Why does Charity Navigator advocate hoarding?

Another part of Charity Navigator’s financial rating system is to have reserves for a rainy day.  In order to get a top rating from Charity Navigator, an organization must have 12 months of operating expenses in the bank (depending on the sector: lower for food banks and relief organizations; higher for foundations, libraries, parks, foundations, etc.)

I fully agree that nonprofits should build reserves.  There are natural ebbs and flows of both revenues and expenses in the nonprofit world; usually one is ebbing while the other is flowing.  Additionally, funders sometimes have demands that are off-mission, counterproductive, or political.  You need a bank of money so that you can say no to quick bucks at the long-term expense of your mission.  And you want to be able to take advantage of unforeseen opportunities as well as preparing for unforeseen difficulties.

Because it has a basis in need, this may be CN’s most helpful financial metric, which is much like the Taller Than Mickey Rooney Award: you can still be very short and win.

Remember, Charity Navigator purports to be a guide to where you should give your money as a donor.  And there are two problems with it as guidance to donors.

First, it rewards the hoarding of money.  There literally is no upper limit on how much you can have in reserves and still max out your reserves rating.  In fact, they brag about this on their site:

“Givers should know that other independent evaluators of charities tend not to measure a charity’s capacity. Indeed, charities that maintain large reserves of assets or working capital are occasionally penalized by other evaluators. In our view, a charity’s financial capacity is just as important as its financial efficiency. By showing growth and stability, charities demonstrate greater fiscal responsibility, not less, for those are the charities that will be more capable of  pursuing short- and long-term results for every dollar they receive from givers.” (here)

The simple question is would you rather fund an organization that ten months of expenses in the bank or ten years?

My inclination, as I would think most carbon-based lifeforms’ inclinations would be, is the ten-month organization.  If you have ten years of reserves in the bank, you are almost certainly not funding worthy projects and not investing in your infrastructure or growth.

BBB asks that you cap your reserves at three years to make sure you aren’t doing this — it seems like a better practice that CN is actively avoiding.  Or, put well from ACEVO, Charity Finance Group and the Institute of Fundraising:

“Charities need to justify their reserves. Holding a high level of cover for risks and unforeseen events appears sensible, but is this right if worthwhile projects are going unfunded? Charity funds are meant to be spent; therefore charities should be able to provide solid, considered justification for keeping funds back as reserves and not spending them.”

Nonprofits do not exist for the purpose of existing.  They exist to solve a societal problem.  If you have too much in reserves, you are privileging your existence over your mission.  And to that I say

shame-bell-lady-from-game-thrones

Second, it advises against giving to those who may need it most.  Let’s say there are three nonprofits, both with substantial (let’s say 15 months worth of) reserves.  Disaster strikes: a grant that makes up more than half of each of their budgets dries up.  Thankfully, they have prepared for this rainy day and, after consulting with their boards, they each take action:

  • Nonprofit 1 has a policy that they will not go below 12 months of reserves, per Charity Navigator’s advice.  They spend some from their reserves, but have to make small cuts in program and large ones in infrastructure to keep their bank balance solid.
  • Nonprofit 2 also believes strongly in a solid reserve, but not at the expense of their programmatic activities.  They dip into their reserves, taking them below the 12-month mark (knowing they will be penalized even more if they cut program activity), and prop up their program activities to a stable level.  However, they make no move to upgrade their fundraising abilities to replace their revenues.
  • Nonprofit 3’s board says that moments like this are the reason you have reserves.  They do what it takes to replace their program expenses and invest in ways to increase their unrestricted giving to replace the missing funds.

Charity Navigator ranks these organizations 1, then 2, then 3.  As a donor, three is the only one I’d want to give to — the only one that cares enough about their programs to sustain them for the short term and work to salvage them for the long term.

At the point where you are advising people to give to nonprofits in the exact wrong order than the one you should be, you probably need to rethink your financial metrics and do more than rearrange the deck chairs.

But that’s not the worst part.  Not only does Charity Navigator advise against giving to those who need it most; it advises against giving to those who have the most impact (or at the very least, is impact agnostic).  We’ll talk about that more tomorrow.

Why does Charity Navigator advocate hoarding?

