Friday, March 02, 2007

Admin Percentage is a Dumb Metric

The March issue of the Mission-Based Management Newsletter is available. This month's topic is on Administrative costs. Regular readers know my feelings on this, but here's the Management Tip from the newsletter:

"Get ready. This is a subject that makes me almost literally froth at the mouth. So, straight to the question: Are Admin costs Important? Yes, but they shouldn't be. Administrative costs are a stupid and ineffective metric by which to value or even worse, compare, nonprofits.

Can you hear me now? The nearly obsessive emphasis on this one statistic drives me nuts. Comparing nonprofits by admin % is like comparing 5 cars you might buy by weight. It's interesting, but not of much value. And, it indicates laziness to me. If you want to find out what's going on from reading the financials, you have to drill down and do the work More on that later.

First, NO ONE can tell you what a "good" admin percentage is, although that hasn't stopped people from showing their ignorance by declaring that 12% or 13% is good and anything higher is bad. Nonprofits are so diverse, have such varying capital structures, that declaring one number the right one do I say this nicely? Naive. Of course, we compound this error with the prevailing assumption (particularly among funders and large donors) is that less admin is always better.

Or not. The National Center for Charitable Statistics has a great brief "Getting What We Pay For: Low Overhead Limits Nonprofit Effectiveness" , which talks about the damage low overhead does. Why would a nonprofit cut overhead to a damaging level? Because every funder harps on this and the ED and board simply follow the funders' guidelines. And it hurts organizations, sometimes to the point of killing them. Read "How I Cooked the Books", if you don't believe me.

I see this damage all the time in my work. And, as we transition from Boomer ED's to GenX ED's over the next ten years, we'll see more damage--our admin costs are held so low that we have no management "bench", no cadre of mid managers who are being groomed for top spots. What else gets cut in the quest to meet the admin % expectations of funders, press and public? Leadership development, training, continuing education. Sounds like a formula for crappy services to me. I recently was told of a community foundation that sponsored (and posted on their website) a contest to see who could have the lowest admin costs. A race to the bottom if I ever heard of one.

Anyone think that FedEx is poorly run? No, they are a lean, profitable organization. How about Southwest Airlines? One of my MBA students ran a comparative analysis on FedEx's financials, and found that FedEx's "admin costs" were over 30%, and that Southwest's were 31%. Hmmm. And why is it that this admin obsession pertains only to smaller nonprofits? Most universities have admin % add-ons of over 100% on research grants, and the feds OK them without blinking...again: Hmmm.

If you think I'm exaggerating about the witch hunt mentality about admin costs, try this. Go to Google, type in the search string "Nonprofit Administrative Costs" and hit "enter". What do you see? Ads for "Find The Best Charities", and "100 Best Charities". Why? Because these online watchdogs use admin costs as a key metric in their rating system. Here's another fact: CPA firms don't all account for admin the same way...yet another reason that using admin to compare the effectiveness of different organizations is like comparing apples to watermelons.

One more thing. When I talk about administrative costs I am not talking about fund raising costs. That's a different measure, and usually more valuable, if it's used with full disclosure on how it was calculated.

Am I contending that admin costs are always a bad measure? No, not in one particular case: Year-over-year data for the same organization that is measuring admin costs the same way, is a good metric, if it is used as a gateway to deeper examination. I use this with my clients regularly. If I see four year's of data and admin costs as a percentage of total revenue go way up or way down, I raise my hand and ask why. I do the same thing with an organization that I want to donate to....I examine three year's 990's and look for any big variations in administrative and other costs. But absent this one use (which is, as I say, a good warning flag) I'm much more concerned about quality of services, or increased output of services, etc. than I am about an artificial percentage that may or may not indicate something amiss.

Remember, good quality usually requires more training, more infrastructure, etc. Such valid expenditures add to admin costs just as much as the much taunted "Excess executive pay". Finding the real cause requires a little work to drill down to examine the actual contributors to the total administrative line.

NOTE TO THE PRESS, PUBLIC, DONORS AND FUNDERS: Think, and do your homework before you rant about an organization's "ineffectiveness" because its admin % rises to the unbearable level of 13.2735%."


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Arun said...

Thanks for this much needed articulation!

We face this a lot at CRY (Child Rights & You;, and it's quite a task to get people to understand that with an indicator like admin costs, they're comparing apples to oranges.

We try to make them see that NGO's like CRY are transparent for a reason, and that they need to use our transparency (and others' opaqueness) to intelligently analyze the organizations' effectiveness.

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cettefille03 said...

Dear Peter,
What a great illustration of why we need to look beyond financial metrics when deciding which nonprofits deserve our time, money, and public support. In fact, the entire existence of GreatNonprofits is based on that principle – we’re basically a qualitative response to GuideStar’s obsession with the IRS.
As the largest online database of user-generated reviews of nonprofits, we aim to add a whole new dimension – the volunteer/donor/client experience – to nonprofit evaluation.
Don’t hesitate to contact me if you have any questions about the site, or just want to talk more! Keep up the great work -- the Form 990 really shouldn't be as deified as it is in the nonprofit community.
Best Regards,
Elizabeth Rosen