The Hidden Cost of Underpaying Nonprofit Staff

There's a persistent belief in the nonprofit sector that keeping salaries low demonstrates fiscal responsibility—that every dollar not spent on staff is a dollar available for the mission. It's an intuitive argument. It's also wrong.

Decades of research from the corporate sector—and increasingly from nonprofit-specific studies—demonstrates that underinvesting in compensation doesn't save money. It destroys value. The question isn't whether your organization can afford to pay competitive salaries. The question is whether it can afford not to.

The Real Cost of Turnover

When an employee leaves, the visible costs—posting the job, interviewing candidates, perhaps paying a recruiter—are only the beginning. The full cost includes productivity lost during vacancy, time spent by remaining staff covering duties, onboarding and training the replacement, the months it takes a new hire to reach full productivity, and the institutional knowledge that walks out the door permanently.

Visible compensation costs are just the tip of the iceberg. The true cost of turnover lies beneath the surface.

How significant are these costs? The Society for Human Resource Management (SHRM) estimates that replacing an employee costs 50% to 200% of their annual salary, depending on the role's complexity. The Center for American Progress found that for executive positions, turnover costs can reach 213% of annual salary.

Let's make this concrete. If your $75,000-per-year program director leaves, you're looking at $37,500 to $150,000 in total replacement costs. If your executive director departs, multiply their salary by two or more. These aren't theoretical numbers—they represent donor dollars being spent on recruiting and retraining rather than on programs.

Compensation Is the Primary Driver

When researchers ask why employees leave, compensation consistently tops the list. According to PayScale's 2023 Compensation Best Practices report, 35% of organizations identified compensation as the primary reason for voluntary turnover, with another 18% citing it as a secondary factor. The Nonprofit Leadership Alliance found that among nonprofit employees specifically, 47.6% cite compensation and benefits as a reason for leaving.

The contrast between organizational stability and chronic turnover affects every aspect of mission delivery.

Research from Harvard University quantified this relationship directly: among warehouse workers, every $1 per hour increase in pay produced a 2.8% improvement in retention. Conversely, every $1 per hour decrease caused a 28% increase in turnover. The relationship between pay and retention isn't theoretical—it's measurable and significant.

What the Corporate Sector Learned Decades Ago

The for-profit world grappled with this question more than a century ago and reached a clear conclusion. The economics of "efficiency wages"—paying above market rates to improve productivity and retention—is now well-established in labor economics research.

The Ford Motor Company Experiment

In 1914, Henry Ford doubled his workers' wages to $5 per day—well above market rates. Critics predicted the move would bankrupt the company. Instead, the results were remarkable:

• Employee turnover plummeted from 370% annually to just 16%
• Absenteeism dropped from 10% to 2.5%
• Productivity increased 40–70%
• Despite doubling wages, the cost per unit actually decreased

This wasn't philanthropy—it was smart business. The savings from reduced turnover and increased productivity more than offset the higher wage costs. NBER economists who studied Ford's policy concluded it was consistent with efficiency wage theory: paying more made the company more profitable.

Modern Corporate Examples

This principle continues to prove itself. Costco pays employees significantly more than competitors like Walmart. The result? Industry-leading sales per employee, dramatically lower theft, higher customer satisfaction, and employee retention rates that save millions in annual recruiting and training costs. The company's stock has consistently outperformed its low-wage competitors.

A meta-analysis published by the Academy of Management confirms what these case studies suggest: across industries, high turnover negatively impacts organizational performance, especially where roles require knowledge, relationships, and coordination. Sound familiar? These are precisely the qualities that drive success in nonprofit work.

The Nonprofit Starvation Cycle

The nonprofit sector has a term for what happens when organizations chronically underinvest in their own capacity: the "starvation cycle." First identified in research from the Urban Institute and later named by the Stanford Social Innovation Review, the starvation cycle describes a self-reinforcing pattern:

The starvation cycle: funders expect low overhead, nonprofits conform, infrastructure erodes, and the cycle repeats.

1. Donors expect low overhead ratios as a proxy for efficiency
2. Nonprofits respond by underinvesting in staff, systems, and infrastructure
3. Underfunded organizations struggle to deliver results and demonstrate impact
4. Poor results create donor skepticism, increasing pressure to cut costs further

The result: donor funding leaks through cracks in organizational capacity—burnout, inconsistent delivery, and missed outcomes.

