Tricks of the Charity Trade: Donors Unknowingly Pay to Receive More Solicitations
How many return address stickers, note pads, and greeting cards have you collected from charity mailings urging you to make a contribution? How many phone calls have you received from pushy telemarketers using any and every tactic to secure your donation? These mailings and phone calls, which also include information about a charity and its cause, are clearly designed to raise funds. But people who have given in response to such solicitations are often surprised to learn that many charities consider the costs of contacting potential donors to be, at least in part, one of their "educational" programs. A big portion of the donation you just gave likely will be used by the charity to send out more trinkets and information to other potential donors, and probably more to you in the future, as well.
Under current accounting rules (AICPA SOP 98-2), a charity that includes an "action step" in its phone or mail solicitations, such as "don't drink and drive" or "buckle your seatbelt," can claim that it is "educating" the public. It can therefore report much of the cost of these appeals (often amounting to hundreds of thousands, if not millions, of dollars) as a program expense rather than a fundraising expense in its financial reporting. Such "action steps" are typically relayed to potential donors through for-profit professional fundraising companies hired by charities to broadly solicit the public for donations. The "educational" component is often information that is common knowledge, or that could otherwise be distributed to the public using a method far more efficient and targeted than fundraising solicitations. Professional telemarketers, on average, keep two-thirds of the money they raise before the charity receives anything. What this means is that someone donating $50 to charity through a professional fundraiser may have just paid over $30 to be solicited and "learn" that they should buckle their seatbelt.
In charity financial reporting, the funds a nonprofit spends on telemarketing, direct mail, or other solicitation activities that also include an "action step" or "call to action" are referred to as "Joint Costs." Charities often use joint cost reporting as a way of inflating their reported program spending and deflating reported fundraising costs. In this way, they can tout a high program percentage and low overhead in their marketing materials, web site, and fundraising pitches to donors. This accounting trick, while often perfectly in line with reporting rules, makes it difficult for donors to understand whether or not a charity will use their donations on the programs they are intending to support.
The following real-world example concerning National Veterans Foundation (NVF), a Los Angeles based veterans charity, illustrates how impactful joint costs can be on a charity's financial efficiency ratios:
NVF's claimed mission is to serve the crisis management, information and referral needs of America's veterans and their families. The left-hand column in the above chart represents the percentage of NVF's budget it claims to have spent on veterans programs in 2011, 2010 and 2009, respectively. While not outstanding, taken at face value these ratios reflect a fairly efficient charity. However, after CharityWatch reviewed NVF's tax forms for these years, we found that the majority of its reported program expenses consisted of "joint costs." Once CharityWatch adjusted these expenses out of program and into fundraising, NVF's program spending on veterans was extremely low, as reflected in the right-hand column above. NVF would earn an F rating from CharityWatch for these years based on these adjusted program percentages ("without joint costs").
As with many charities that report costs related to joint educational/fundraising activities, NVF contracted the services of a for-profit professional fundraising company to solicit donors on its behalf. Specifically, NVF entered into an exclusive direct mail fundraising consulting agreement with Brickmill Marketing Services (Brickmill) effective July 1, 2008. Per the agreement, Brickmill was to conduct a direct mail campaign with a "call to action" that would help NVF "reach its mission goals and, at the same time, when appropriate, include an incidental request for financial support." NVF spent $20 million of its $24 million in total expenses from fiscal 2009 to 2011 paying Brickmill and other independent contractors for fundraising activities.
NVF eventually was made to come clean about how it was spending donations. The California Attorney General's office examined NVF's finances and concluded that its solicitation activities were not eligible to be reported as joint costs. Following the examination, the charity re-filed its 2009, 2010 and 2011 tax returns. As a result, NVF's amended returns for the years CharityWatch rated NVF (2009 and 2011) reflect the same low program percentages that we had reported for the group all along.
Unfortunately, many inefficient charities are able to waste millions of charitable dollars on fundraising activities while staying well within accounting rules, and they continuously trick well-meaning donors into thinking their donations are used efficiently on programs. When a charity claims that it spends "85% on programs," many donors do not realize that this 85% may include telemarketing, direct mail, and fundraising consulting costs. CharityWatch believes that most donors do not consider a charity's joint solicitation/educational activities to be equivalent to the purely programmatic activities they are intending to support with their donations; e.g., sheltering and feeding the homeless, assisting injured veterans, conducting literacy programs, funding cancer research, etc. For this reason, during our financial analysis we adjust such solicitation expenses out of reported program expenses and add them to fundraising prior to calculating a charity's efficiency ratios and letter grade rating. Activities that are purely educational and that do not contain a fundraising component are not "joint costs" and are included in a charity's reported program spending. CharityWatch treats expenses spent on purely educational activities as legitimate programs and does not reallocate them to fundraising when making our efficiency calculations.
If there are donors who do consider joint solicitation/educational activities to be charitable programs, CharityWatch also provides the efficiency ratios that include the charity's reported joint costs for program services. By providing both sets of calculations, CharityWatch has been ahead of other charity monitoring and rating services in giving donors the choice of assessing a charity's efficiency based on their own opinions regarding joint solicitation/educational activities and whether or not they should be included as program service activities for a given charity.
Before donating in response to a direct mail solicitation or telemarketing call, ask the fundraiser what percentage of your donation will be used on charitable programs that do not include any joint costs. Otherwise, there is a high probability that your donation will be spent on funding more fundraising rather than furthering a charitable cause. Better yet, be proactive by seeking out efficient charities to support. Donating to a charity you know nothing about simply because you received a phone call or letter often results in a missed opportunity to accomplish anything charitable.
For more discussion on the accounting rules that allow nonprofits a lot of discretion on how they report their joint solicitation costs, read: Accounting Rules Allow Nonprofits Discretion in the Reporting of Joint Costs.