Truth, Transparency & Overhead

It is puzzling — and yet entirely true — that there is a truth-telling problem in the economic sector that purports to do the right thing: the nonprofit-philanthropy sector. There is, of course, a truth-telling problem in the for-profit sector — and also the public sector. But Splash resides in the nonprofit sector, where the disincentives to telling the truth are both palpable and powerful.

If leaders in the nonprofit sector aren’t modeling truth-telling, then who will?

Just as any business can choose to create value and/or differentiate positioning based on quality, price or customer service, any nonprofit can choose to create value and differentiate based on impact, transparency and integrity. Oddly, this hasn’t been happening very much.

Through the discussion, below, I will personally dare nonprofit leaders to:

1. Tell the truth

2. Behave transparently, and

3. Articulate value-creation (instead of co-signing on “overhead” mythology)

These three items exist in succession order: If you are committed to telling the truth, you can prepare to behave transparently. Then, if you are behaving transparently, you can prepare to articulate value-creation. But the logic doesn’t flow the other way. Therefore, let’s begin in the beginning:

Truth

We live and breathe in an era when:

  • the Red Cross can appeal for funds following a natural disaster;
  • a generous public can respond swiftly, in good faith that funds (over $300 million) will go where they are most needed; but then
  • 18 months later, the Red Cross can confidently refuse to explain where the donors’ funds were placed in service!
  • Not only are facts being evaded, in this case, but they are being proactively touted as trade secrets.
  • Variations on this theme have been well chronicled regarding Greg Mortenson and the Central Asia Institute, and before these many others.

These are not the only kinds of truth-telling problems. There are many more. They stem from the fear that if we tell the truth to donors, they might stop giving. This latest “trade secrets” defense is actually a symptom of something much deeper, rather than being a core pathology itself.

Let’s be clear: Philanthropy is fundamentally an activity of sacrifice. One parts with a personal asset on behalf of others. It makes perfect sense that a donor would want to know where their funds go upon giving them away. Yet the most honest explanation is nuanced – for good reasons, reasons any prudent nonprofit would happily explain if given the time and attention so to do. However, in our hurry and haste to raise funds there become incentives to overstate, understate or not state the facts. Over time, the aggregate effect has been to erode truth telling and reward “spin” sector-wide.

This is a problem – a deep and far-reaching problem.

Transparency

Transparency has become an elusive buzzword – but it doesn’t have to be. Transparency is a logical extension of truth-telling. In fact, it is illogical to discuss transparency for an organization that isn’t willing to risk telling the truth in the first place.

If everyone believed that transparent practices would raise more money (rather than risk losing money) then everybody would be doing it! No question. There is only one reason not to be transparent: The fear of losing funding.

At Splash, we decided from our very founding to be as transparent as we could be. And, year over year, we have raised significantly more money. In fact, in cases where Splash’s transparency has showcased failure, most often donors have renewed future gifts or grants at a higher level (rather than reducing giving, or ceasing altogether, as some might fear).

Donors crave high impact, honest communication, and genuine relationships. Splash has positioned itself to provide these very things. We have done so because we believe it is right, not because we thought we’d raise more money. However, in stepping out we learned that when donors are treated as investors – rather than ATMs – they rise to the occasion.

Splash believes that if we aren’t prepared to tell the truth, then we shouldn’t intervene in the first place. This extends throughout the organization, in every country of operation. Truth telling is required. (In fact, nobody at Splash will lose their job for making a mistake – but they may very well lose their job if they don’t tell the truth about a mistake. Consider the impact of this ethic upon organizational culture!)

Value Creation

There is a long history of false indicators of excellence in the nonprofit sector. Donors seeking to understand “where their money is going” and “how are their specific dollars making a difference” have relied on indicators that are misleading (at best) or fallacious (at worst). And nonprofits haven’t turned the tables proactively to define value, impact, and return-on-investment in order to bring accurate indicators of excellence to bear.

Fortunately, the past decade has brought a timely upswelling of attention to “the overhead myth.” Through a wildly popular TED Talk by Dan Palotta, to a widely circulated article in Stanford Social Innovation Review, to critiques of “the overhead ratio” by rating agencies, the conversation of false indicators of excellence is finally gaining critical mass and momentum.

How about this for an indicator of excellence? value-creation relative to impact

Value creation is under-understood in the nonprofit-philanthropy economy. Curious this, as value creation is at the very heart of nonprofit business models. Consider these three scenarios:

Scenario I

A donor wants to do something about homelessness. They want to make a positive difference. They have $100 to donate. They set $100 on their front porch and hope somebody does something with it to impact homelessness.

Scenario II

A donor wants to do something about homelessness. They want to make a positive difference. They have $100 to donate. They give $100 to a homeless person they would have otherwise walked by.

Scenario III

A donor wants to do something about homelessness. They want to make a positive difference. They have $100 to donate. They give $100 to a nonprofit organization that serves homeless people and advocates in the state legislature. The nonprofit organization spends 75% of expenses on direct program services, and 25% on administration and fundraising.

In Scenario I, there is no value creation. In fact, the $100 might get swept away by the wind.

In Scenario II, there is a chance of value creation – and a chance of no value creation. In other words, the homeless person might use the $100 for food, shelter, clothing or job training. They might also use it for cigarettes or alcohol. At best, there may be a 50/50 chance of value creation relative to impact desired.

In Scenario III, there is value creation at a ratio of 3:1. For every $25 of investment, there is a $75 return on investment. If I told you that I could assure you of an annual 3:1 ROI ratio in the stock market, you would call me a genius! But in the philanthropy economy we don’t seem to understand value-creation. The 3:1 ROI ratio and the 25% overhead ratio are the exact same thing. If the overhead percentage were 20% the ROI ratio would be 4:1. But because the ROI is that of social impact, it looks different to us (namely, because the funds don’t return to the donor) and this obfuscates our view. Consider this:

A Business Example for Comparison

When we purchase a $4 latte, let’s imagine the ingredients actually cost the vendor $1. The labor costs $1. And the facility expenses are $1. Therefore, the profit margin is $1. This means that for every $3 expended, $1 is earned (or 33% ROI). Interestingly 33% ROI would be regarded positively in free markets. Contrast this example, then, with the 300% ROI from Scenario III above, and you can appreciate how remarkable value-creation is for a nonprofit that can return $75 of impact for every $25 invested. However, rather than celebrate 300% SROI (“social return on investment”) most nonprofit leaders co-sign on fallacious indicators of excellence, like the embattled “overhead ratio.”

Overhead is Like Cholesterol

Overhead is like cholesterol: There is good overhead and bad overhead. The wise analyst understands the difference! For example, paying for expensive furniture or wasting funds could count as “bad overhead.” But investing in professional training, appropriate technology, or a financial audit could be examples of “good overhead” that lead to and lever greater impact. Highly educated and savvy donors understand the value of building appropriate capacity such that true impact can be delivered at a compelling ratio, like 3:1 or 4:1.

It is unfortunate that the very sector dedicated to social, environmental and artistic good has strong incentives to be dishonest. The economic forces have been too strong to resist, for most. But I earnestly challenge (and dare) my peers in nonprofit leadership to tell the truth, to behave transparently, and learn to define and articulate your value proposition, value creation, and your true impact for good. I believe, as do my peers at Splash, that you – and more importantly the world – will be well served if you do so.

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