect costs sitting at an average of 63% while direct service organisations see a more modest average indirect cost of 23%. This means that many projects are priced at a loss and NGOs are losing money to execute their work.
If you look at the private sector similar variation exists and indirect costs are not considered a measure of effectiveness or efficiency but rather just a reflection of the costs required to deliver results.
As stated in the 2019 Bridgespan research report Momentum for Change: Ending the Non-profit Starvation Cycle a serious problem that follows on from this is that NGOs “strive to deliver strong results but often at great institutional and personal cost.” This manifests in various ways:
- Financial weakness in the social sector: gaps between funding and the cost of delivering the work hollows out organisations by persistently draining resources and placing organisations at risk of financial collapse.
- Poor investment in capacity: NGOs often put off improving infrastructure, investing in new technology and staffing. Reducing back-office expenditures often compromises an organisation’s ability to meet their goals and objectives by reducing productivity and efficiency.
- Under-reporting of indirect costs: NGOs are reluctant to communicate openly with funders about the true cost for fear of losing a grant
- Poor knowledge: Under-reporting also results in poor knowledge of actual indirect costs which can impact on strategic decision making
- Increased costs: Many NGOs experience an increase in indirect costs as a result as they often spend more on reporting and accounting to comply with funder requirements.
- Pressure to raise rare unrestricted funding: This puts greater pressure on organisations to raise unrestricted funding to fill any shortfalls, which in turn costs the NGO more.
In the Momentum for Change report one grantee said: “The work gets done, but people burn out, and we have to make trade-offs. For example, we don’t have computers that are less than 12 years old. Everyone has to bring their personal laptop because we can’t spend money on that. We’re out there to help beneficiaries, but it prevents our staff from working efficiently and expanding our reach.”
NGOs adopt a few strategies to mitigate the problem of insufficient indirect cost funding but largely these strategies are influenced by:
- Organisation type: The kind of organisation they are and if they have a higher indirect cost rate impact on their ability to recoup costs.
- How they are funded: hose organisations that are primarily funded through restricted funds will struggle to recoup the cost.
- Financial acumen: more sophisticated organisations can invest in financial management systems that allow them to directly charge as many expenses as possible, while grassroots organisations may struggle to implement these kinds of systems.
What does this mean for funders?
Funders needs have changed and so too should their approach to funding but shifting an entrenched funding culture is difficult.
To start to move the dial requires widespread stakeholder engagement across the sector so that funders better understand what it takes to deliver impact and so that NGOs can begin to report more accurately. This in tun will require investment in training of both NGOs and funders to start moving towards methods for reporting that encourage more equitable funding of costs.
One novel approach piloted with 17 NGOs and funders in the US was the verification of indirect costs by an independent third party. This verification found that indirect cost were out by an average of 17% and this prompted funders to adopt a “pay their fair share” approach.
The Full Cost Project, an initiative of Philanthropy CA says this: “Non-profits are often built with remarkable resourcefulness—but a lack of sufficient funding is a serious threat to their ability to deliver social good. The expectation to continuously work with unrealistically low administrative and fundraising costs can exact a high price from non-profits, many of whom are compelled to contort their budgets and skimp on staffing in order to deliver results within funders’ budget structures. Funders … are beginning to recognize that a low budget does not equate with organizational effectiveness. In order to manage successful programs, non-profits must have the capacity to invest in infrastructure and the people at the heart of their work over the long-term.”
We couldn’t agree more.
To download the full 2020 Research Report Disruption with Impact and read more about other key trends facing the development sector, click here.