How a short-term response to COVID-19 can better support philanthropic grantees in the long run
Caps on indirect costs have been a polarizing issue in the social sector for many years. Once they were the most ubiquitous measure of administrative efficiency employed by philanthropic institutions. For informed donors they were standard litmus test to ensure their dollars were having an impact on the issues that motivated them. Today more and more leading voices in philanthropy are calling into question the true utility of these tools. They have created a race to the bottom among grant giving organizations- where the recognized standard was once a 20% cap on indirect costs, it is now common to see ceilings as low as 15% or 10% imposed on social sector organizations by the funding partners that sustain them.
There is a growing recognition, however, that they are poor measures of efficiency or effectiveness. Rather than guarantee consistent allocation of funding to program and impact, this practice usually results in creative bookkeeping and reporting as leaders seek to contextualize as many costs as possible as direct. Nor does it provide any incentive for organizations to differentiate on the quality of their outcomes, the efficacy of their programing, or the learnings they can provide to their respective sectors.
While the social sector is grappling with this measurement standard, COVID-19 has upset the proverbial apple cart. Philanthropic organizations are deploying broader use of unrestricted grants and funding to help keep the lights on and sustain grantees. This will naturally lead to greater spend on overhead and indirect program costs. Grant making organizations recognize how necessary this is, and should help individual donors and contributors to understand the financial impact of this looming imbalance in the FY21 books. However, they should do more: this as an opportunity to revisit how institutional decision-makers approach philanthropic prioritization and planning.
Philanthropic donor institutions must move past the practice of using indirect costs as a proxy for quality when benchmarking mission-driven organizations. There is little logic in holding two organizations with entirely different industry backgrounds or business models to the same standard. Consider a donor attempting to make an informed comparison between an educational program focused on farming technical assistance in Central America and a sustainable agriculture research & development institution located in a developed country. The ability to hit the same externally mandated benchmark on overhead costs tells us almost nothing about the efficiency and efficacy of these organizations. It does not contextualize the realities inherent in those separate ecosystems, nor does it ensure that each dollar spent on programming is maximizing potential impact.
At a minimum, more attention should be paid to variation in standards by sub-sector. Philanthropic organizations should use more nuanced standards for indirect costs across their portfolios and focus industries to ensure a more level playing field for prospective grantees with bulkier cost-structures.
Ideally, philanthropic organizations should work with grantees to cultivate more sophisticated, industry relevant monitoring and evaluation programs. These capabilities are critical for social sector organizations not just to prove their impact and make them more competitive for subsequent funding, but to understand the true drivers of efficiency and efficacy within the context of their programs. Once these practices are more common, the philanthropic donor institutions will have far better standards against which to measure mission-driven organizations.