There’s a lot of public debate about how charities should be spending money that they raise. One thing that comes up again and again is the concept of fixed costs, also referred to as core costs. We talk to Kimberley Scharf, a professor of behavioural economics at The University of Warwick, for her views.
What are fixed costs and why can they sometimes be controversial for charities?
Fixed costs are costs that don’t scale up with the size of charitable programmes, but are nevertheless necessary. Often these costs have to do with short-run investment that makes it possible to run programmes at lower costs or to reach a larger number of beneficiaries for the same cost.
Here’s an example.
Imagine carrying out a vaccination scheme in a rural area of a developing country. You need doses of the vaccine, as well as a four-wheel-drive truck. The cost of the truck does not scale up with the number of beneficiaries like the vaccine does: you can use the same vehicle to reach 500 or 1,000 people (this is why this type of cost is described as fixed), whereas vaccinating 1,000 children will require twice as many doses as vaccinating 500 children (this is why this type of cost is described as variable).
Fixed costs are important for charities because they allow for cost savings through the building of capacity. However, they can be perceived as wasteful by donors if they fear that they’ll eat into programme costs excessively, leaving no funds to run the programmes. In turn, this means that charities sometimes find it difficult to persuade donors to fund their fixed costs.
Is a charity with low fixed costs more efficient at spending money than a charity with larger fixed costs?
Charities do seem to worry about this. Rosemary McCarney, CEO of Plan Canada, says: “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”. But this is wrong. Fixed costs are not wasteful.
Many of the costs incurred by private, profit-maximising business are fixed costs, and those businesses choose to incur them to reduce overall costs. Fixed costs are particularly large in certain sectors, such as transportation and telecommunications, but no one would suggest in those cases that they’re wasteful.
Charities pursue aims that are different from those of private businesses, but charities are no different from private businesses when it comes to the technology choices they must make.
Why do you think people have an emotional reaction to fixed costs in the charity sector but not in the private, for-profit sector?
Donors are often reluctant to fund fixed costs and may expect their donations to be earmarked to funding programmes. In other words, donors want to be reassured that every extra pound they give will translate into a larger programme rather than being used to cover fixed costs.
In part, this may be the result of donors having a limited understanding of the logistics of provision. It may also be because donors fear that their donations will be wasted if they’re used to fund fixed costs. Or it may be because by funding programme costs they can feel that their contribution is making a more tangible difference – if I make a donation towards an additional dose of vaccine, then my donation means that one additional person will not get the disease.
The reason why donors aren’t concerned about fixed costs when dealing with private businesses is that these costs aren’t relevant – if a private business offers me a good for a price, I will only care about the price I have to pay and not about what the cost of producing the good to the business is. And if the business has incurred costs that are too high, and yet is charging me a low price, the business will make a loss, but it won’t affect me if I’m a consumer.
Charities, on the other hand, are not-for-profit organisations, and so any wasteful use of funds translates into lower charitable provision rather than into a loss for the owner of the business or for the shareholders of the company, and lower provision matters to me if I’m a donor.
How can charities communicate their fixed cost expenses in a way that donors would better understand and accept?
Explaining what fixed costs are, why they are necessary, and especially what difference they can make for charitable programmes could go a long way to offsetting donors’ negative perceptions.
Fundraising techniques can also be adapted to offset donors’ resistance.
For example, running a campaign that sets a target to cover both fixed and variable costs and makes the running of a certain programme conditional on reaching that target, could reassure donors that no waste can occur and would make them feel that, if the target is reached, their individual donation is indeed making a difference.
Finally, it’s also a matter of charities reassuring donors that there isn’t unnecessary duplication between what they do and what other charities do. Making a clear case with donors for why a charity provides a distinctive service and openly addressing donors concerns in this respect may also help.
What are your thoughts on how donors react to fixed costs? Please share your experience by filling in our quick survey.
For more insight into behavioural economics in the charity sector, follow Kim on Twitter @kimberleyscharf