In a prior commentary, “Overhead –It’s More Important Than You Think”, I promised a follow-up on the implications of using the term ‘overhead’ versus its predecessor term ‘indirect costs’. This is the promised follow-up. ‘Indirect cost’ was the term in use when I began working in nonprofits in the mid-1960’s. It incorporated three important yet simple concepts:
1. What constituted indirect costs were easily determined: they were any costs not clearly applicable to a budgetary unit (program, service, research project, etc.).
2. Nonetheless, such costs were understood to be real and thus part of each budgetary unit’s expenses.
3. It offered an easily understood basis for determining how to allocate the pool of indirect costs to each unit. Options included a unit’s salaries or number of personnel or number of square feet occupied as a percent of all salaries, number of personnel, etc. More importantly, it cemented the concept that there are certain costs (such as utilities, accounting, IT networks, employee benefits programs, etc.) which service and benefit all parts of the overall organization. )
This is not to say that allocated costs were met with universal acceptance. But the push back was less about the concept than about the relative value or benefit of such costs. And of course there were unit heads who were furious that some portion of the funds they may have raised themselves (e.g. donations, funded research, etc.) could not be used for their own programs. Such is human behavior. But the concept of indirect costs was not itself challenged.
Indeed, such feedback, regardless of the tenor, was a useful imperative to ensure that indirect costs were carefully managed and under constant scrutiny. Then, somewhere during the intervening years, the term ‘overhead’ came into use in lieu of ‘indirect costs’. Although I have no hard evidence to cite, my experience was that this change was part of the larger trend that was taking place in the 1980’s to corporatize nonprofits, to think of, to treat and to manage nonprofits more like private sector enterprises than as nonprofits. (I’ll return to that larger trend in another commentary.)
Simply put, ‘overhead’ is a private sector term to describe costs which do not generate revenue. Even worse, such costs diminish profits and thus paychecks, bonuses and dividends. That reason alone is a powerful monetary motivation to minimize overhead costs, often without consideration of any other consequences.
It should therefore come as no surprise that ‘overhead’ is a word that carries distinctively negative connotations. For example The Business Dictionary defines overhead as, “A resource consumed or lost in completing a process, that does not contribute directly to the end-product. Also called burden cost.”
On the other hand, in our sector the ability to most effectively and efficiently deliver programs and services varies in direct proportion with the effectiveness and efficiency of indirect costs. Inadequate information, outdated hardware and software, poorly functioning utilities, delays in securing supplies and other necessary tools, noncompetitive employee benefits and insurances, hard to access or unsuitable facilities, inadequate and late financial information………while the costs for these services may be indirect their consequences on programs and services and those who provide and benefit from them are direct and consequential.
One way to think about the role of indirect costs in nonprofits is in physiological terms: The brain, bones, muscles, limbs – the machinery – are what provide the programs and services and the organs are the indirect suppliers of the blood, oxygen and other materials which fuel the work of the providers. Fully functioning organs make possible fully functioning providers, and compromised organs compromise providers. It’s that simple.
Even so, in our sector indirect costs have historically been and still are consistently underfunded for two reasons: (a) the understandable imperative to put every possible dollar into direct benefits for those being served, and (b) chronic underfunding of indirect costs by governments, foundations and corporations. To make matters worse, the added corporatized pressure to reduce ‘overhead’ has further weakened an already compromised and inadequate support infrastructure of most nonprofits.
A simple way to describe the differences, with all their implications and connotations, between the current term and old one is this: ‘indirect costs’ can and need to be explained; ‘overhead costs’ can and need to be defended. Euthanizing ‘overhead’ and replacing it with ‘indirect costs’ would be a simple and effective way to change the conversation by using a neutral and more easily explainable term. More importantly it would change the way we ourselves think and talk about such an important component of the effectiveness and impact of our nonprofits.