why do charities worry about fixed costs so much?
DESCRIPTION
Kimberley Scharf looks at why the not-for-profit sector is so concerned with fixed costsTRANSCRIPT
Fixed Costs and Efficiency in the Non-profit Sector
Kimberley ScharfCarlo Perroni, Ganna Pogrebna, Sarah Sandford
March 29, 2014
PRELIMINARY
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Two research questions
1. Are donors afraid of charities’ fixed costs?
2. In the presence of fixed costs, can the rich control the charitableagenda?
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs
In economic terms, fixed costs are costs that do not scale upwith output
In accounting terms, they can be some kinds of administrativecosts or overhead costs or other costs associated with thingslike
IT systems
Financial systems
Skills training
Salaries in some situations
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs and scale economies
Taking advantage of scale economies ⇒ fixed costs need to beincurred, because that is how scale economies are exploited
This is justified only for a certain scale of operations,otherwise the spend on the machine is wasted
Implications of fixed costs and scale economies for efficiency inthe private sector are very well understood and studied
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs and scale economies in the private sector
Fixed costs do not present a challenge for private firms: inprivate markets, the most cost effective technology will win
For firms that use fixed cost technologies, goods can beoffered at a cheaper price ⇒ customers can be stolen from lessefficient firms, which are driven out of the marketplace
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs and scale economies in the non-profit sector
In the non-profit sector, even though charitable goods andservices cannot be ‘bought’ and ‘sold’ as they are in privatemarkets
In order to be cost effective, charities (of all sizes) must incur fixedcosts as their scale of operation increases
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
But does not seem to be what we see
This idea of cost effectiveness and fixed costs seems to presentspecial challenges to charities
And this seems very strange for economists who are mainlyconcerned about efficiency
We see that charities seem to relate to fixed costs differentlythan do private firms
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs seems to present special challenges for charities
Charities seem to worry about how fixed costs affect their positionand viability
“There’s an idea out there that a charity is good if it onlyspends 20% on administration and fundraising and 80% onprogram costs, and if you’re out of that approximate range,somehow you’re bad or inefficient”
(Rosemary McCarney, Plan Canada)
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Fixed costs seems to present special challenges for charities
There seems to be a perception in the non-profit sector that, forsome reason, donors do not want to pay for fixed costs
“. . . we believe that a highly efficient charity should bespending just 15% on overhead, so we give our best score tocharities that spend 85% or more on programs . . . we give topmarks for fundraising organizations that flow 90% or more oftheir expenditures to other charities, leaving just 10% foroverhead”
(Moneysense, Charity 100)
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Challenges have implications for sectoral efficiency
They seem to imply that a ‘good’ charity has a small fractionof fixed costs relative to variable costs
Fixed costs seem to be thought of as being wasteful
Variable costs seem to be interpreted as measuring actualprogram activities
But this makes no sense from an economics point of view
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
For an economist . . .
It is like saying that research and development expendituresthat result in innovations are wasteful
WastefulEven more wasteful
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
The efficiency implications
If donors are reluctant to pay for fixed costs, and if this is thesituation that charities are faced with ⇒ no guaranteees thatthe most cost effective charities are selected by donors ⇒inefficiency in the sector
If charities respond to concerns by adopting inefficientstrategies that avoid fixed costs ⇒ innovation slowdown in thesector ⇒ inefficiency in the sector
There is an efficiency based economic rationale for governmentintervention targetted towards fixed costs
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Our research
We are researching this question and trying to understandunderlying mechanisms
Analytical findings are that analysis of performance of thenon-profit sector requires different economic tools than theones we use when analysing performance in the for-profitsector
Preliminary lab experiments suggest that donors do relate tofixed costs in a peculiar way; and one reason for this is thatthey think of provision that involves relatively large fixed costsas being more ‘risky.’
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
How subjects relate to fixed costs in the lab
In situations where small groups of subjects have to choosebetween two options involving fixed costs – a higher fixed costoption which is more efficient and which payoff dominates –for the same money, provision is higher – a less efficient lowerfixed cost option . . .
The efficient option is chosen only 63% of the time
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Evidence points choices being driven by behavioural reasons
Our evidence suggests that subjects think of high-fixed costoption as being ’riskier’ than low-fixed cost option ⇒ poorcoordination ⇒ subjects spread out between the two options⇒ waste/inefficiency through duplication of fixed costs
Our evidence also suggests that this coordination inducedinefficiency is more serious, the bigger is the difference in fixedcosts between the two options
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Lab results on performance with two contribution options
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Conclusions from first question
This is academic research (still in progress)
First time anyone has looked at this (anywhere)
Our preliminary analytical and empirical evidence suggests
(1) Donor responses to fixed costs do appear problematic
(2) They can cause serious inefficiencies in the sector andinnovation slowdown
Both results provide a rationale for corrective governmentintervention systematically targetted to fixed costs; and haveimportant implications for fundraising and reporting of costs(but you know about those)
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Second question
In the presence of fixed costs, can the rich control the charitableagenda?
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Story
Question related to this is that of the coordinating role thatlarge donors can play
In situations where you have different charities providing thesame services
Donors have to coordinate on one thing or the other otherwisethere is waste
Large donors are naturally coordinated since they can put all oftheir donation onto one thing
This can be an economically efficient because large donors cantrigger coordination by funding fixed costs, and then smallerdonors might coordinate around that ⇒ potential for efficiencyenhancing coordination on the ‘right’ provider
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
Issues
To the extent that there are different priorities and viewsabout the missions that charities should adopt, then largedonors might naturally use their advantage in ‘herding’donations towards their own favourite cause, which might notbe the mission that smaller donors prefer
We are planning more experiments around this
Agenda raises a number of serious issues and there arepotentially a number of important implications – for the sectoras a whole, for fundraising strategies, and last but not least,for public policy
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector
Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?
THANK YOU!!
My e-mail address is [email protected]
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Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector