For an organization focused on financial metrics, the American Institute of Philanthropy can be very interesting. I can’t do justice to this excellent article on Smile Train with an excerpt, and I urge you to read it all.

It thoroughly debunks an alleged claim by Smile Train that “100% of your donation goes toward programs — 0% goes toward overhead.” Smile Train currently seems to have backed off this claim at least somewhat, although Steven Levitt of Freakonomics appears to have been sold this story (and to have bought it) in 2006.

If identifying effectiveness with “low overhead” is silly, the idea of “0% overhead” simply seems absurd. As the article shows, it doesn’t (and can’t) mean that there are no operating costs affecting the total costs of the program. Rather, it’s another case of zooming in on “your” money, rather than discussing the true total costs of the program you’re supporting the existence of. It makes no sense in an analytical framework; it’s a feel-good gimmick.

That’s why we were surprised when we first saw this gimmick prominently displayed by a group that many consider to be the epitome of hard-nosed, analytical giving: Robin Hood.

Robin Hood’s financials make the situation look similar to Smile Train’s (minus the questionable reclassification of funds that AIP attributes to the latter). About 11% of Robin Hood’s total expenses are “Administration salaries and overhead” or “Fundraising and Public Information,” but because Board member donations are earmarked to those expenses, everyone else can be told their donations are “overhead-free.”

If your goal were to minimize overhead, the fact that Robin Hood tags funds this way shouldn’t be very relevant to you. Robin Hood could allocate more of those Board donations to programs if it spent less on overhead. If you gave to another organization, you could be scaling up an overall lower-overhead operation.

Bottom line: The “0% overhead” claim is promoting the wrong metric (low overhead) and offering a false way to accomplish it.

Today, the most common way that donors evaluate charities - when they evaluate them at all - is by asking questions about financials, such as “How much of my donation goes to programs vs. salaries?” This approach makes no sense.

We’ve argued this point before at length. Picking charities based on the “overhead ratio” is like picking your doctor by the percentage of revenue spent on medicine (more absurdity-highlighting analogies here). The actual reported “overhead ratio” is vaguely defined and generally up to the charities reporting it; the concept of “minimal money on overhead” discourages a lot of good and necessary spending, and is ultimately irrelevant to the question of whether a charity is changing lives.

What today’s press release (PDF) makes clear is just how much agreement there is on these points. Today’s two most prominent sources of financial metrics - GuideStar and Charity Navigator - agree that there needs to be more to the picture, and are working toward more meaningful metrics.

It’s scary to think about how commonly this metric is touted, when it’s recognized as a red herring. It seems to us that people have responded to the extreme scarcity of information on charities by using whatever information is available, whether or not it’s meaningful. Fortunately, alternative ways of evaluating charities are emerging.

GiveWell, Great Nonprofits and Philanthropedia are all new, small organizations. None of us have perfected a methodology yet - no one has - and all of us would benefit from more input. If more donors took a look at these resources, we would finally see the conversation around “Where should I give?” move beyond the distracting and unhelpful question of “Who has the lowest ‘overhead?’”

That would be a huge step toward a world in which donors reward charities for effectiveness in improving lives.

• GiveWell’s top charities
• Great Nonprofits
• Philanthropedia

Jeanne Panossian left two very interesting comments on our blog discussing donor irrationality, from the point of view of someone running a small charity.

• On donor illusions: ” … It takes extraordinary ethical fortitude to openly tell people how complicated your organization is, normally a donor has made their basic decision in the first 15 to 30 seconds of a conversation …”
• On the administrative expense ratio: “…While I love to talk all day about [my charity’s impact], I have learned it is not worth my while. Waving a flag and telling people how we pay for our paper clips yields me more funds faster …”

Recommended reading.

Good Intentions are not Enough gives some stunning examples of how charity can go wrong, and specifically points at the widespread emphasis on “low overhead” (which we have repeatedly criticized) as a culprit.

It’s worth noting that literal “administrative expenses” metric is often less harmful than the broader definition of “overhead.” For example, many evaluation and planning expenses can be and are classified as program expenses. However, the distinction is not always as clear to donors and even to charities as it is to accountants, so things that “feel like” overhead may be under-invested in even if they don’t affect the numbers on the Form 990.