Activity-Based Costing Analysis SHARING KNOWLEDGE. GROWING IMPACT. Activity-Based Costing Analysis Kick-off Presentation cfinsights.org

Aligning Fee Structures with Market Realities Activity-Based Costing Methodology Key Questions to Answer and Applying the Findings CF Insights 2012

Alignment New Realities – and Opportunities to Create Value – Require Community Foundations to Rethink their Fee Structures and Services The role of community foundations has fundamentally changed The way community foundations calculate fees has not shifted as their role and activities have changed As a result, they now face an imbalance between the cost of services provided and the revenues generated Solving this problem requires a re-examination of their cost and revenue models Fees must be linked more directly to services provided, requiring: Examination of the internal costs of services Program Administrative Development Donor education Community services beyond grantmaking Understanding the fees and offerings of other philanthropic service providers Learning what donors value and are willing to pay for Making informed decisions about which services to expand, maintain or reduce Developing alternative sources of revenue to more fully cover costs 3 CF Insights 2012

Alignment Operating Budgets Are No Longer Able to Absorb the Cost of Continually Expanding Services There is a growing mismatch between services and fee structures The traditional fee structure – an annual fee based on a percentage of assets – was never intended to support today’s expanded range of services Community foundations have generally absorbed the cost of additional services within their operating budgets Administering donor advised funds Advising and educating donors to become more knowledgeable about giving Providing advice and continuing education to professional advisors Helping local nonprofits raise funds or develop their own endowments Convening funders to organize solutions to community problems Compiling studies of the local philanthropic and nonprofit sector These costs have often been covered on a case-by-case basis through self-administered grants or good luck in the rapid growth of investment portfolios There is no link between the cost of these services and the movement of asset values in the stock market Flat asset-based fees do not reliably cover costs when a range of services are provided unrelated to the investment and custody of funds The critical roles that many community foundations play in their regions cannot be dependent on the volatility of the stock market 4 CF Insights 2012

Determinants of Revenue Are Not Aligned with Determinants of Cost Alignment Determinants of Revenue Are Not Aligned with Determinants of Cost Determinants of Revenue Value of investment portfolio Contributions received Interest rate on float Stock dividends and bond income Grants from other foundations ? Determinants of Cost Donor development Grant review and evaluation Services provided to donors Services provided to nonprofits Services provided to financial advisors Community activities Studies, commissions, convenings Publications & website ? 5 CF Insights 2012

Different Kinds of Donors Require Different Kinds of Services – Alignment Different Kinds of Donors Require Different Kinds of Services – The Cost of These Services Is Often Unrelated to Fund Size Less Engaged Donors Want Efficient and Inexpensive Service More Engaged Donors Want Advice and Participation “Money-in, money-out” pass through account with no endowment or minimum balance requirement Self-directed control over how funds are allocated and granted Tax and time-efficient processing of gifts and donor advised grants Prompt and accurate reporting Briefings on issues of interest Advice on grantmaking and local nonprofits Leadership opportunities in priority interest areas Matching funds for their projects Opportunities to come to the table with others working for common goals Participation in setting the agenda for the community Different donor needs translate into different Foundation activities and costs 6 CF Insights 2012

Traditional Pricing Structures Do Not Reflect the Value That Alignment Traditional Pricing Structures Do Not Reflect the Value That Community Foundations Add for Differently Involved Donors Pricing to Yield Revenue Flat Fees Fees Dependent on Size of Fund Tiered Service Levels Pricing To Cover Costs of Service Delivery Services and Prices Determined by Donor Preferences Pricing to Build Relationships in the Community Offering low fee donor advised funds and agency endowments Considering the difference between the cost to service the funds and the income generated as an investment in building relationships Putting a price tag on foundation expertise and knowledge Determining access to high-cost, high-quality services according to fund size Setting prices in accordance with donor and agencies’ demand for services Ensuring that foundation operating costs are adequately covered Foundations have focused on increasing donors’ access to expertise, but rarely price their offerings to reflect the value of these enhanced services 7 CF Insights 2012

New models must be designed to match the changing marketplace Alignment A Competitive Model that Keeps Pricing Low While Adding Costly Services Cannot Be Sustained Commercial gift funds have economic advantages Commercial gift funds impose a ceiling on the annual fees that community foundations can charge, although commercial funds have a significantly lower cost structure for donor advised accounts Community foundations are differentiated by higher levels of advice and personal service provided for donors, as well as the value created for their communities – but none of this translates into revenue A newly emerging market for philanthropic advisors demonstrates the value of providing advice and service to donors Philanthropic advisors set an independent market price for services that parallel those a community foundation usually offers to its donors for free Typical prices are $100-$250 per hour or 5-10% of the annual grants for managing a small foundation, on top of investment advisory fees incurred Community foundation program staff are often more experienced and better qualified than these professional advisors Community foundations can manage small foundations more cost effectively than most independent advisors New models must be designed to match the changing marketplace 8 CF Insights 2012

Sustainability Requires Aligning Revenue Models with Strategies – Alignment Sustainability Requires Aligning Revenue Models with Strategies – Through Understanding True Costs and Perceptions of Value Tiered pricing would better align revenue with the costs of service Community foundations have the ability to package services for donors with different service preferences Valuing advice at market rates increases its perceived value Rather than absorbing program costs as part of overhead, community foundations must begin to see these activities as services that have a definable value Revenue models should recognize the market rates set by independent philanthropic advisors Philanthropic services provided to the community should be recognized as an investment in creating value, and the foundation’s contribution should be valued Moving to an approach that recognizes the value of community foundation services requires both a rigorous cost analysis and an understanding of the value customers place on these services New strategies require new revenue models 9 CF Insights 2012

