January 1, 2017

Improving Indirect Cost Recovery

It is critical that nonprofits recover the true costs of doing there work, and this only happens if funders heed the call. 

Ford Foundation CEO Darren Walker knows what it is like to run a nonprofit on a shoestring budget. "I used to be a COO of a community development organization, Abyssinian Development Corporation, which lived with overhead funding caps and the limiting, and at times paralyzing, constraints they placed on us," he explains. "As the leader of a foundation, I have now come to understand that solutions to financing overhead costs are neither clear nor straightforward. But we must find a way to finance key grantees so that they are financially sustainable over the long term and able to help solve society’s most critical problems."

Since its inception, The Bridgespan Group has worked to understand what it takes to build strong nonprofits. We believe the first step a nonprofit should take is to recover the true costs of doing its work. In 2009, Bridgespan’s "Nonprofit Starvation Cycle" research pointed to a cycle that begins with funders’ (public and private) unrealistically low assumptions about the true costs of running a high-performance nonprofit. In turn, many nonprofits underreport overhead spending to meet funders’ expectations. This reinforces the assumptions that kicked off the cycle in the first place (see graphic below). In 2013, Bridgespan took a closer look at the impact on INGOs in "Stop Starving Scale." Our research found that many large INGOs experience “fragmented growth that feeds the programmatic branches and starves the operational core.”

The Nonprofit Starvation Cycle

Project-restricted grants, the norm for the US government, multilateral funders like the European Commission and the United Nations, and private foundations, further exacerbate the problem. Project grants are typically “priced” at direct costs plus indirect costs and most funders cap indirect costs with flat rate policies ranging from 10 percent to 20 percent of direct costs.

In 2016, Bridgespan's "Pay-What-It-Takes Philanthropy" analyzed the true indirect cost of 20 high-performing nonprofits, demonstrating that 10–20 percent is too low to cover true indirect costs for most organizations. This data also led us to divide the group into segments based on their business models—an idea we think holds promise for better understanding variability in true costs.

Today, Bridgespan is collaborating with a number of social sector leaders who are committed to finding new and sustainable ways of funding nonprofits that accurately reflect the cost of creating meaningful and lasting social change. This requires nonprofits to understand, communicate, and manage their costs—and funders to pay what it takes to achieve results.

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Additional resources on indirect cost recovery

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The Bridgespan Group would like to thank the JPB Foundation for its generous and ongoing support of our knowledge creation and sharing work.