Cyber Voyeurs

April 1, 2008       Thomas McLaughlin      

They’re out there and they’re watching you. They have earnest names and they have figured out a way to measure you based on one or more criteria for success. They appear in the popular press whenever some non-streetsmart nonprofit management team commits a blunder. They offer up a pithy quote or two and then they go back to their computer screens. You know these groups. They are the charity watchers.

A new species of advocate, charity watchers have fashioned a mini-industry out of publicly-available information regarding nonprofit public charities. And the truth is, they are needed. Explicit government oversight of public charities is, in all honesty, lax. One can count on a single hand the number of state government charity oversight officials with anything more than a barebones budget and systems that are even close to being adequate.

As a sector, nonprofit has to be one of the most honorable and accountable. But there are always a few bad guys sprinkled here and there. Auditors require a certain level of disclosure, but sunlight really is the best disinfectant and that’s what the charity watchers supply.

At the same time, it’s not pleasant to be rated, especially by a distant presence whose only exposure to your organization is likely to come from less than a megabyte worth of data and no in-person contact. Moreover, some no doubt harbor the suspicion that charity watching is more about the watchers than it is about improving the charity world. In the end, however, these are quibbles.

Publicly-held companies know that their stock prices are partially at the mercy of analysts, some of whom never leave the comfy world of lower Manhattan to see the companies they rate. Why should it be any different for public charities?

In any event, the watchers are with us, and streetsmart managers will find ways to deal with them. There are four ways of coping with the watchers. Each has its own logic, and each can offer a different set of solutions to the potential problems caused by the watchers.

1. Data Presentation Is there anyone in the voluntary sector, with more than about six months’ worth of experience, who believes that the Internal Revenue Service Form 990 doesn’t matter? Unlike the personal Form 1040, the Form 990 is considered an informational return because no money is expected to exchange hands as a result of the information it presents.

Sure. Tell that to the nonprofit that didn’t get a grant because the donor didn’t like the organization’s percentage of administrative spending. The publicly-available Form 990 has become the information currency of the nonprofit sector.

Take the quick calculation that many have learned to make. Divide line 45C by line 12 to get the management costs as a percentage of revenue. This is a guide to overhead costs for the reporting organization, but the percentage climbs if you throw in fundraising costs on line 44D. Overhead costs like these are becoming the acid test for some donors and funders. Everyone “knows” that overhead costs take away from programs and services, so everyone “knows” that the greater the overhead percentage the less efficient and therefore less worthy is the organization. The point is reinforced by some of the watchers’ rating methods.

This dynamic tension is probably permanently enshrined in the nonprofit sector. So the expense information had better accurately represent your organization, or it could carry a high cost. Most nonprofit board members and executives alike sincerely wish to keep administrative costs low, as do the charity watchers. But that doesn’t mean that they report those costs accurately.

Internal inconsistencies can derail a Form 990. Combine those with untutored analysts and the stage is set for a public relations gaffe. For example, one major newspaper pulled a large sampling of Form 990s and printed an analysis of which ones raised the most dollars from the public. In at least one case a reporting entity mistakenly called government funding “public contributions.” The newspaper accepted the declaration uncritically, even though the organization’s small and accurately reported fundraising expenses would have meant their cost of fundraising was an absurdly efficient 1 percent.

Of course, if one’s management expenses are high for legitimate reasons, well, that’s just the reality and everyone will have to find a way to be comfortable with that, including the watchers. But eliminating sloppy or misleading reporting should be a natural first step.

2. Allocation methodologies Direct costs have the benefit of being traceable to specific services or programs or types of spending. But many costs cannot be directly attributable to any program or activity and must be allocated according to some reasonable formula. Management and general costs from column C on the second page are classic allocations.

Sometimes it is possible to allocate a cost directly to the management function. For instance, a bookkeeper is virtually always going to be a management cost of some sort. But other allocations are not so clear cut, and ultimately they tend to be a judgment call.

Allocations also have a way of working themselves into everyone’s consciousness and where they take on more credibility than they sometimes deserve. For instance, one well-known public charity consisted of a large central office where most of the programming and management tasks were carried out, and several small satellite offices, which were largely direct service and a bit of management. Many years earlier, when the charity watchers didn’t exist, the organization started lumping the satellite direct service operations into administration because it was easier that way.  This greatly inflated administrative costs, which never mattered much — until the watchers came to town. Reducing their ratios was largely a matter of correctly segregating direct service costs from administrative costs.

3. When they’re right Then there are the times when the watchers get it right — you are inefficient. If that’s the case, how you report the financial results is largely irrelevant. You’ve got work to do.

Many managers see inefficiency in two dimensions, like a mathematical formula. If you want the top part of the formula to come up, you have to push down on another part.  Rarely is inefficiency that simple. If you really do spend too much money on fundraising, the chances are that it’s your fundraising model and your related cultural expectations that are to blame. It might have worked to base your fundraising on special events 10 years ago when the organization was small, but to get to the next level it will take a complex effort involving a new organizational strategy, staff retraining, donor management, and serious cultivation efforts. This is a major undertaking and it’s the right thing to do for the organization. Just don’t expect it to show up in the watchers’ ratings for a while. In the meantime, you at least have a case to make based on your constant improvement.

4. Communication Throughout the process of dealing with an unfavorable charity watcher rating, try to keep the channels of communication open. Some watchers are more amenable to this than others. It never hurts to try to open up lines of communication with a watcher. Some allow nonprofits to place additional information on their Web sites. In general, more communication with the watchers and your constituencies is better than less. If nothing else, you have more of a chance to shape the dialog and should be less in a reactive mode.

In some instances, nonprofits use independent parties to do things like conduct an objective analysis of a charity watcher’s score or to model a situation to identify the true drivers of a low score. They can also act as intermediaries between an organization and a watcher.

Charity watchers have become part of the fiber of the voluntary sector. They serve a useful function even if aggrieved managers might not always feel that way. So the streetsmart manager will find ways to manage this new development just like they manage so many other things. And there’s a certain symmetry to this. Who else is going to watch the watchers?  NPT

Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in Boston. He is the author of the book Nonprofit Strategic Positioning (John Wiley and Sons, 2006). His email address is thomas.mclaughlin@gt.com. Mark Oster of the New York City office of Grant Thornton assisted with this article.

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