A blog post by Lucius Caviola & Nadira Faulmüller, cross-posted from the Practical Ethics blog at Lucius' request.
Imagine a car company advertising as follows: “90c of any dollar you pay for your car goes directly to building cars. Only 10% of our expenses go into planning, designing, and advertising them.” Such a campaign strategy would seem patently bizarre; when buying a product few of us are interested in how much went into administration, all we care about is what we get for our money. Overhead ratio (the proportion of money going into administration) is irrelevant; only cost-effectiveness matters.
This common sense approach to purchasing goods or services does not seem to translate into the non-profit sector, however. Consider the following advertisement by the organisation CARE: “More than 90 percent of our expended resources – among the highest of all philanthropic organisations – support our poverty-fighting projects around the world. Less than 10 percent of expended resources go toward administrative and fundraising costs.”
CARE campaign strategy is quite common for a non-profit. Many charities attempt to win donors by emphasising their low overhead ratio. Perhaps they are right to so do, as more than a third of US citizens believe that charities should spend much less on administration. Further, lab studies have shown that people tend to donate more to charities with low overhead ratios. Consequently, in order to fulfil donors’ expectations charities are forced to keep their overheads small as illustrated in Dan Pallotta’s TED talk.
Few donors are able to identify the irrelevance of overhead ratio to effective giving. The interventions of some charities are far more cost-effective than others, so that even if only a small percentage of donated money reaches the destination, the overall impact will be much more beneficial than a larger percentage of donations for a less effective intervention.
Indeed, charity evaluators have not found any correlation between overhead ratio and cost-effectiveness: Organisations with a low overhead ratio can still fail to be effective, and organisations with a high overhead ratio can be very effective – maybe precisely due to good administration, including competent staff, infrastructure, fundraising, and evaluation.
Given donor’s proven aversion towards overhead, charities could consider offering ‘overhead-free’ donations (by, for example, soliciting unrestricted funding from a few large donors to cover administration costs). A recent study published in Science has found that average donations can triple when donors are told that overhead costs are already covered. One explanation for this result is that people perceive their personal impact to be greater if all of their money reaches the destination.
These findings raise an important question: Why are people so preoccupied with overhead ratio in the first place? A study we have recently conducted suggests that they may be falling prey to an error called evaluability bias; people focus on overhead ratio because it is easier to evaluate than cost-effectiveness.
We found that when people are presented with information for a single charity (namely its overhead ratio and number of lives saved per dollar), on average charities with lower overhead ratios received more donations, irrespective of cost-effectiveness. However, when people are presented with information for two charities (allowing them to compare the cost-effectiveness of the two charities), they gave more to the charity with the greater cost-effectiveness, irrespective of overhead ratio. These findings suggest that people do care about saving lives, not administration costs, but that unless the information needed to evaluate cost-effectiveness is readily available, they will fall back on the easier-to-evaluate overhead ratio.
So although people are biased about what matters in the non-profit sector, the good news is that appropriate information about cost-effectiveness can go a long way to correcting this bias. We must try to better inform potential donors about the irrelevance of overhead ratio when selecting a charitable cause, and work to improve their decisional architecture to make it easier for them to realise the importance of cost-effectiveness. Shifting resources to the most cost-effective charities is crucial; a lot of individuals’ lives depend on it.