The Case for Activity-Based Costing Analysis Alignment The Case for Activity-Based Costing Analysis WHEN YOU ANALYZE YOUR OPERATING MODEL YOU GAIN INSIGHTS Match economics to mission Prioritize changes based on true surplus and subsidy of fund types in light of mission and other external factors. Prioritize products Inform conversations about intentional investments or the need to adjust revenues and costs. Adjust fee schedules Consider fee or policy changes and analyze revenue impact of adjustments. Evaluate alternative revenue sources Assess role of existing or new income sources beyond traditional administrative fees (e.g., fee-for-service). Gauge community leadership investment Understand degree of investment and compare external funding sources for community leadership. Compare your results to peers, highlighting unique strengths and challenges 10 CF Insights 2012

Aligning Fee Structures with Market Realities Activity-Based Costing Methodology Key Questions to Answer and Applying the Findings CF Insights 2012

Methodology The Cost-Revenue Study Uses Activity-Based Costing to Assess the True Cost of a Foundation’s Products and Services Activity-Based Costing (ABC) allows organizations to determine the actual cost associated with each product or service Cost data is gathered and traced to specific activities, then costs are allocated to products or services based on their utilization of activities Expense 1 Expense 2 Expense 3 Expense 4 Costs are assigned to activities… Activity 1 Activity 2 Activity 3 …then allocated based on utilization of activities Product 1 Product 2 12 CF Insights 2012

Methodology A Critical Component of Activity Based Costing Is Allocating 100% of Staff Time to the Activities that Enable the Foundation to Deliver Each of Its Products Staff Activity Survey Product 1 Product 2 Product 3 Product 4 Product 5 Product 6 Product 7 Product 8 Activity A X% Activity B Activity C Activity D Activity E Activity F Activity G Activity H Activity I Total Staff costs are assigned to activities and products based on reported time, weighted by individual salaries and including taxes and benefits 13 CF Insights 2012

Methodology Once Staff Costs Have Been Assigned, Direct and Indirect Foundation Costs Are Allocated Across the Matrix of Activities and Products Allocate Direct Costs such as events, publications, or investment management consultants to activities and products based on specific allocation rules Staff Activity Survey Product 1 Product 2 Product 3 Product 4 Product 5 Product 6 Product 7 Product 8 Activity A $Y Activity B Activity C Activity D Activity E Activity F Activity G Activity H Activity I Total Allocate Indirect Costs such as occupancy and office expenses to activities and products based on the distribution of staff time The complete matrix of products and activities includes staff, direct and indirect costs for each activity and product Note: Some allocation approaches will assign minor costs to all products 14 CF Insights 2012

Product Definitions Drive the Activity-Based Costing Analysis Methodology Product Definitions Drive the Activity-Based Costing Analysis Before starting the work, the Foundation must identify 8-12 products to use for the Activity-Based Costing Analysis These product definitions must not change through the project, so it is vital that they are selected carefully Some products will be relatively standard fee-based philanthropic vehicles such as: Donor advised funds Designated funds Scholarships Competitive grantmaking funds (Unrestricted and/or Field Of Interest) Supporting organizations Other products may be unique large funds, planned giving products, services to nonprofits, or initiatives without any clear associated revenue such as convening and community leadership efforts 15 CF Insights 2012

Methodology The Following Set of Criteria Should Be Considered in Defining a List of Products Offered by the Community Foundation Bundled set of services delivered to customers/donors for a published fee. Note that similar services offered for similar fees can be bundled together in one product category (e.g. Donor Advised and Donor Designated Funds) Customized set of services delivered to customers/donors for negotiated fees Unique set of activities which represents a significant amount of the Foundation’s staff time, is designed to serve the community or the field, but which may not generate revenue (such as proactive initiatives or community leadership initiatives) Set of funds or activities that need to be separated from another product area because the foundation is considering a major strategic decision concerning them or because including them could significantly distort findings. For example, one large fund that requires significant staff time and customized processes, or donor advised funds advised by a committee vs. by individual donors) Note: Do not include your operating endowment in the list of products. There is a separate analytical process that accounts for your operating endowment in CF Insights’ methodology 16 CF Insights 2012

Aligning Fee Structures with Market Realities Activity-Based Costing Methodology Key Questions to Answer and Applying the Findings CF Insights 2012

Key Questions Study Findings Answer a Wide Range of Questions and Inform Major Strategic and Operating Decisions Questions Answered How much do the different funds and products we offer really cost? Which products make money for the foundation and which do we subsidize? How do our costs compare with other foundations? Where can we cut back spending while still supporting our mission? In an increasingly competitive market, how does the Foundation best position itself for sustainability? Each foundation should determine at the outset how the analysis can best inform future decision making CF Insights 2012

Applying the Findings Each Foundation Reacts Differently to Findings, But Each Makes Major Decisions that Impact Its Strategy and Operations Applying the Findings Foundations react to similar results in very different ways based on their mission and values, history, asset base, and position in the marketplace Foundations have made or major changes as a result of the analysis: Prioritizing the acquisition of select products Reprioritizing or eliminating select products Changing fee levels to more appropriately match the cost of service for different products – both raising and lowering fees, in some cases Differentiating fees for donors interested in enhanced services Changing policies regarding minimum fund size Decreasing customization and increasing standardization Examining processes to cut costs and redirect staff effort to the most valuable activities The best strategic decisions result not only from an understanding of costs and revenues – but also from an understanding of the Foundation's mission and a perspective on the external environment in which the Foundation operates 19 CF Insights 2012