Image by Albert González Farran/UNAMID | Medical personnel from the local NGO, Humanitarian Assistance and Development (HAD), treat displaced people in North Darfur, Sudan
  • Report
  • 17 November 2022

Overhead cost allocation in the humanitarian sector: Chapter 1

Introduction

chapter 1
Contents

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On behalf of IASC Results Group 5 on Humanitarian Financing, DI, in partnership with UNICEF and Oxfam, conducted research on overheads which informed the development of newly endorsed IASC guidance.

Background to the study

To fully recover the costs of delivering humanitarian programmes, organisations must have access to overheads. Overheads – also referred to in this report as ‘indirect costs’ or indirect cost recovery (ICR) – support a range of functions. Being able to recover such costs is considered one of the most effective ways to strengthen the capacity of organisations and support their long-term sustainability. Despite their critical importance, local and national NGOs (L/NNGOs) are often unable to access overheads. International intermediaries including UN agencies and INGOs – through which the overwhelming majority of funds received by L/NNGOs pass – have been criticised for not passing on a fair share of overhead costs to downstream partners.

Indirect cost recovery (ICR) is a complex issue and practice is inconsistent and often opaque. There are various challenges involved for both intermediaries and donors in the process of providing local and national partners with fairer overheads. Nevertheless, there is a clear and recognised need for change and providing overheads is a tangible way to realise some of the high-level rhetoric and commitments made around localisation.

Various discussions around the issue of cascading overheads to L/NNGOs have taken place within the framework of the Inter-Agency Standing Committee (IASC) Results Group 5 (RG5) and other fora at technical and policy levels related to more efficient and effective humanitarian action. In March 2021, an RG5 core group led by UNICEF and Oxfam was established to investigate current practices related to indirect cost coverage and the provision of indirect costs to downstream partners. In parallel, the UN High Commissioner for Refugees (UNHCR) and the Norwegian Refugee Council (NRC) are also leading a separate RG5 workstream on the harmonisation of cost classification.

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Box 1

‘Sharing’ overheads versus providing overheads

It is important to clarify the distinction between UN agencies and INGOs around the allocation or ‘cascading’ of overheads to partners. In cases where UN agencies provide overhead funding, it is generally not shared from the specific indirect costs they receive from donors. In the majority of cases where unrestricted overhead funding is provided to partners, it is reported back to donors as direct programme costs, such as under an implementing partner’s budget line. The concept of ‘ICR sharing’ is therefore not applicable to UN agencies and relates more to INGOs who do sometimes share the ICR they receive from donors. Very occasionally, INGOs might receive additional overheads from donors that are designed to be passed onto downstream national partners.

This research was carried out by DI with UNICEF and Oxfam between January and April 2022 to support the work of the RG5 core group. It aims to investigate the current state of overhead sharing by mapping current practice across UN agencies and INGOs and identifying pockets of current and emerging good practice to understand the priorities of local and national actors. The findings of the study will be used to inform a guidance note on best practice in sharing overheads with local and national partners for wider IASC endorsement.

The study sought to answer the following questions:

  1. What are the current practices of UN agencies and INGOs related to the provision of overhead and indirect costs to local and national implementing partners?
  2. What does good practice in providing indirect costs look like for local partners?
  3. What are the main barriers and enabling factors in providing indirect costs to local partners?

Approach

To complete the mapping of current practice, requests for information were submitted through the IASC group and other relevant networks (including Charter 4 Change, ICVA and NEAR). In total, DI mapped the practices of 22 organisations, including eight UN agencies, 13 INGOs and one Red Cross and Red Crescent organisation. To identify examples of good practice and ongoing challenges, representatives from 26 L/NNGOs from 11 countries were consulted via focus-group discussions and interviews. DI also conducted interviews with four UN agencies, 10 INGOs and four donors. This report presents findings from the mapping (detailed in Annex 1) and interviews as well as case studies of good practice.

Indirect costs recovery: policy context

Indirect cost recovery is critical for local and national partners for many of the same reasons as it is for INGOs and UN agencies. L/NNGOs require overheads to fund non-project costs essential to day-to-day operations as well as to invest in institutional capacity development. L/NNGOs do not generally receive direct funding from bilateral government donors; instead, they secure humanitarian funds through UN or INGO intermediaries. Given the projectised funding model through which international funding often reaches national partners, there can be an expectation that L/NNGOs only claim for direct project delivery costs. There is growing evidence – including a recent study that quantifies the extent of national organisations’ underfunding[1] – highlighting the issues that arise when local organisations are unable to recover indirect costs. These include:

  • Reliance on negative coping strategies to meet uncovered costs, including re-directing funds from critical programmes; not paying staff salaries; under-managing security and operational risks; and adopting poor cash management practices.[2]
  • Inability to build organisational capacity, such as the development of policies and systems to allow actors to better meet the requirements for receiving direct international funding.
  • Inability to invest in staff to avoid turnover and the loss of institutional knowledge; inability to resource staff to participate in response coordination outside of specific projects.[3]
  • Inequitable funding practices based on a sub-contracting model that reinforces asymmetric power dynamics.[4]
  • Ultimately, a reduction in local actors’ ability to prepare and respond to humanitarian crises.
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Box 2

What do we mean by ‘indirect costs’ or ‘overheads’?

