Kimberley Scharf looks at why the not-for-profit sector is so concerned with fixed costs

1. Fixed Costs and Efficiency in the Non-profit Sector
Kimberley Scharf
Carlo Perroni, Ganna Pogrebna, Sarah Sandford
March 29, 2014
PRELIMINARY

2. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Two research questions
1. Are donors afraid of charities’ fixed costs?
2. In the presence of fixed costs, can the rich control the charitable
agenda?
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

3. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs
In economic terms, fixed costs are costs that do not scale up
with output
In accounting terms, they can be some kinds of administrative
costs or overhead costs or other costs associated with things
like
IT systems
Financial systems
Skills training
Salaries in some situations
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

4. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs and scale economies
Taking advantage of scale economies ⇒ fixed costs need to be
incurred, 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 in
the private sector are very well understood and studied
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

5. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs and scale economies in the private sector
Fixed costs do not present a challenge for private firms: in
private markets, the most cost effective technology will win
For firms that use fixed cost technologies, goods can be
offered at a cheaper price ⇒ customers can be stolen from less
efficient firms, which are driven out of the marketplace
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

6. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs and scale economies in the non-profit sector
In the non-profit sector, even though charitable goods and
services cannot be ‘bought’ and ‘sold’ as they are in private
markets
In order to be cost effective, charities (of all sizes) must incur fixed
costs as their scale of operation increases
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

7. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
But does not seem to be what we see
This idea of cost effectiveness and fixed costs seems to present
special challenges to charities
And this seems very strange for economists who are mainly
concerned about efficiency
We see that charities seem to relate to fixed costs differently
than do private firms
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

8. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs seems to present special challenges for charities
Charities seem to worry about how fixed costs affect their position
and viability
“There’s an idea out there that a charity is good if it only
spends 20% on administration and fundraising and 80% on
program 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

9. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Fixed costs seems to present special challenges for charities
There seems to be a perception in the non-profit sector that, for
some reason, donors do not want to pay for fixed costs
“. . . we believe that a highly efficient charity should be
spending just 15% on overhead, so we give our best score to
charities that spend 85% or more on programs . . . we give top
marks for fundraising organizations that flow 90% or more of
their expenditures to other charities, leaving just 10% for
overhead”
(Moneysense, Charity 100)
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

10. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Challenges have implications for sectoral efficiency
They seem to imply that a ‘good’ charity has a small fraction
of fixed costs relative to variable costs
Fixed costs seem to be thought of as being wasteful
Variable costs seem to be interpreted as measuring actual
program activities
But this makes no sense from an economics point of view
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

11. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
For an economist . . .
It is like saying that research and development expenditures
that result in innovations are wasteful
Wasteful
Even more wasteful
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

12. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
The efficiency implications
If donors are reluctant to pay for fixed costs, and if this is the
situation that charities are faced with ⇒ no guaranteees that
the most cost effective charities are selected by donors ⇒
inefficiency in the sector
If charities respond to concerns by adopting inefficient
strategies that avoid fixed costs ⇒ innovation slowdown in the
sector ⇒ inefficiency in the sector
There is an efficiency based economic rationale for government
intervention targetted towards fixed costs
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

13. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Our research
We are researching this question and trying to understand
underlying mechanisms
Analytical findings are that analysis of performance of the
non-profit sector requires different economic tools than the
ones we use when analysing performance in the for-profit
sector
Preliminary lab experiments suggest that donors do relate to
fixed costs in a peculiar way; and one reason for this is that
they think of provision that involves relatively large fixed costs
as being more ‘risky.’
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

14. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
How subjects relate to fixed costs in the lab
In situations where small groups of subjects have to choose
between two options involving fixed costs – a higher fixed cost
option which is more efficient and which payoff dominates –
for the same money, provision is higher – a less efficient lower
fixed cost option . . .
The efficient option is chosen only 63% of the time
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

15. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Evidence points choices being driven by behavioural reasons
Our evidence suggests that subjects think of high-fixed cost
option as being ’riskier’ than low-fixed cost option ⇒ poor
coordination ⇒ subjects spread out between the two options
⇒ waste/inefficiency through duplication of fixed costs
Our evidence also suggests that this coordination induced
inefficiency is more serious, the bigger is the difference in fixed
costs between the two options
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

16. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Lab results on performance with two contribution options
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

17. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
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 and
innovation slowdown
Both results provide a rationale for corrective government
intervention systematically targetted to fixed costs; and have
important implications for fundraising and reporting of costs
(but you know about those)
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

18. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Second question
In the presence of fixed costs, can the rich control the charitable
agenda?
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

19. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Story
Question related to this is that of the coordinating role that
large donors can play
In situations where you have different charities providing the
same services
Donors have to coordinate on one thing or the other otherwise
there is waste
Large donors are naturally coordinated since they can put all of
their donation onto one thing
This can be an economically efficient because large donors can
trigger coordination by funding fixed costs, and then smaller
donors might coordinate around that ⇒ potential for efficiency
enhancing coordination on the ‘right’ provider
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

20. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
Issues
To the extent that there are different priorities and views
about the missions that charities should adopt, then large
donors might naturally use their advantage in ‘herding’
donations towards their own favourite cause, which might not
be the mission that smaller donors prefer
We are planning more experiments around this
Agenda raises a number of serious issues and there are
potentially a number of important implications – for the sector
as a whole, for fundraising strategies, and last but not least,
for public policy
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector

21. Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control t
THANK YOU!!
My e-mail address is k.scharf@warwick.ac.uk
My homepage is here
I sometimes Tweet @KimberleyScharf
Kimberley Scharf
Fixed Costs and Efficiency in the Non-profit Sector