Forcing charities to keep administrative costs excessively low may prevent them from achieving their missions.
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Last week I wrote that nonprofits should aim to optimize costs, not minimize them. Administrative costs are not only justified but mandated if they contribute to an organization's social impact. Therefore, forcing charities to keep administrative costs excessively low may prevent them from achieving their missions.

Dan Pallotta, author of the controversial new book Uncharitable: How Restraints on Nonprofits Undermine Their Potential, adopts this position to challenge some sacred cows of the nonprofit sector. Pallotta argues that our preconceptions about how charities should behave--for instance, that they should pay low salaries and not buy advertising--actually hinder their social missions. In short, Pallotta doesn't think charities should have to play by different economic rules than businesses.

For example, Pallotta wants to free charities to use paid advertising to "compete with consumer products for the customer's dollar." Paying $50,000 for a newspaper ad is justified if it brings in $500,000 in new donations. Pallotta argues that allowing charities to use paid advertising can turn dollars that would be spent on for-profit goods and services towards charity.

Charities also need to be able to invest those dollars in long-term strategies. All great businesses invest in building infrastructure and developing staff skills. They spend enormous sums to find and train great leaders. But some donors expect charities to spend their dollars immediately to serve the needy, not build their organization's capacity to have future impact.

According to Pallotta, the expectation that donated dollars should immediately serve the needy prevents nonprofits from building the capacity necessary to make fundamental change. If they're forced to use all their resources to remedy problems in the short term, nonprofits can't invest in actually solving them. In fact, the Hewlett Foundation acts on this idea by awarding Organizational Effectiveness grants for nonprofits to hire consultants, work on strategy, and improve communications and evaluation systems. We believe that these long-term investments can produce transformational results.

Pallotta also thinks that low salaries in the social sector reduce the supply of top talent. He believes that compensating people who work in charity "according to the value they produce" will help attract better leaders to the sector.

It's an error to think that because a charity serves the poor, its staff should be kept poor as well. When they identified and investigated twelve of the most successful nonprofits, for example, Heather McLeod Grant and Leslie Crutchfield found that high-impact nonprofits tend to compensate their executives well, investing in human resources to increase their impact.

Donors often monitor a charity's practices rather than its impact because measuring social impact is hard, and it's much easier to give a nonprofit a rating based on available financial data such as administrative costs. But rather than acquiesce in this state of affairs, we should demand information about results. There's a growing movement to create a nonprofit information marketplace to do this.

In the meanwhile, if some donors are turned off by nonprofits' paying decent salaries, the rest of us should try to educate them. If Pallotta's book helps change some people's minds about this, it will have done a real public service.

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