CHARITY DONATIONS: why having high core costs can discourage donors

Charities that have high core operating costs (or fixed costs) discourage donors from giving them money even if they are more efficient, which can undermine competition in the charity market. This suggests that there is an argument for government intervention targeted at charity’s core costs.

This is the key finding of a new study by Kimberley Scharf, Carlo Perroni, Ganna Pogrebna and Sarah Sandford, published in the August 2019 issue of The Economic Journal, which uses theoretical arguments and experimental evidence to show that donors’ contributions can be adversely affected by the presence of fixed costs.

The issue of how charities manage donations has always generated debate. One of the principal controversies is core operating costs – including administration, organisational infrastructure and training. – especially when they are perceived to be too high, relative to programme costs. Donors often view high core costs as an indicator of poor management, leading charities to worry that if they spend too much on operating costs, they will be less successful in their fundraising.

In economic terms, core costs are 'fixed costs', i.e. costs that do not scale up with output. For example, the cost of renting a car to deliver vaccinations to those in need is a fixed cost since the rental cost is incurred only once and does not depend on how many vaccinations (the output) are being delivered.

It is widely understood that incurring fixed costs can be a condition for achieving production efficiency in for-profit markets. For example, manufacturers must incur significant fixed research and development costs in developing new and lower-cost products. The consumers who buy these products pay a price that reflects these costs, yet this does not discourage them from buying the products.

In the non-profit sector, even though charitable goods and services cannot be bought and sold as in for-profit markets, charities still need to be run in a cost-effective manner. And in order to be cost-effective, charity providers must also incur fixed costs as their scale of operation increases, just as for-profit firms do. The reluctance of donors to see their donations used to cover charities’ core costs thus presents a special challenge for charities, potentially discouraging them from undertaking cost-effective investments and stifling innovation in the non-profit sector.

This new research explains why fixed costs can discourage donations. Unlike in the case of private purchases, donors do not pay a price for the services that are provided by donative charities in exchange for those services. The absence of a link between price and provision means that the cost-effectiveness of a charity with high fixed costs depends on how many donors it manages to attract, and so donations towards that charity are viewed by donors as being comparatively riskier. In turn, this can skew competition in favour of those charities that face lower fixed cost but are also comparatively less cost-effective.    

These findings mean that, in principle, there is a rationale for corrective forms of government intervention that are systematically targeted to fixed costs. Still, explaining what fixed costs are, why they are necessary, and especially what difference they can make for charitable programmes might go a long way to offsetting donors’ negative perceptions of them.

Are Donors Afraid of Core Costs? Economies of Scale and Contestability in Charity Markets by Kimberley Scharf, Carlo Perroni, Ganna Pogrebna and Sarah Sandford is published in the August 2019 issue of The Economic Journal

Kimberley Scharf

Professor of Economics at University of Birmingham

Ganna Pogrebna

Professor of Economics at University of Birmingham

Sarah Sandford

Research Fellow at ESSEC Business School

Carlo Perroni

Professor of Economics at University of Warwick