Peer-reviewed research using 25 years of nonprofit data confirmed this phenomenon is real and worsening. The study found that "the brunt of the cuts have fallen on non-executive staff wages," which "heightens the concern of ill effects from a fixation on overhead costs."

Research confirms there's an optimal level of investment in staff. Underspending hurts mission effectiveness just as much as overspending.

A 2022 study published in Nonprofit and Voluntary Sector Quarterly went further, testing whether overhead spending actually affects program outcomes. The finding contradicted conventional wisdom: there is an optimal level of overhead spending, and organizations that spend too little on infrastructure—including staff—deliver worse outcomes than those that invest appropriately. The relationship follows an inverted U-curve: underspending hurts performance just as much as overspending.

Applying Corporate Logic to Mission-Driven Organizations

The economic principles that drive corporate compensation decisions apply equally to nonprofits. The difference is how we measure return on investment. For corporations, the return is shareholder value. For nonprofits, it's mission impact.

Human capital forms the foundation that supports every aspect of organizational effectiveness.

Consider a foundation program officer with deep expertise in a specialized issue area—say, early childhood literacy or sustainable agriculture. That person has spent years building relationships with grantees, developing sector knowledge, and learning which interventions work in which contexts. When they leave for a better-paying position, the foundation doesn't just lose an employee. It loses:

• Institutional memory about what has and hasn't worked
• Trusted relationships with grantee organizations
• Nuanced understanding of the communities being served
• Continuity of strategy and vision
• The confidence of grantees who must now build trust with someone new

These losses directly affect the foundation's ability to achieve impact—the very outcome that compensation decisions are supposedly protecting.

A Framework for Board Conversations

Board compensation discussions require balancing short-term budget pressure against long-term organizational capacity.

When discussing compensation with your board or finance committee, consider framing the issue using the same logic corporations use to justify investment in human capital:

The Bottom Line

Compensation decisions made in the boardroom have lasting consequences for organizational capacity and mission delivery.

Foundations, endowments, and nonprofits exist to create impact. Every decision—including compensation decisions—should be evaluated against that standard. When we underpay staff in the name of keeping overhead low, we're not being frugal. We're spending donor dollars on an expensive cycle of recruiting, training, and rebuilding lost capacity instead of investing in the stable, expert teams that actually deliver results.

The for-profit sector learned this lesson long ago. It's time for the philanthropic sector to catch up.

Competitive compensation isn't a diversion from mission. It's an investment in the capacity to achieve it.

Selected Sources

Turnover Costs and Compensation Research

• Society for Human Resource Management (SHRM), "The Real Cost of Employee Turnover"
• Center for American Progress, "There Are Significant Business Costs to Replacing Employees"
• Gallup, "This Fixable Problem Costs U.S. Businesses $1 Trillion"
• Harvard Business Review, research on pay compression and retention
• PayScale, "2023 Compensation Best Practices Report"
• Academy of Management, meta-analysis on turnover and organizational performance

Efficiency Wage Economics

• Raff & Summers, "Did Henry Ford Pay Efficiency Wages?" (NBER)
• Peterson Institute for International Economics, policy summary on efficiency wages

Nonprofit-Specific Research

• Gregory & Howard, "The Nonprofit Starvation Cycle" (Stanford Social Innovation Review)
• Lecy & Searing, "Anatomy of the Nonprofit Starvation Cycle" (Nonprofit and Voluntary Sector Quarterly)
• Altamimi & Liu, "The Nonprofit Starvation Cycle: Does Overhead Spending Really Impact Program Outcomes?" (2022)
• Candid/GuideStar, "The Overhead Myth"
• Illinois Partners for Human Service, sector compensation and turnover report
• Nonprofit Leadership Alliance, "The Cost of Employee Turnover"

Disclosures: This article is for informational purposes only and is not investment, legal, or tax advice. Together Forward Capital is an SEC-registered investment adviser operating as a DBA of R.F. Lafferty & Co., Inc. Registration does not imply a certain level of skill or training.