Episode 110: The Dreaded Overhead - A New Normal Level for Tomorrow

It's another edition of around with Randall and of course I'm Randall. today's podcast centers around finance and with that several of you probably just deleted the particular segment. But I think it's an important conversation, particularly with the inflationary challenges that our nonprofits are facing, and then on top of that obviously the pressure that's being placed on the home front from our donors. We've talked about this in various ways, but it's never been about the actual nonprofit. It's about a donor. It's about acquisition. It's about philanthropy. And what I want to talk about really, today, is about what's going on inside our organizations. We're beginning to see some reports come out that concern, I think, anyone who's paying attention and everyone in the nonprofit sector.

Number one is, I saw from the nonprofit times a study done where the amount of operating capital is down 10 to 15 percent in most nonprofits, which means they have less wiggle room to their budgets, which means they're drawing from reserve funds to make monthly ends meet in some ways. And the real reason is salaries is really driving increased expenses and obviously that's based on inflation. On top of that, or in in addition to that, in California there were two bond issues we won't know the results of the actual, that bond but votes on minimum wages. And in fact two California cities Durante, in measure put on the ballot initiatives that would raise the minimum wage, ironically, only in health care, $25 an hour. And the local CEOs and the local leaders indicated that in some cases they weren't sure the hospitals would stay open. Obviously those who would be the recipients of the $25 an hour were very supportive of the measure. So while the Nonprofit Times story talked about overall, this is what we're seeing in terms of inflationary pressures in a very specific sector. We'll see what happens in those particular cities.

The challenges is that as we've discussed in previous podcasts, that in healthcare particularly, they're price takers. They don't get to increase their prices if their expenses go up. They're negotiated with commercial pay. Blue Cross, Aetna, and others, and then the government just tells them. So we'll see how that plays out.

And then there was a third story about - the word collapse in the title - but the collapse of small gifts uh and what's going on in terms of annual giving and how as a recession looms what we know is is that we have less donors today than we ever have. And that if you want to book recommendation, Brian Crimens, Nathan Chappelle. The Generosity Crisis talks about this. I think it's probably the most important book in 20 or 30 years. If you don't have it, go get a copy. Is that it's an issue and challenge of the fact. We're seeing it just a decimation over the last 15 to 20 years of our donor basis that it used to be two-thirds of our population or households made a philanthropic gift. Today it's less than 50 percent and on the downswing, and that it's the smallest donors that we're having the most trouble with. And if you don't have a couple of really large players, your organization in terms of revenue's really struggling. In addition to this, when we talk about just overall finances we see challenges in health care. Number of organizations having huge, huge issues with losses. We're seeing some push now financially, or at least pushed it for the information about from universities and colleges with decreased student populations. And that's pushing immense pressure on those educational institutions.

We certainly have seen a lot of what I'll call ancillary conversation around things like food and and housing. non-profits as they are being pressed with inflationary costs with their particular needs in terms of housing or food and what that's doing, I think, what's coming next unfortunately is we're going to start seeing membership organizations zoos, museums, places like that see less. I'll call it patronage. Meaning and we do this in our house that we have a Zoo membership so we have unfettered access to the zoo. That's more expensive. Are we going to go as often? And things of that nature. Same thing with museums. Children's Museums, anything that's a membership-based activity. All of this leads to a conversation about how are we financed? And the dreaded term which I want to spend a few minutes on, overhead.

Traditionally the word overhead has such a negative connotation that what it does is we get the question how much of your organization is spent on the dreaded overhead. It's administrative costs. It's salaries. It's things that aren't driving revenue. It's not going to the actual mission and purpose because it's what runs the organization. And over the last 20 to 25 years there's been an immense push by, and not nothing I would not indicate that that was being done nefariously or in terms of of really bad purpose, but a lot of larger donors. And in particular institutional donors, corporations, foundations, donor-advised funds, things of that nature, have pushed organizations, nonprofits to become less overhead-driven. And so there's been an efficiency move in the nonprofit space. With that said, let me say I'm all for efficiencies. I believe in them, but is there a place or a point at which you cut so much on the overhead that it affects the outcome? And the answer to that is yes. And the reason this is important as we are seeing inflationary pushes on salaries, on seeing reduced cash reserves and operating income, as we're seeing pressures on the inputs, that a nonprofit has that. It actually utilizes food, kitchen, food. And inflation there.

Where does the organization first turn, and the answer is they go internally and start cutting. Nowhere is this more true in my experience than in healthcare, and that's part of the deficit of understanding about philanthropy and nonprofits in healthcare. People get a little wiggy when the numbers get off, and they just start cutting. We are beginning to hear rumors of nothing to announce. I don't have any inside information that there will be incredibly large job cuts coming in the next three months, maybe out to six months, in many healthcare organizations. I'm talking about thousands of jobs and organizations because that's how they view. They're going to right size their losses, and what that does is that lessens the overhead.

