Imagine what an extra $100 billion a year could do for philanthropic and other nonprofit institutions. That's more than three times the annual giving of every charitable foundation in the United States combined. It's nearly twenty times the amount spent annually on Head Start. In fact, it's enough to give every high-school graduate in the country a $40,000 scholarship. Adding such a windfall to nonprofit services seems too good to be true. But according to a study we recently completed with our McKinsey & Company colleagues, the nonprofit sector could free up that amount—maybe even more—by challenging the operating practices and notions of stewardship that currently govern the sector.
We believe that challenge must be taken up—today. The U.S. nonprofit sector has never had more assets at its disposal, but neither has it faced such pressing demands. During the boom years of the 1990s, the sector grew enormously. By 2000, nonprofit assets had reached $2 trillion, and total revenues exceeded $700 billion. And as the baby boomers move into their prime giving years over the next two decades, they are expected to bequeath or donate trillions of dollars. Unfortunately, the demands on nonprofits are growing as fast, if not faster. Pressures to cut government spending are shifting more social burdens onto charities—a trend that will intensify when the seventy-six million baby boomers start retiring and the government is forced to spend an even larger share of its resources on healthcare and pensions.
| The U.S. nonprofit sector has never had more assets at its disposal, but neither has it faced such pressing demands. |
| —Bill Bradley, Paul Jansen, & Les Silverman |
As nonprofits are increasingly called upon to do more, it's important to take a hard look at how the sector operates. Therefore, we decided to examine the finances, practices, and management of the 200,000 largest nonprofits in the United States—those with revenues of more than $25,000 a year—as well as the philanthropies and intermediaries whose financial and other contributions are so crucial to the sector. These organizations represent a wide range of interests: social services, health, education, arts and culture, the environment, and issue advocacy. Donations from fund providers—such as individuals, corporations, government agencies, and financial institutions—typically make their way to nonprofit service providers (NSPs) in one of two ways. Either the funds are given directly to NSPs, or they're channeled through intermediaries, such as the United Way or government agencies.
The central questions we asked in our study were simple: does the money flow from its source to its ultimate use as efficiently and effectively as possible? If not, where are the big opportunities to increase social benefit? To answer these questions, we drew on IRS data from 1998 and 1999 as well as surveys and supplementary data from the Urban Institute, the Independent Sector, and our own consulting activities.
We discovered substantial opportunities for improvement. We estimate that by changing the way funds are raised, nonprofits could save roughly $25 billion a year. By speeding the distribution of funds, they could put an extra $30 billion to work. More than $60 billion a year could be generated by streamlining and restructuring the way organizations provide services and by reducing administrative costs. And even more money—in fact, an amount that's impossible to estimate—could be freed up by better allocating funds among service providers.
| Soliciting large volumes of tiny contributions as the majority of nonprofits must do, is inherently inefficient. |
| —Bill Bradley, Paul Jansen, & Les Silverman |
We acknowledge that producing a single estimate of the potential gains that this highly diverse sector could achieve is a tricky proposition. After all, the nature of the opportunity differs widely depending on the type and size of the institution. We also admit that achieving these targets won't be easy; it will require fundamental changes in both the practices and mindsets of nonprofit managers and donors. But, over time, it is possible. Already, some innovative nonprofits—from the Hewlett Foundation to the National Assembly of Health and Human Services Organizations—are blazing trails that others can follow. These leaders are showing that by emulating certain management practices from the business world and by creating and sharing their own best practices, nonprofits can have a far greater impact on social problems.
Reduce funding costs
The old adage "It takes money to make money" is certainly true. But the question is, how much does—or should—it take? Estimates vary. According to IRS data, nonprofits report their fund-raising costs to be 4.6 percent of their total contributions, on average. Yet in interviews, executive directors of NSPs estimated their fund-raising costs were actually two to three times greater than reported. That's because when they fill out their IRS forms, many NSP directors don't include all the costs of staff, board, and volunteer time devoted to fund-raising. In fact, over two-thirds of the organizations that reported receiving donations claimed no fund-raising costs at all. Our analysis suggests that in 1999, the nonprofit sector actually spent $36 billion to raise and deliver $195 billion; that's a fund-raising cost of approximately 18 percent, or about one dollar for every five dollars raised. A forthcoming study by the Urban Institute estimates that nonprofit funding costs are even higher.
What accounts for the high costs? For one thing, soliciting large volumes of tiny contributions, as the majority of nonprofits must do, is inherently inefficient. You tend to incur a lot of labor, marketing, and other costs for every dollar you bring in. For another, trying to get your share from a pool of more than 50,000 foundations and millions of individual donors leads to a lot of overlap and waste. One graduate school of a major public university with a $20 million budget, for example, receives its revenue via 161 separate "funds," including dozens of state and federal grants and myriad corporate and foundation donations. And since fund providers often require detailed reports on how their grant money is spent, it's easy to see how administrative costs can skyrocket. Finally, there's the dilemma of the incremental dollar. From the point of view of any individual organization, it's rational to keep spending as long as the marginal dollars raised are greater than the marginal dollars spent. For the sector as a whole, however, the competition to tap a finite pool of funding drains billions of dollars from social causes. To make matters worse, some nonprofits aren't even marginally successful: IRS data for 1999 show that 2,000 nonprofits raised less money than they spent on their fund-raising efforts.
By way of contrast, take a look at the efficiency of raising funds in the for-profit sector. The cost of raising capital to start and grow a business is approximately 2 percent to 5 percent of funds raised; the cost of sales and marketing, which some consider a better comparison, is typically 10 percent for businesses that directly serve customers. It's true that the nonprofit sector doesn't have the standardized processes and established networks of investment and commercial banks, venture capital firms, and other funding sources that make private fund-raising efficient.
But some nonprofits are already approaching this level of efficiency. The United Way, for example, raises and disburses about $4 billion in funds at a cost of less than 14 percent. Over time, the nonprofit funding market could develop practices to narrow the gap and cut fund-raising costs from the current 18 percent to between 5 percent and 10 percent. That would pump an additional $15 billion to $26 billion each year into the system, assuming about $200 billion were raised.
Our study identified a number of existing or emerging best practices that could help many nonprofits trim their fund-raising costs significantly in the coming decade: online solicitation, donor-advised funds, shared resources, and larger grants. 
Five Steps to Save Nonprofits $100 Billion
- Reduce funding costs.
- Distribute holdings faster.
- Reduce program service costs.
- Trim administrative costs.
- Improve sector effectiveness.