Do We See Economies of Scale in the Nonprofit Sector?

I recently worked with a human services agency that operates with two separately incorporated, but legally affiliated organizations. The two organizations have separate identities and programs, but share administrative services (e.g., development, facilities, IT, HR and finance). As part of our work, we set out to answer a critical question: Do shared services save money?

 

We did a lot of research to get to the bottom of this question, and I want to share what we found. Our research was focused on a particular client, of a particular size, in a particular industry and geography, but the general findings are more broadly applicable.

 

Bottom line: There appear to be cost savings from shared services, but they are modest.

 

Because this was a complex problem without a definitive source, we triangulated across multiple data sources to get our answer. We spoke with experts in the field, reviewed published research and ran our own analyses. We were not comfortable drawing conclusions from any one data point. But when we compared the findings from each of the sources, we arrived at a conclusive answer for our client: Sharing services saves a modest amount of money, likely on the order of 2% of total organizational expenses.

 

Here are some of the key data points and sources used:

·         Sharing overhead typically results in savings of 1 to 2 percent of total expenses, according to an interview with a Partner at a firm that specializes in nonprofit mergers

·         According to a study that assessed overhead rates for over 10,000 New York City nonprofits, human services organizations of comparable size to our client had a 1.2 to 3.3 percentage point drop in the ratio of administrative expense to total expense when revenue doubled.

·         In a review of 40 New York City human services organizations, we found no clear pattern of correlation between an organization’s size and the percent of total expenses spent on overhead

·         The incremental personnel cost incurred by forgoing shared services for our client was estimated to be ~1.3M, which is ~2% of their total expenses (this was calculated by estimating new staff lines that would need to be created to fill staffing gaps)

 

As nonprofits seek ways to increase effectiveness while operating in a lean environment, many have explored the concept of shared services or even full organizational mergers to cut administrative costs. Organizations should be applauded for this kind of creative thinking, but they should also be aware of the facts: In most cases, shared services result in modest cost savings. Organizations might save on department head salaries (e.g., having 1 IT Director instead of 2), but most of the back office functions increase linearly with the size of the organization. Clearly, each organization is unique and must weigh the costs and benefits of pursuing these options. What may feel like a modest amount of cost savings to one organization may be significant to another. Either way, I would advise organizations to run their own calculations to understand the potential costs and benefits, and be wary of situations where economies of scale are the single motivating factor for a significant organizational shift.