What I found interesting is that I very rarely hear any conversation, data about what is the proper level of overhead. We just need less of it. We know in terms of philanthropy from a fundraising, funding, generation perspective that we traditionally have heard you want to cost about 25 cents on the dollar. That that's a decent ROI. We spend a quarter to make a dollar. Or if you want to look at it differently, for every dollar that comes in a quarter was used to generate that dollar. Look at it, cost to raise dollar or ROI doesn't make a difference, that only really has applied to the fundraising elements of what we do. What does it mean for the entire organization? And as we as an industry are being asked to be more and more efficient and keep our overhead low, but yet our expenses are going up and our revenues maybe aren't. This begs the question, what are we really talking about?

I appreciated a story in the Chronicle Philanthropy in September. It really grabbed my attention and I held on to it because I wasn't quite sure what to do with it. Then these other pieces kind of popped up in terms of data, information. Things that I found interesting that led me to today's podcast. But this was about talking about how to actually put data to the idea of what our overhead should be. As an organization, the Chronicle Philanthropy went out and did a really large study along and I think really it started with the Boston Globe. They went and looked at 22,000 so I give them a lot of credit really a great or sample size 22,000 nonprofits, particularly in the arts and culture area. Really we're talking about museums, theaters, things of that nature, and they looked at a 10-year period from 2008 through 2018 because that's where the data is from, 990s and others, is going to be the most relevant. So we're pre-pandemic. With that said there's been a change or two with pandemic, no question. But over those 11 years what they found is the organizations that were the most financially stable were using about a third of their revenue as or classified as overhead, salary, marketing outreach, organizational structural cost, heating, cooling, things of that nature. And the organizations that tried to be more efficient then, 33 percent actually, went into something they called the starvation cycle, meaning they cut too much.

So let's take a just a museum or a zoo or a theater or something of that nature, which I found to be really interesting is as sectors and what their situation might be. They may see a little bit of a downturn in revenue so they're going to decrease their expenses, which means the first public place they're going to cut is their marketing budget. Maybe marketing people. Secondarily probably is their fundraising team. So let's compare that to the for-profit world for a moment. If you see decreasing sales, so I'm a for-profit company, I'm looking out a year or two. How am I growing? What am I trying to accomplish? And I see a hole in potential clients. The one place I'm not cutting is marketing because I want people to know about me. And the one place that I'm not going to cut, and I'm a small person group is, I'm not going to cut my time to business development equation, equal. equating to philanthropy or fundraising. But yet that's the first place we see nonprofits cut, and what begins that starvation cycle is, well, they're not out marketing because that was an easy thing to cut. Now there's not as many people coming in before as before and we're not raising as much money because me and it begins to cycle. That all of a sudden becomes self-perpetuating.

The number that they pose as a really strong goal for overhead, based on the 22,000 non-profits in 11 years worth of data was 35 percent. If you took your organization out to the public and fundraising opportunities and said we, our overhead is 35 percent, my guess is you're going to have some donors, some organizations, philanthropists whomever who are going to push back and say oh you're spending way too much money. And the answer is you're not. That's why I'm a data person. We now have data to help us better understand how we grow, how we maintain. And you can't maintain by just cutting. Eventually you'll start a cycle that's very hard to get out of, particularly doing it when times are difficult, when you have less options. If you were in a strategic cost cutting series of activities prior to the pandemic you might have had the opportunity to have the resources to be really smart about it, but if you're losing money right now you have less options, which means you may make more rash decisions. And in making those rash decisions you may hurt your organization more than you realize.

What does all of this mean? Well I think that it begs the question overall, and then we'll get to the tacticals we always try to do here on "Around with Randall" is that funders may hold an unrealistic sense of expectations about how much we should be spending on overhead. So how do you deal with this? How do you have the conversation about what you should look like as an organization? I think there's four things to consider, with some sub points.

The first is you need to have an honest assessment of yourself and really a 360. My fear in 360 evaluations is they always turn out to be 140. And you may say what in the world is Randall talking about? Maybe that's even a normal question. All of a sudden when we do an assessment it's amazing how many people we leave out of that process. And it seems to be driven by finance, which I'm not opposed to. But doesn't include everybody. And all of a sudden, finance makes a decision. We're going to do this, this, and this. Finance has a wonderful important role in our nonprofit world. I don't want to get rid of them, but they can't drive the ship alone. There are consequences, decision, two decisions. And sometimes you need to bring in outsiders, and I'm not talking like Accenture just to do cost-cutting measures. How about understanding if you cut the marketing budget by X it has this particular effect on attendance on people coming in.

Remember, in the for-profit world the first place if you're seeing a lack of sales they add money to is marketing, and yet for some reason in the nonprofit world it's the first place we cut because it's the dreaded overhead. 360 means everybody, philanthropy, marketing, board, everybody has a voice in this conversation of a 360 assessment for our our organization and how we're going to fight the challenges of the day.

