why do charities worry about fixed costs so much?

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

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  • Fixed Costs and Eciency in the Non-prot Sector Kimberley Scharf Carlo Perroni, Ganna Pogrebna, Sarah Sandford March 29, 2014 PRELIMINARY
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Two research questions 1. Are donors afraid of charities xed costs? 2. In the presence of xed costs, can the rich control the charitable agenda? Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs In economic terms, xed 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 Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs and scale economies Taking advantage of scale economies xed costs need to be incurred, because that is how scale economies are exploited This is justied only for a certain scale of operations, otherwise the spend on the machine is wasted Implications of xed costs and scale economies for eciency in the private sector are very well understood and studied Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs and scale economies in the private sector Fixed costs do not present a challenge for private rms: in private markets, the most cost eective technology will win For rms that use xed cost technologies, goods can be oered at a cheaper price customers can be stolen from less ecient rms, which are driven out of the marketplace Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs and scale economies in the non-prot sector In the non-prot sector, even though charitable goods and services cannot be bought and sold as they are in private markets In order to be cost eective, charities (of all sizes) must incur xed costs as their scale of operation increases Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t But does not seem to be what we see This idea of cost eectiveness and xed costs seems to present special challenges to charities And this seems very strange for economists who are mainly concerned about eciency We see that charities seem to relate to xed costs dierently than do private rms Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs seems to present special challenges for charities Charities seem to worry about how xed costs aect their position and viability Theres 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 youre out of that approximate range, somehow youre bad or inecient (Rosemary McCarney, Plan Canada) Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Fixed costs seems to present special challenges for charities There seems to be a perception in the non-prot sector that, for some reason, donors do not want to pay for xed costs . . . we believe that a highly ecient 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 ow 90% or more of their expenditures to other charities, leaving just 10% for overhead (Moneysense, Charity 100) Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Challenges have implications for sectoral eciency They seem to imply that a good charity has a small fraction of xed 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 Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed 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 Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t The eciency implications If donors are reluctant to pay for xed costs, and if this is the situation that charities are faced with no guaranteees that the most cost eective charities are selected by donors ineciency in the sector If charities respond to concerns by adopting inecient strategies that avoid xed costs innovation slowdown in the sector ineciency in the sector There is an eciency based economic rationale for government intervention targetted towards xed costs Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Our research We are researching this question and trying to understand underlying mechanisms Analytical ndings are that analysis of performance of the non-prot sector requires dierent economic tools than the ones we use when analysing performance in the for-prot sector Preliminary lab experiments suggest that donors do relate to xed costs in a peculiar way; and one reason for this is that they think of provision that involves relatively large xed costs as being more risky. Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t How subjects relate to xed costs in the lab In situations where small groups of subjects have to choose between two options involving xed costs a higher xed cost option which is more ecient and which payo dominates for the same money, provision is higher a less ecient lower xed cost option . . . The ecient option is chosen only 63% of the time Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Evidence points choices being driven by behavioural reasons Our evidence suggests that subjects think of high-xed cost option as being riskier than low-xed cost option poor coordination subjects spread out between the two options waste/ineciency through duplication of xed costs Our evidence also suggests that this coordination induced ineciency is more serious, the bigger is the dierence in xed costs between the two options Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Lab results on performance with two contribution options Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Conclusions from rst 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 xed costs do appear problematic (2) They can cause serious ineciencies in the sector and innovation slowdown Both results provide a rationale for corrective government intervention systematically targetted to xed costs; and have important implications for fundraising and reporting of costs (but you know about those) Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector
  • Two Research Questions Are donors afraid of charities xed costs? In the presence of xed costs, can the rich control t Second question In the presence of xed costs, can the rich control the charitable agenda? Kimberley Scharf Fixed Costs and Eciency in the Non-prot Sector