Why do charities worry about fixed costs so much?

21
Fixed Costs and Efficiency in the Non-profit Sector Kimberley Scharf Carlo Perroni, Ganna Pogrebna, Sarah Sandford March 29, 2014 PRELIMINARY

description

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

Transcript of Why do charities worry about fixed costs so much?

Page 1: Why do charities worry about fixed costs so much?

Fixed Costs and Efficiency in the Non-profit Sector

Kimberley ScharfCarlo Perroni, Ganna Pogrebna, Sarah Sandford

March 29, 2014

PRELIMINARY

Page 2: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Two research questions

1. Are donors afraid of charities’ fixed costs?

2. In the presence of fixed costs, can the rich control the charitableagenda?

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 3: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs

In economic terms, fixed costs are costs that do not scale upwith output

In accounting terms, they can be some kinds of administrativecosts or overhead costs or other costs associated with thingslike

IT systems

Financial systems

Skills training

Salaries in some situations

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 4: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs and scale economies

Taking advantage of scale economies ⇒ fixed costs need to beincurred, 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 inthe private sector are very well understood and studied

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 5: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs and scale economies in the private sector

Fixed costs do not present a challenge for private firms: inprivate markets, the most cost effective technology will win

For firms that use fixed cost technologies, goods can beoffered at a cheaper price ⇒ customers can be stolen from lessefficient firms, which are driven out of the marketplace

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 6: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs and scale economies in the non-profit sector

In the non-profit sector, even though charitable goods andservices cannot be ‘bought’ and ‘sold’ as they are in privatemarkets

In order to be cost effective, charities (of all sizes) must incur fixedcosts as their scale of operation increases

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 7: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

But does not seem to be what we see

This idea of cost effectiveness and fixed costs seems to presentspecial challenges to charities

And this seems very strange for economists who are mainlyconcerned about efficiency

We see that charities seem to relate to fixed costs differentlythan do private firms

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 8: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs seems to present special challenges for charities

Charities seem to worry about how fixed costs affect their positionand viability

“There’s an idea out there that a charity is good if it onlyspends 20% on administration and fundraising and 80% onprogram 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

Page 9: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Fixed costs seems to present special challenges for charities

There seems to be a perception in the non-profit sector that, forsome reason, donors do not want to pay for fixed costs

“. . . we believe that a highly efficient charity should bespending just 15% on overhead, so we give our best score tocharities that spend 85% or more on programs . . . we give topmarks for fundraising organizations that flow 90% or more oftheir expenditures to other charities, leaving just 10% foroverhead”

(Moneysense, Charity 100)

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 10: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Challenges have implications for sectoral efficiency

They seem to imply that a ‘good’ charity has a small fractionof fixed costs relative to variable costs

Fixed costs seem to be thought of as being wasteful

Variable costs seem to be interpreted as measuring actualprogram activities

But this makes no sense from an economics point of view

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 11: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

For an economist . . .

It is like saying that research and development expendituresthat result in innovations are wasteful

WastefulEven more wasteful

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 12: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

The efficiency implications

If donors are reluctant to pay for fixed costs, and if this is thesituation that charities are faced with ⇒ no guaranteees thatthe most cost effective charities are selected by donors ⇒inefficiency in the sector

If charities respond to concerns by adopting inefficientstrategies that avoid fixed costs ⇒ innovation slowdown in thesector ⇒ inefficiency in the sector

There is an efficiency based economic rationale for governmentintervention targetted towards fixed costs

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 13: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Our research

We are researching this question and trying to understandunderlying mechanisms

Analytical findings are that analysis of performance of thenon-profit sector requires different economic tools than theones we use when analysing performance in the for-profitsector

Preliminary lab experiments suggest that donors do relate tofixed costs in a peculiar way; and one reason for this is thatthey think of provision that involves relatively large fixed costsas being more ‘risky.’

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 14: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

How subjects relate to fixed costs in the lab

In situations where small groups of subjects have to choosebetween two options involving fixed costs – a higher fixed costoption which is more efficient and which payoff dominates –for the same money, provision is higher – a less efficient lowerfixed cost option . . .

The efficient option is chosen only 63% of the time

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 15: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Evidence points choices being driven by behavioural reasons

Our evidence suggests that subjects think of high-fixed costoption as being ’riskier’ than low-fixed cost option ⇒ poorcoordination ⇒ subjects spread out between the two options⇒ waste/inefficiency through duplication of fixed costs

Our evidence also suggests that this coordination inducedinefficiency is more serious, the bigger is the difference in fixedcosts between the two options

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 16: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Lab results on performance with two contribution options

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 17: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

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 andinnovation slowdown

Both results provide a rationale for corrective governmentintervention systematically targetted to fixed costs; and haveimportant implications for fundraising and reporting of costs(but you know about those)

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 18: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Second question

In the presence of fixed costs, can the rich control the charitableagenda?

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 19: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Story

Question related to this is that of the coordinating role thatlarge donors can play

In situations where you have different charities providing thesame services

Donors have to coordinate on one thing or the other otherwisethere is waste

Large donors are naturally coordinated since they can put all oftheir donation onto one thing

This can be an economically efficient because large donors cantrigger coordination by funding fixed costs, and then smallerdonors might coordinate around that ⇒ potential for efficiencyenhancing coordination on the ‘right’ provider

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 20: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

Issues

To the extent that there are different priorities and viewsabout the missions that charities should adopt, then largedonors might naturally use their advantage in ‘herding’donations towards their own favourite cause, which might notbe the mission that smaller donors prefer

We are planning more experiments around this

Agenda raises a number of serious issues and there arepotentially a number of important implications – for the sectoras a whole, for fundraising strategies, and last but not least,for public policy

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector

Page 21: Why do charities worry about fixed costs so much?

Two Research Questions Are donors afraid of charities’ fixed costs? In the presence of fixed costs, can the rich control the charitable agenda?

THANK YOU!!

My e-mail address is [email protected]

My homepage is here

I sometimes Tweet @KimberleyScharf

Kimberley Scharf

Fixed Costs and Efficiency in the Non-profit Sector