Number two is once you come up with a plan is to communicate. And it's top-down communication approach. It obviously starts with the board and having almost, if not complete, idea of consensus. If you have your board doesn't want to do this but it wins by, let's say one vote, then you aren't where you need to be. It may mean some negotiation at the top. So number one is your board, number two are your senior leaders.

Number three is your staff. Number four, your donors, your community. Why we're doing what we're doing. What does it mean? Number A or letter A, shown the numbers, be open. The interesting thing about the study that was in the Chronicle Philanthropy from September was this. I mean 22,000 nonprofits over an 11-year span, I mean that is unbelievable amount of data. And they came back and said it should be about 35 percent but we're running at 24. Yeah but we're losing money. How do we do we need to increase our overhead our marketing, our outreach, our philanthropy so that we have more to invest back into the organization? Is this a short-term, long-term solution? Show them numbers.

Number two, compare. I'm doing an analysis and kind of semi-strategy for a client and I compared them to about five or six other nonprofits like them in their community, gift officers, organizational size, things of that nature, and showed it to the CEO. And you like it because they had the smallest staff when it came to outreach, and I said and you are raising the least amount of money and have the least amount of exposure in the community. But but these aren't fair comparisons, and I push back and said darn right. They're in your community. They're your basic area of interest or service in the nonprofit sector, they're about the same size. They've just chosen to allocate their resources differently, and you wonder why they have more money. So being able to compare and then explain that is critical.

The other thing is that, and this goes I'll give credit to Dan Polenta. There's a video from 2000, I don't know 14, 15. I've used it a million times where it's, YouTube sampling to boards and non-profits, you can Google it. But he talks about the world being depressing when it's always the same size of the pie. What he's meaning is that decisions to just cut are based on the concept that the pie, the amount of dollars out there, is limited. And what he's arguing for, and I can't articulate this enough and this was the conversation I had with this CEO here recently about outreach in their budget and size and other things for versus other like competitors, I said you're assuming the pie is this big. It's not. The pie could be five times as big if you had more people out there engaging. This is the argument for marketing budgets and philanthropy and outreach and getting people to know who you are and choose to spend their disposable dollars, either philanthropically or through a membership organization or something of that nature on you rather than someone else. The pie can be as big as the economy is. It depends on how people want to spend it, and that's what he's referring to. So if you need a reference point, you might think about that video as a great way of looking at philanthropy and outreach and the ability to tell your story and branding.

Number three, be ready for pushback. I was doing another study with a client who wanted to talk about their special events and I gave them the recommendations, which was you need to reduce them. And there were board members that were just furious, and it was my job to listen to them. Why is this important? And then explain back through the data why they have a better opportunity to increase their high, so to speak, the size of the pie if they wouldn't do as many special events and concentrate on major gift activities. People don't like change. Be willing to listen and adjust. Still get to your point. Still get to your direction. But you may have to deviate two or three points or elongate the strategic plan, a year or two, to bring more people into the tent that want to be a part of your solutions and finally you got to tell the story not repeat, not in isolation, if you're a museum. And you're the only one in town telling the story about the 35 percent. You're going to look like the anomaly. But if every Museum, zoo, and otherwise based on that story in the Chronicle Philanthropy is telling the same story, then the community gets the vantage point of, wait a minute. There's something going on here.

Going it alone can be challenging. You may have to but if you can do it more collaboratively as an organization and as an industry subsection of nonprofit work, you'll find I think that there's a better opportunity to change the story about the expectations. Get an honest, full 360 assessment. Communicate to your constituencies. Be open for suggestions and pushback, and lastly, gather as a group to tell the story as to why we need to make adjustment and change. And then you'll have a better chance of resetting your non-profit in a way that allows it to move forward in a much more financially productive situation.

Don't forget check out the blogs at Hallett Philanthropy, two a week or so. And also, if you'd like to communicate with me, that's podcast@hallettphilanthropy.com. Always love to hear if you have suggestions on a particular topic or something of that nature, just tell me I'm crazy. Happens every day at home. It could be very much part of this as well in the end. It's a challenging time economically for nonprofits, for just people, and we've come out of the pandemic hopefully financial challenges with inflation. I want you to take a second if you can coming out of the Thanksgiving holiday and before the Christmas, Hanukkah holidays to realize that you have incredible value. You're doing great things, and although sometimes life's a little chaotic. It's important for you to realize you're making a contribution. Don't forget my favorite saying, some people make things happen, some people watch things happen, then there are those who wondered what happened. And in today's world, you're someone making something happen, representing an organization that's making something happen for the people and things in our community that are wondering what happened, and that has value. It doesn't mean there's not challenges, but it does mean that what you're doing is making a difference. And if nothing else, you know I appreciate it even if we've never met, and I don't know anything about you, you're doing good.

I'll look forward to seeing you next time right here on "Around with Randall". Don't forget, make it a great day.