Meet the new Charity Navigator. Same as the old Charity Navigator…

Last week, Charity Navigator released its new 2.1 rating system after reassessing its financial ratings.  This was an approximation of my reaction:

248578-full

I’d heard about Charity Navigator 3.0 and thought that maybe they would finally start focusing on nonprofit results.  But then they tried to use their lack of expertise to judge the logic models of experts in the field.  I argued then as now that I would trust the American Heart Association on how to prevent heart disease more than Charity Navigator, just as I would trust the doctor or nurse in the ER more than an intern at the hospital’s accounting firm.

I was hopeful with this effort was euthanized.  And I’d hoped that new leadership and time would change things.  But then their new leadership said that (in essence) mail may not make sense for nonprofits (story here).  As if we need less money to go to noble causes, not more.

Then they surveyed nonprofit leaders about the effectiveness of their metrics.  I gladly participated, telling them what were their most and least helpful metrics (answer: they were all tied for least helpful, in that they are not just not helpful but counterproductive).  Again I hoped for change.

What we saw on the first were a couple of tweaks: the manicure to a patient with a sucking chest wound.

This is frustrating, but I believe in the idea of giving insight into nonprofits for those who want it.  Like companies, people, or governments, there are good nonprofits and great nonprofits and scam nonprofits and blah nonprofits.

And I like that nonprofits are stepping up to do this.  When governments have to get involved, we too often see a cleaver used instead of a scalpel.

Charity Navigator’s own accountability and transparency metrics are very strong and helpful (other than the misguided view of what a privacy policy is).  When you don’t have things like an independent board, systems to review CEO compensation, regular audits, and so on, there’s a good chance you might be a scam (or very young as an organization).

But Charity Navigator continues to prop up the overhead myth, as described here.  While this is the most grievous sin, it is by no means the only one.  Thus, this week, we’ll take a look at why you should not only ignore the Charity Navigator financial metrics, but actively do the opposite.

With the new Charity Navigator ratings, program expenses are on a rating scale instead of using the raw value.  This focuses even more on the fallacious overhead rate, giving greater emphasis to differences among nonprofits.  In my post on the overhead myth, I talked about how a focus on overhead generally will prevent a non-profit from making the investments needed to grow.  Now, let’s look at a specific case of how focusing on fundraising expenses hurts growth, that of diminishing marginal returns.

Perhaps like me your econ class was at 8 AM, so let me explain with a thought experiment. Let’s say you were going to do a mailing to only one person.  You’d clearly pick out the best possible donor to send to — the person who gives you a significant donation every single time.

Now, let’s say you found an extra couple of quarters in your couch and wanted to mail a second person.  You’d find another person who is almost as good as the first — maybe they give a significant donation 99% of the time.

Let’s repeat this 10,000 times.  Now you are getting into people who are either less likely to donate or who will likely give smaller gifts.  Your revenues per mailing sent will still be very good — it will more than pay for itself by a wide margin — but not as good as that first person.

Now repeat 100,000 times.  The potential donors are getting even more marginal here.  But your expenses have barely gone down.

This is diminishing marginal returns in action.  As you try to reach more people and grow, your outreach becomes more probabilistic and less profitable.  

But it’s still profitable. (In the real world, you would hopefully be looking at this along the donor axis rather than the piece axis, asking if each piece added to lifetime value, but let’s not gum up the thought experiment).

If you had a magic box into which you could put $1, and get $1.10 in lifetime value out, should you do it?  Many of we fundraisers would be putting money into that box like a rat designed to get a, um, pleasurable experience when it pushed a level.  And we’d be right to.  More money = more mission.

But by focusing on the cost of fundraising, CN would have you cut off at the 10,000 mark (or not to mail at all).  Less money, fewer donors, less mission.

That’s the starvation cycle in action on the fundraising side of things.  And it’s made even worse by Charity Navigator’s stubborn refusal to allow for joint cost allocation of joint fundraising/programmatic activities, which we’ll cover tomorrow.

