Impact Investing

The Distortion Risk in Impact Investing

How do we ensure that philanthropic subsidies in impact investing are put to productive use?

Omidyar Network first entered the world of microfinance in 2004 because we believed that small loans, wisely made, could yield massive benefits for the poor. But we also knew that it would be difficult to scale the microfinance industry to reach the billions in need. The challenges of serving “base of pyramid” (BOP) markets are well documented: limited transportation, communication infrastructure, and product awareness and long timeframes needed to establish trust with customers.

Since 2004, we’ve invested more than $100 million in 26 microfinance organizations—12 for-profits and 14 nonprofits. Roughly half went to organizations working to supply credit to poor people. Another half went to build infrastructure for the industry itself—from MIX, a platform for information exchange, to MFX, an organization allowing lenders to reduce the risk of buying and selling in local currencies.

We know that grant capital was crucial to enabling microfinance to get off the ground—eventually reaching the 150 million-plus customers it has served to date. We suspect the same will also be true for the many other fields—education, health care, etc.—that impact investors work in. So we were pleased when Monitor and Acumen recently released, “From Blueprint to Scale: The Case for Philanthropy in Impact Investing.” This important report, funded by the Gates Foundation, has provoked a critical discussion for our field.

We heartily agree with the overall argument that philanthropy can be a catalyst for businesses that serve the poor. And we like many of the examples of firms—from M-Pesa to Driptech—that benefited from grant capital in early stages. But we also want to raise a few key questions not fully addressed in the report.

1. How can we distinguish between subsidies that accelerate growth and those that stymie market development?

We need to be smart about grant money to avoid distorting the very markets we hope to strengthen. The most obvious risk here is crowding out capital. Over the years, we’ve seen several strong for-profit enterprises serving the BOP that we were eager to invest in—but who ultimately found it too difficult to compete with other companies that had received large grant support from well-meaning philanthropists. Subsidies should be used only in situations when more sustainable for-profit models aren’t feasible (or can’t fully reach an underserved population)—and removed quickly when they are.

A related risk is propping up failure. Venture capitalists know that only some of their investments will pay off; they walk away from their losses quickly in search of the next win. We’re worried that enterprise philanthropists may have a harder time with this, and thus continue to provide grants to failing businesses instead of redirecting their funds to organizations that have the best chance of creating impact. As a field, we need to develop reasonable benchmarks and timeframes to evaluate early success—and develop the discipline to be able to walk away.

2. How do we coordinate limited philanthropic funds for impact investing?
If there’s one takeaway from the Monitor report, it’s that impact investing isn’t just about doing deals. It’s about scaling entire sectors and innovations. Such scaling up requires collaboration among policymakers, local entrepreneurs, philanthropists, and commercial funders. And it often requires a combination of grants and for-profit investments.

At present, grant funding in support of impact investing is severely constrained. That’s not likely to change in the near-term. It thus remains an open question whether impact investors can let a thousand flowers bloom—in education, agriculture, financial inclusion, and many other sectors—or whether we need to concentrate our resources in a few key verticals and geographies so as to truly move the needle. We tend to think it’s the latter.

Last year, for example, we worked with McKinsey to map the BOP market for med-tech in India. We found that coordination of market development efforts (certification bodies, consumer needs research, appropriate regulatory policy, etc.) could dramatically accelerate growth—allowing the market to reach a size of 10 billion dollars by the year 2020. Such acceleration would allow much-needed medical services to more quickly reach hundreds of millions of people in need. But it can’t happen without government, philanthropists, and impact investors deciding to concentrate on this sector—and working together in a committed fashion to move it forward.

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  • BY Harvey Koh

    ON May 9, 2012 09:03 AM

    Paula, these are very important questions and we’re glad you’ve highlighted them. We don’t want grant funding to crowd out impact capital, especially at this critical juncture in the development of the field. And given the limited resources available, it is important that enterprise philanthropists focus on area where they really add value.

    This is precisely why we laid out the four stages of pioneer firm development in the report, describing the needs that firms would face at each stage, and why we described in detail how funders like Shell Foundation help pioneer firms take disciplined steps towards viability and scale.

    Also, in the Enterprise Philanthropist’s Playbook towards the end of the report, we set out some important questions that funders should ask before jumping in. Is there really high uncertainty around model viability such that investor capital is unlikely to flow? Do demand or supply factors in the market require considerable amelioration, and the required investment so large and the benefit so diffuse that investor capital is unlikely to meet that need? Using these guideposts, we hope that enterprise philanthropists will be able to focus on the right (non-distorting) situations, and deliver targeted help, not slush funds.

    Stepping back from this a little,  though, of course we can see situations where subsidies that could really distort or stymie markets, especially when charities (or governments) give something away without tightly targeting only those who can’t afford it. Why buy anything from an inclusive business when you can get it for free? It is particularly troubling when these subsidies are short-term, so they fail to deliver sustained impact AND hurt inclusive businesses that offer a more sustainable solution.

    Knowing when (and having the discipline) to step away is a really tough nut, especially when things are going badly: should we call time and cut our losses, or invest more money, time and energy to try to make it work? This is particularly hard when we’re driving radical innovation to deliver breakthrough benefits for the poor, and working in the (let’s face it) optimistic and passionate world of social change. But I agree that this drive needs to be tempered with discipline. Persistence is only one of the Four Ps of enterprise philanthropy that we offer in the report, and only works in concert with the other three Ps. Are we all still aligned on Purpose? Is the business focused on getting to a Profitable Proposition? Is the business learning from what isn’t working, and showing Progression towards viability and scale?

    On coordinated whole-market development and acceleration, we couldn’t agree more with you, Paula, and it’s great to see Omidyar Network’s leading efforts here. It is high time we saw inclusive business ventures as just being a piece of a much bigger puzzle, rather than entire scale solutions in themselves, and we absolutely agree that philanthropy is uniquely positioned to take this more systemic approach.

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