3 comments from this ex-CEO on indirect costs in NFPs

Reflecting on my experience running an NFP after reading Philanthropy Australia’s Paying what it takes: Funding indirect costs to create long-term impact. It is an excellent report, I just have two things to add/build on and have one controversial opinion at the end…

The report

The summary reads,

Not-for-profit indirect costs are not being covered by funders in Australia, leading to lower capability and effectiveness across the sector.

New research by SVA and CSI has shown that NFPs are underinvesting in critical capabilities, thanks to a belief that funders are unwilling to fund the full cost of impact. Solving this issue requires substantial shifts across NFPs, philanthropy, government, the public and the media to ask the question — are we paying what it takes?

The answer to that rhetorical question is of course, “no”. Digging into how indirect costs are defined:

…costs incurred by an organisation that cannot be directly and easily attributed to a specific project. This means if the project did not exist, the organisation would likely still need to incur this cost. Indirect costs include IT, finance, human resources, learning and development, measurement and evaluation.

The report goes into the definitions of Indirect costs, including how inconsistently they are defined and reported across the sector.

I want to expand on two issues:

1. Ongoing indirect costs vs transformational indirect costs
2. The impact on staff engagement and wellbeing

Some indirect costs are neither ongoing nor project support

The modelling contains an unspoken assumption that while there are ‘front-facing’ costs (delivery of outcomes) and ‘support’ costs, the latter only exists as a proportional contribution to the front-facing activities. This is revealed in a pie chart:

From p14 of the report

But this is misleading. There are categories of spend that can be attributed like this for sure, such as:

• office rent
• audit, board costs
• administrative staff

This yields an organisation that can carry on as it is, in its originally conceived state, delivering the same kind of thin it’s always done. Conceptually, an org based on ‘feed homeless people’ could gain a grant to ‘clothe homeless people’ and the model wouldn’t shift.

But NFPs also need deal with changing service needs and developments in the operating environment. And that requires something very specific — one-off indirect costs. These one-off indirect costs will never be covered by a service delivery grant. Examples?

When I joined Renew in 2020, the organisation was operated from a physical server, with hard drive backups. The systems were not compatible with the ATO’s single touch payroll system, and required dialling in to reach files. I moved all this into the cloud. I needed an external IT expert to assist, and it required staff time. That cost money that was neither ongoing annual costs nor attributable to one project.

And over five years, the organisation moved a complex web of old membership databases into a contemporary CRM. This cost money and staff time — ‘project development’ costs and staff time to create the thing, and then ‘operational costs’ and staff time to continue running the thing. The long-term benefits are clear, but neither of these attributable to a current grant project.

Worst of all, the creation of a bequest program was never possible. With a loyal and aging member cohort, this is a no-brainer financial sustainability project for long-term income. But it’s also a non-trivial task, requiring clear legal advice, careful stakeholder communications and so on.

I have to credit funders such as the Lord Mayor’s Charitable Foundation, who made significant contributions to the CRM replacement project. But this was/is very rare.

The report covers the issues with running costs very well — for what it’s worth, I agree with it all. But it doesn’t usefully separate out the issue of one-off costs.

Runners need new shoes every 750km. So while I can run today, and tomorrow, I can’t run all year without finding a magic money tree for the one-off investment in new shoes.

Impact on staff

The report talks about adding admin tasks to delivery staff, just so they can be funded. This is a real issue. What I would add, though, is the effect on psychology of staff of the endless starvation cycle and underinvestments in improvements. The obvious ones:

• Talent won’t join because underpaid
• Talent leaves because training and career development don’t happen
• Talent leaves because of hand-to-mouth precarity
• Talent slowly becomes untalented — because no training, no new systems (who would employ a membership person without CRM experience?).

So effectively, many NFPs only function by applying extractive practices on their talent.

The pernicious extraction, though, is hope. Many NFP employees — and Boards, and leaders — have become so accustomed to this relentless, consistent underfunding that they lost hope it it ever changing. Gallows humour abounds, with a shrug of ‘what can you do, huh?’.

This contributes to cohorts of staff that:

• are resistant to change (‘it’s always been like this’)
• see their personal career management (eg training) as something they have to do for themselves
• tolerate of poor practices from managers, board, stakeholders, partners — either through ignorance that it can be better, or through fatalism that nothing ever changes
• are so motivated by the passion of the Cause that they are sacrifice their wellbeing (and many would say that managers, CEOs and Boards tacitly encourage this)
• Get into a mindset of embattled groupthink and resist alternative ways to deliver the mission (surplus-generating activities with different revenue models, for instance)

The sector cannot respond to the challenges of the Climate Emergency without creativity, flexibility and optimism. Business-as-usual and a big spoonful of passionate commitment won’t cut it. But that needs funders to enable a culture of security and safety, by supporting what it actually takes.

Power corrupts; those with power must fix the problems

The report is really clear the power imbalance between NFPs and funders exists,

…the power asymmetry that exists between funders and not-for-profits is a significant contributor to the not-for-profit starvation cycle and it can be understood as a central feature…

…but i think it pulls its punch before then end. Where power imbalances exist, someone is benefiting from privilege, and someone is suffering. I’m not in a role where i’m seeking funding, now. So i’ll say the quiet part out loud, that those in the sector can’t:

funders who refuse to pay indirect costs then claim plaudits for NFP achievements are parasitic on the NFP sector and the passion and skills of NFP employees.

If funders want to deliver their agenda through funding NFPs (rather than by hiring staff and doing it themselves) then they also have an obligation to contribute to a healthy, functioning future-proof NFP sector. Some already are, but just as men must work to deconstruct the patriarchy, so must all funders must work to fix the problems baked in by decades of narrow funding practices.

How?

The report’s recommendations are excellent. I’d only add,

• NFP Boards need to have better conversations about these issues, and consciously support their team in clearer asks for indirect costs. This means being prepared to be unsuccessful, and creating the space for the team to ‘fail’ safely.
• The sector needs to be clearer on outcome definition and evaluation — so this becomes easier and the focus of reporting, rather than financial reporting
• Funders need to collaborate in changing the culture (noting many already are), which is starting with this report and needs to go further.

A bolder approach? Stop referring to ‘indirect’ and ‘direct’ costs altogether. The ACNC and Auditors don’t. Other sectors don’t. When I buy a litre of milk, I don’t try to subtract the cost of the shop’s finance team’s salaries. I pay what they tell me the milk costs or i go without milk.

So fund outcomes. Fund them at the cost it takes to deliver them; which is the cost the NFP tells you. No NFP is trying to gouge, they just aren’t built that way.