Meet the new Charity Navigator. Same as the old Charity Navigator…

It’s time to stop… the big check photo

Every nonprofit has a photo like this somewhere:

ansari_x-prize_check

It’s not necessarily a bad thing to do.  It’s a photo that your corporate partner can use on their Web site or in their annual report as a way of showing their commitment to the community.  And, among a still-sadly-plurality-older-white-male business community, the big check sends the message to other business people in the audience:

Your check is too small.

And this, to stereotype broadly, is not an audience that wants their anything to be too small.

But for goodness sakes: do not put this big check picture in your donor communications.

Ever.

Because it sends the message “your check is too small.”  This is sometimes a message you want to send.  We’ve talked about social proof nudges like “the average donor gives $X” as an upgrade strategy for people who don’t know what the socially acceptable amount is.  (Side note: can any of my readers let me know what the proper amount is to tip a shared-ride (Uber, Lyft, Sidecar, etc.) driver?)

But that is usually trying to get a person to increase their gift by double or less.  What you are saying with the big check is:

  • “What you are giving is 1/10000th of what this person is giving”
  • This is how we treat people who give us things like this: note that we look to be dressed nicely at what appears to be a fancy hotel and really yucking it up with each other.”
  • “This is how we treat people who give us what you give: we send them this letter.”

Needless to say, this is not a response rate booster.  And, since the amount is so far off from not only what they give, but what they could possibly give, it is not an effective anchor for a higher gift.

It also indicates that this type of thing is what you do with your time as nonprofit employees.  This doesn’t help us dispel the overhead myth that we should have Robin Leach narrating the story of our non-profit; it reinforces it.

But the most grievous sin the picture has (and this goes for award pictures and ribbon cutting ceremonies): it’s not about the donor.  Remember that for the donor, you are a means to the end that they are hoping to create in the world.  The opportunity cost of that photo is immense when you could be showing visual proof of the impact the donor is having on the world.

It is a cultural shift because the big check photo is one of those things that is done.  But it shouldn’t be.

Instead, ask if you could also get photos of your corporate partner, grantor, or their employees doing some of your mission work.  Someone in a logoed polo shirt planting a tree or serving on your crisis phone line or reading a story to children is something you can use in your communications.  And it helps cement the bond between you and the person who gave you the big check.  Because they are (hopefully) in it for the impact as well and having a photo of trees, services, or kids is a far better reminder of that than phony grins and foam core.

It’s time to stop… the big check photo

The power of a lead gift

Back in late December, we looked at a study that indicated that a lead gift is a better direct marketing strategy than a matching gift.  While it seemed to slightly depress response, the extra authority and social proof helped increase average gift significantly.  With a matching gift, the reverse seemed to happen: response rate went up, but average gift dropped significantly, with people thinking that they didn’t need to give as much to have the impact they wanted.

Now, there is another study that may show another impact of lead gifts, but at a cost.

The title of the article is Avoiding overhead aversion in charity, which should give you some idea of why I have some uneasiness about the cost of the tactic.  Gneezy et al found that many people are averse to covering overhead expenses of a nonprofit, wanting to fund only the work of that nonprofit.  (This, of course, leaves aside how the work of the nonprofit will get done without that overhead, but it is a concern expressed by some donors, so it is worth considering.)  So donations decreased when the percent of overhead increased.

Then, the study looked at whether having a lead donor, matching donor, or lead donor covering overhead influenced donation rates to increase.  Here were the conditions:

  • Control: “Our goal in this campaign is to raise money for the projects. Implementing each project costs $20,000. Your tax-deductible gift makes a difference. Enclosed is…”
  • Seed money: “A private donor who believes in the importance of the project has given this campaign seed money in the amount of $10,000. Your tax-deductible gift makes a difference. Enclosed is…”
  • Matching gift: “A private donor who believes in the importance of the project has given this campaign a matching grant in the amount of $10,000. The matching grant will match every dollar given by donors like you with a dollar, up to a total of $20,000…”
  • Seed money to cover overhead: “A private donor who believes in the importance of the project has given this campaign a grant in the amount of $10,000 to cover all the overhead costs associated with raising the needed donations…”

Here were the results, in response rate and revenue per piece:

  • Control: 3.36% with $.80 revenue per piece
  • Seed: 4.75% with $1.32 revenue per piece
  • Match: 4.41% with $1.22 revenue per piece
  • Seed covering overhead: 8.85% with $2.31 revenue per piece

So, having a donor or donors to cover the overhead of an endeavor raises the likelihood that someone will donate significantly, seemingly combining the benefits of authority and social proof from a lead gift and the direct donation to the cause from low overhead.

