Efficient Systems are Wasteful

The most efficient organization is not necessarily the most effective. It might sound crazy, but it is straightforward to show that it’s true.

Think about a charity run entirely by volunteers that provides meals to hungry people. This charity receives $1000 per month in donations, which they use to buy meals for hungry people. Food is literally their only expense. They wish to increase the monthly money available for buying meals, so they decide to start advertising to bring in more donations. They find that when spending no money on advertising, they got no advertising-driven donations (obviously). By spending $100, they can get $300 in advertising-driven donations. By spending $225, they can get $450. And by spending $400, get they can get $600. How much advertising should they do?

The first $100 in spending will bring in $300. These donations, minus the $100 in advertising cost, leaves $200 extra to provide meals. Spending $225 brings in $450, leaving $225 extra to provide meals. And spending $400 generates only $200 extra after the advertising cost is paid. So, of the three, the maximum amount of money to provide meals comes from spending $225 per month. This is the optimal amount of money for this charity to spend on advertising.

[These numbers follow the ‘square root rule of advertising’ by the way, specifically REVENUE = 30 x SQRT(SPENDING). If you are inclined, you can check for yourself in Microsoft Excel that, for this particular case, the extra money for meals (donations minus advertising spending) is the highest when advertising spending is $225.]

By spending $225, they can take in $450, giving $225 more than they would have had otherwise. By advertising, they have $1225 rather than $1000. But, charity organizations are often judged by the portion of their donation that goes toward “The Cause”, the purpose for which they exist, as opposed to business expenses like office space, staff salaries and marketing. If they do not advertise, 100% of their income goes to food. If they do advertise, then only $1225/1450 = 84% of their income goes to food.

By increasing the amount of service delivered, the charity reduces its efficiency.

Let’s say our charity makes an effort to get better at advertising, to better understand potential donors and get more bang for its advertising dollar. Now, its ad-driven donations are equal to REVENUE = 40 x SQRT(SPENDING). So, if the organization spends $100 on advertising, they receive $400 in ad-driven donations (on top of the $1000 they get automatically). If they do $225 in advertising, they get $600 in donations. And if they do $400 in advertising, they get $800 in donations. (Remember, the equivalent values for the previous charity were $300, $450 and $600. So, the second charity is simply better at advertising regardless of how much it spends.) So, this organization simply gets more revenue per advertising dollar spent, for all possible levels of advertising spend. It is simple a more-effective organization at advertising.

charity-before-after
How much advertising should the charity do now?

We can check different values and see that to maximize the amount of money left over to deliver meals after advertising costs, they should spend $400 per month on advertising and receive $800 in ad-driven donations. This takes in a total of $1800 per month ($1000 from regular donations, plus $800 from advertising-driven donations), leaving $1400 per month to provide meals. For this more-effective charity, the amount of money spent on meals relative to their total revenue would be $1400 / $1800 = 78%.

The charity is now undeniably better at advertising and therefore spends more on advertising. But the result is that the more-effective charity’s advertising spending is higher (22% compared to 15%), which means that the charity looks more wasteful and less efficient when in fact it is simply better at getting results from advertising.

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