There are no standardised definitions of the different cost categories. Broadly speaking, partners can receive three types of cost:

However, there is no standardised definition of these different types of costs, and donors and international organisations take different approaches. Broadly, overheads are used to refer to expenditures necessary for an organisation to deliver its mission that fall outside the normal programme implementation costs.[5] These outgoings could cover central support costs, such as senior management positions; or functions, such as establishing and maintaining overarching organisational policies and systems. Overheads ultimately enable an organisation to deliver programmes effectively, efficiently, and safely.[6] Two useful definitions of overheads/indirect costs are:

These costs may also be referred to as core or support costs, administration fees and general operating support.[7] A broad definition of indirect costs and overheads was adopted in this study in order to map a wide range of practices. The issue of cost classifications and definitions is being explored by a separate RG5 sub-group on cost classification led by UNHCR and NRC. This report therefore uses the terms ‘overheads’, ‘indirect costs’ and ‘indirect cost recovery (ICR)’ interchangeably.

Perhaps more useful than a specific definition is focusing on the characteristics of the type of funding typically provided to cover these types of cost, i.e., as an unrestricted percentage of the total project grant. This was the description used as a reference point in interviews and discussions.

Commitments around quality funding and localisation made in the Grand Bargain have increased attention on the issue of overheads, and the importance of providing core funds to local partners is increasingly recognised.[8] Allocating unearmarked overhead costs for the institutional development of L/NNGO partners has been identified as a key component of localisation[9] and equitable pass-through of overheads has become a top advocacy priority for many organisations.[10] For instance, signatories of the Charter for Change have called for a fair and consistent approach to overheads for local partners. Recent IASC guidance on localisation and the Covid-19 response also emphasised the importance of providing overheads to local partners in new partnership agreements.[11] A small number of Grand Bargain signatories have made progress on sharing equitable overheads and the 2021 Annual Independent Review of the Grand Bargain highlighted that more widespread provision of increased core costs could be ‘transformative’ in driving the localisation agenda and empowering local actors as leaders of humanitarian response.[12]

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Box 3

What initiatives to harmonise approaches to indirect costs already exist?

Approaches to the classification and quantification of indirect costs are varied, complex and often opaque. Overheads are just one element of the complex strategies developed by humanitarian organisations to fully recover all their costs. There is not one standard approach to defining, classifying, and calculating humanitarian overheads; making it difficult to compare the indirect costs of different organisations.[13] The lack of transparency around the breakdown of indirect cost rates means that lower overheads are often considered a sign of efficiency by donors.[14] As a result, organisations have often competed to lower rates; giving organisations with access to higher amounts of unrestricted funding a distinct advantage, while smaller ones – including national organisations – can appear uncompetitive.[15] Without a harmonised approach to indirect costs, donors and international organisations have had to develop their own approaches to cost classification to gain the required visibility over downstream costs; setting out eligible and ineligible costs within their own budget and reporting templates. As has been documented in previous studies, the flat-rate approach traditionally applied to overheads is not a true reflection of an organisation’s indirect costs, because organisations classify and fund overhead costs in different ways.[16] Complying with these different systems places a large administrative burden on partners. The Boston Consulting Group (BCG) estimates that a potential 2.3 million hours could be regained each year if harmonised and simplified solutions were implemented.

Figure 1: The absence of any harmonised approach to classifying overheads creates inefficiencies within the system

One initiative seeking to rectify the inconsistency in cost classifications is the Money Where it Counts (MWIC) protocol, developed by NRC and BCG. The protocol proposes a harmonised approach to cost categories, cost charging and financial reporting. The simplified definitions for cost classifications provide the foundations of the protocol and inform the cost-charging methodology and standard financial reporting templates for international funding of humanitarian agencies. It is based on the principle that donors agree to pay the full, indirect costs of activities. It also provides a standard, indirect cost-rate calculation that uses the implementing organisation’s actual costs in the last complete financial year.[17] An RG5 sub-group led by the UNHCR and the NRC is taking forward work to harmonise agency cost classifications based on the first component of the MWIC protocol.

Other relevant NGO-led initiatives that establish a common cost classification include the Dioptra tool for cost-efficiency analysis, developed by the International Rescue Committee (IRC). Similar to the cost classification component of the MWIC protocol, the Dioptra tool distinguishes between ‘direct costs’, ‘shared costs’ and ‘indirect cost recovery’. The IFR4NPO is another initiative born from the need for an international accounting standard for non-profit organisations (both humanitarian and development). The guidance is being developed through consultation in three phases with release scheduled for 2025. Within the UN system, an inter-agency working group of the Finance and Budget Network is focused on harmonising UN cost classifications.

Notes