I would encourage you to tread lightly here, however.  The concern is that it could reinforce the (in my opinion) mistaken notion that overhead is bad or something to be avoided.  Not only is it necessary for organizations to exist, it’s necessary for them to grow.  Too often, nonprofits avoid investment that will bring back rewards for their cause and for their organization because it gives the perception of high overhead.

I believe in this so strongly that I dedicated all of last week to discuss overhead and vent my spleen on this.  However, if you want the TL;DR version, I strongly recommend overheadmyth.com, which goes into the mistakes of this approach.

My concern is that there will be a tragedy of the commons with regards to this.  If nonprofits choose to compete on overhead, then everyone will have to compete on overhead and it drags the industry down.

So my counsel is to be cautious with this.  It’s one thing to say that a lead donor has covered the infrastructure costs of a campaign.  It’s another few steps down the slippery slope, however, to say that this nonprofit is good because they spend 92.2% on programs, versus this one that only spends 89.3%.

The power of a lead gift

Trust indicators in direct marketing

Another challenge with overhead ratios is that they are proxies for trust.  People trust XX% of the dollar goes to the mission because it seems honest (even though a scam can fake this number along with all of the others).

People want to believe in something bigger than themselves.  This credulity means that we fall for cons.  But it also means that the real thing is that much more inspiring.

There are five sources that I would hold up as ways to prove yourself to someone you just met — that new constituent that you are on a first date with:

  • Charity Navigator’s Accountability and Transparency measures.  I know.  I gave Charity Navigator a very hard time on Wednesday.  But that’s only because they deserve it.

    But their accountability and transparency measures come from a really good place (other than privacy policy: running an opt-in only list exchange/rental campaign would hamper much of the good that nonprofits do nationally). They are a good starting place for your efforts.

    And if you do well there, you can point there when donors complain about your low scores on the financial side of things, where you should be aiming for about two stars, maybe three.

  • The Better Business Bureau Wise Giving standards here.  BBB is a known name and their seal can help as a trust reinforcer online and off.  I wouldn’t put it on your outer envelope since plainer envelopes get opened more, but on reply devices can help.  There’s good stuff here on cause-related marketing standard as well that other ratings don’t go into as much.

    They also made this great chart:

0dac383

  • GuideStar.  If you haven’t been there in a while, they have a beautiful new redesign that helps nonprofits lay out their logic models and the way they are making an impact.  Moreover, they don’t have a bunch of pseudo-experts spending five minutes trying to understand and judge the work of actual experts’ lifetime of experience on a topic like some organizations who will remain nameless (*cough*cough*CharityNavigator3.0*cough*cough).  Instead, they let you lay out your arguments and let educated donors decide.

  • Independent Sector.  While I don’t know of a rating system or a seal that comes from this, the 33 principles are really good and worthy for board governance.

  • Great Nonprofits.  A different model where your constituents let you, and everyone else, know what they think of you.  At first, it can be a little heavily weighted toward the loud disgruntled (as can any rating system: read Yelp lately?), but once you make it a part of your marketing, testimonials will come in, building trust and social proof.

These are all good ways of building trust without resorting to the overhead rate that cheapens us all.

Trust indicators in direct marketing

Inputs, activities, outputs, outcomes, and impacts in direct marketing

I’ve made the case to avoid the easy, seductive, and wrong-headed use of overhead rates as a way of assessing and marketing nonprofits.

However, this rejection can not be nihilistic; we need to be able to communicate what we do and why that matters.

And, more specifically, since we know that people donate more and more often to prevent a bad thing than to create or sustain a good thing, we need to be able to communicate it in this way.

