Giving Compass' Take:

• This Stanford Social Innovative Review posts explains how nonprofits need better strategies to ensure that public dollars don’t put them in the red.

• How can grantmakers be part of the solution by reexamining views of indirect costs? In what ways can more transparency help address some of the public contracting issues?

• Here's more on why grantmaking should be grounded in real costs.

All grant dollars are equal, but some are more equal than others. Public contracts provide a stable revenue stream for nonprofit human-services providers, but they come with a hidden price tag—contract management costs that make public dollars much more expensive to administer than other types of dollars. Nonprofits often cope with the problem in isolation, using private, unrestricted dollars to offset the expenses of managing public contracts—but this creates opportunity costs for a nonprofit’s least restrictive type of funding.

Indirect costs consist of all expenses that support a program but also serve a broader organizational purpose, such as agency-level accounting and operational expenses. Typically, nonprofits recover these and other overhead expenses by pooling and then allocating them to program contracts. Public funders usually assume that a default rate of 10 percent—assessed against the contract’s subtotal of direct program costs — is sufficient for nonprofit human-services providers to recover their indirect expenditures.

But funders’ assumptions about indirect costs are unrealistic. Understandably wary of disappointing their funders, nonprofits perpetuate the problem by underreporting their needs and then under-resourcing vital agency systems. Research shows that this drives a “nonprofit starvation cycle” of “underfed overhead” — a race to the bottom for nonprofits trying to attract and retain stable revenue streams. Ironically, funders’ efforts to support nonprofit systems have produced an atmosphere of chronic underinvestment.

Read the full article about the hidden costs of public contracting by Mary Kate Bacalao at Stanford Social Innovation Review.