The Trouble With Impact Investing: Part 1
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Stanford Social Innovation Review
January 24, 2012
There's only one bottom line. It ought to be impact.
For all the hoopla, the definition of impact investing is still a dog's breakfast. Inclusive definitions throw in everything from small donations (huh?) to investments that provide a market rate of return or above (which sounds a lot like plain vanilla investing). Here's our -- the Mulago Foundation's -- working definition: impact investing is the practice of putting money -- loans or equity -- into impact-focused organizations, while expecting less than a market rate of return. Investments that provide a big return don't count: the market will take care of those, and we don't need conferences to get people to put money into them.
On its face, impact investing seems like a great deal -- organizations get cheap money (er, "patient capital") and investors get real impact. It's great when it works that way, but the case for impact is often dubious, and there is a lot of confusion about when impact investing works and when it doesn't. What worries us in that not-for-profit organizations in our portfolio are under increasing pressure to take loans, and some have even lost donors to the impact investing camp.
Both philanthropy and impact investing are valid ways of doing good, but applied in the wrong way, either can do harm. For us, the right funding structure is the one that provides maximum impact for the target population. Mulago works to meet the basic needs of people in some of the poorest countries on Earth, and we've ended up with a portfolio that is 95 percent philanthropy. Here's why:
1) Few solutions that meet the fundamental needs of the poor will get you your money back.
Scalable rural livelihoods, basic health care, basic education solutions, clean water -- with very few exceptions, you don't make money off this stuff, sorry. For example, the one education organization in our portfolio is Bridge International Academies, a remarkable for-profit company that provides a high-quality education to Kenyan kids for $4 a month. While they hope for market rate of return, it's going to be a long time at best, and there are multiple levels of uncertainty. Investors are piling on, though, and why? Because there are very few deals like this out there! Fully unsubsidized clean water for really poor people? Essential services to millions of one-acre farmers? Saving lives from the most common diseases? Forging new distribution channels? Forget it -- you're not going to make any money. These represent profound market and government failures.
2) Overcoming market failure requires subsidy.
A businessman in Africa told me that Coca-Cola lost money there for 12 years. In other words, it required over a decade for one of the most competent companies on Earth to break even on the sale of a mildly addictive sugary drink that is absurdly cheap to make. Imagine what it takes when you're focused on impact. Microcredit, the iconic impact investment of the last decade, required more than $100 million in subsidies before it became a profitable business -- and the impact has been disappointing at best.
When overcoming market failure to reach the poor, it takes subsidy to do the R&D, launch the business, build the market, and sometimes even to deliver the product or service over time. Delivering at a price point the poor can afford almost always translates into very small margins. A good example is D-Rev, a small organization designing products that improve the health and incomes of poor people. They use donor subsidies to design products to the point where they are ready for manufacture and distribution at scale by for-profit companies (and sometimes not-for-profits). Because D-Rev can receive royalties via licensing agreements, funders they approach for grants often want them to take loans. Bad idea. To reach the target population, the margins -- and hence the royalties -- must be small. D-Rev is designing products that would never be designed otherwise: saddling them with loans simply means that they a) have to jack up prices and/or b) produce fewer designs more slowly.
3) Revenue does not equal profit.
Organizations in our portfolio that make crop loans to smallholder farmers, sell essential medicines, or market tools to improve rural incomes are often badgered to take loans and/or structure as for-profits. There seems to be this idea that if a revenue stream exists, it could be turbocharged to make a profit. That's simply not so: the best organizations out there -- the ones under the most pressure from impact investors—are already operating efficiently, squeezing out as much revenue as possible while serving the target population well. Think of them as businesses generating the most impact, while losing the least amount of money possible. Just give them the money.
4) Impact investing can drive organizations off mission.
All talk of double- and triple-bottom lines aside, there really is only one bottom line. It's either impact or profit -- and the demands of investors can pull an organization away from the target population toward those able to pay more. We've seen it happen, and we've seen more than a few organizations start in more affluent markets with the intention to move down-market to the real target population when the numbers are right (they almost never do). One thing we've never seen is an investor pulling a loan, because of a lack of impact or failure to reach the target population.
There's more and more talk of blended capital, of a host of investors out there awaiting the emergence of profitable enterprises that will improve the lives of the poor in fundamental ways. The thing is that they're mostly waiting, and waiting longer than anyone thought. In the real world of the poor, real change still means stepping up with money that you don't expect to get back, while demanding maximum returns in the form of impact. When you find someone who can do that, just give them the money.