Our activities can fall into four buckets:

  • Inputs: what resources do we have to get our job done?  The biggest of these, of course, are time and money, but people and expertise also fall into this category.  Picture the Apollo 13 scene where they have to turn this filter… into this filter… with this box of stuff.  Inputs are the box of stuff.
  • Activities: what do you do with your resources?  We love to talk about these.  We give our programs fancy trademarked names and want our donors to care about these.
  • Outputs: what do you get by using your resources?  A training program creates people who are trained.  A research effort creates a white paper and a study.  Everyone loves to talk about outputs because there is a number: we filled X beds, we had a Y% graduate rate, we served Z meals.
  • Outcomes/impacts: what is the effect of your outputs?  A humanitarian delivery of food doesn’t end when the food reaches the dock — the output is reduced hunger among this target population.  Some people look at outcomes and impacts as separate things, with outcomes being a short-term implication and impacts being the long-term impact.  For me, there’s short-term, medium-term, and long-term impacts of the action.

Impacts and outcomes are hard.  Did your delivery of food reduce hunger or was it an improvement in overall economic conditions?  Once you increased the graduation rate, did those people go on to live better lives as a result?

Donors provide us inputs.  Their goal is to buy an impact.  They think that with their donation, they can buy a little more good in the world.

And they care not at all about the name of your trademarked program or the number of outputs that you have.

Your job is to connect the dots between the donor providing the input and what change they will help create.

If you are trying to sell someone on buying a hammer and a nail, it’s easy to talk about the hammer allows you to put a nail in a wall.  Someone might say that the goal is really to hang a picture.

But what the person really wants to do is have a feeling of family, nostalgia, and memories.  To do that, you need to hang a picture and to do that you need a hammer and nail.

So, how do you present your programs without resorting to the destructive “88% of your donation goes right to the people we are trying to serve?”

You cut as much out of the middle part as possible.  In Stephen King’s On Writing, he talks about cutting the parts of the book that people skip over reading (even cutting a section he loved but that his wife Tabitha thought was not necessary).  You must do this too.

You need to cut the activities and outputs to the bone.  Your support keeps the boot of despair off of young people, allowing them to succeed as productive adults — and succeed they do: look at Brian’s story.  You will prevent empty chairs at Christmas dinner.  You make sure that our country doesn’t forget those who served us when they have a time of need.

There’s nary a program name or a 14% percent this or a discussion of logic models.  Start with the end in mind.  That’s what lights a fire in someone and causes them to care little for how much an overhead ratio goes up or down.

Inputs, activities, outputs, outcomes, and impacts in direct marketing

Charity Navigator and the overhead myth

The then-President and CEO of Charity Navigator signed on to a letter about the Overhead Myth that you can read here if you wish.  

There are a couple of key quotes in this piece:

We write to ask for your help to end the Overhead Myth—the false conception that financial ratios are a proxy for overall nonprofit performance.

While overhead can help us identify cases of fraud or gross mismanagement and serve as a part of an organization’s dashboard of financial management metrics, it tells us nothing about the results of your work (i.e., how you meet your mission).

So, financial ratios are good for catching really egregious cases of negligence and help nonprofits with their internal metrics but aren’t really something that you should base your decision to donate to a nonprofit on if they are making an impact in their community.  So says Charity Navigator.

Now, let’s look at Charity Navigator’s rating criteria for financial effectiveness:

  • Percent of expenses spent on programs: a variant of overhead ratio
  • Administrative expense percentages: part of overhead ratio
  • Fundraising expenses: part of overhead ratio
  • Fundraising efficiency: the reciprocal of fundraising expenses and thus the same thing twice, just phrased differently
  • Primary revenue growth
  • Program expense growth
  • Working capital ratio

Four of Charity Navigator’s seven rating financial effectiveness are subsets of the overhead ratio that they claim to disavow.  If using overhead ratios to measure effectiveness is an evil practice, meet the practitioners.

Not only this, but they make the overhead ratio more arbitrary by taking out joint cost allocation.  For those who aren’t direct marketing nerds, what this means is if a mail piece is half to get a donation and half to get someone to sign a petition, 50% of the costs go to fundraising and 50% go to mission (and lobbying).

Charity Navigator says “as an advisor and advocate for donors, when we see charities using this technique we factor out the joint costs allocated to program expenses and add them to fundraising.”

The problem with this is only mail and phone scripts are joint cost allocated.  Efforts like walks are determined by the nonprofit to have a certain programmatic and fundraising component (let’s say 90% mission, 10% fundraising).  So if you put a stamp on a mail piece that asks for a donation, it’s 100% fundraising according to Charity Navigator.  If you hand it out at your walk, it’s 10% fundraising.  Were it possible to make an actively negative measure worse, they did it.

It also ignores that millions of Americans relate to nonprofits only through the phone or mail.  It’s where they learn about issues and act on the causes important to them.  To mark all of this as transactional is whatever the opposite of being an advocate for donors is.

Not surprisingly, this distorted view of charity’s financials is used by the general public and the media to perpetuate the overhead myth.  Consider CBS News’ piece on Wounded Warrior Project:

What caught our attention is how the Wounded Warrior Project spends donations compared to other long-respected charities.  For example, Disabled American Veterans Charitable Service Trust spends 96 percent of its budget on vets. Fisher House devotes 91 percent. But according to public records reported by “Charity Navigator,” the Wounded Warrior Project spends 60 percent on vets.  Where is the money is going?”

Thus, Charity Navigator may talk about the problem of the overhead myth, but it’s a problem that they help keep alive.

It should be noted that days after it contributed to the CBS News hit job on Wounded Warrior Project, Charity Navigator launched on its site and email to its constituents a new piece on “finding charities that support our troops.”  A quote:

“Donors can be confident that contributions made to the higher rated charities will be spent efficiently as these charities have low overhead and fundraising costs enabling them to use more of their resources in carrying out their mission.”

But Charity Navigator abhors the overhead myth.

And Brutus is an honorable man.

Going one step further, another thing that overheadmyth.com decries is the myth that charity CEOs are overpaid.  Here’s a snippet from their FAQ:

“This question gets at the heart of one of the most common misconceptions about overhead: that employee and executive salaries are considered “overhead” expenses. In reality, compensated staff members carry out all of the organization’s functions. Specifically, the applicable portion of employee and executive salary expense are recognized or “allocated” to three functional expense categories based on the estimated time staff members devote to carrying out each of these functions: program service activities, administration, and fundraising. While there are some paid staff (such as accounting and human resource personnel) that usually devote all their time to overhead responsibilities, the vast majority of paid staff members cumulatively devote most of their time to carrying out program service activities.

As for the question of extreme salaries, our data indicate that these circumstances are relatively rare. Rather, it is far more of a problem that mid- and lower-paid direct service nonprofit employees are underpaid than overpaid. As a matter of law, tax-exempt organizations are required to ensure that the salaries and benefits they pay their executives meet the IRS’s definition of “fair and reasonable.” That definition varies from nonprofit to nonprofit; to determine what is “fair and reasonable” for a position at a specific organization, you must research what people in comparable jobs earn at nonprofits that are of similar size and that have similar missions and programs.”

Remember, Charity Navigator signed on to this.  Thus, Charity Navigator should be talking about a holistic view of executive pay, right?  They would never conflate executive pay and overhead rates, imply that CEO salaries are all overhead, or use overhead as one simple criterion for valuing a charity…

Not really.  Their page on “10 Highly-Rated Charities with Low Paid CEOssays:

The leaders of these 10 organizations run highly-rated charities, yet they earn far less than the average compensation of $150,000 reported by the over 7,000 charities rated by Charity Navigator. The low salaries help these charities, which have earned at least two consecutive 4-star ratings, devote more than 80% of their budgets to their programs and services. That means that less than 20% of your dollars are going to such costs as fundraising and administration, including the salary of the CEO.”

Not only are they looking at executive pay in a vacuum, but they are also tying it directly to — you guessed it — the overhead rate.

gambling

Image credit here

One hopes that in the long-term, Charity Navigator will either change to meet its purported beliefs, or that they are exposed for what they are: ambulance chasers if ambulance chasers also helped cause the crashes.

So if you are going to crow about your Charity Navigator ranking, please make sure it’s only the part that matters: the Accountability and Transparency sections that, other than their idiocy on privacy policies, are benign at worst and actively positive in many cases.

Because a high score on their Financial section of Charity Navigator means that you are starving yourself.  And I know that’s true because I read it from Charity Navigator.

Charity Navigator and the overhead myth