Closing the Gap - Philanthropy and impact investment

21.02.2013 Blog

Impact Investment

Impact investment is a growing field looking to find market solutions to the problems of global poverty. It aims to achieve good financial returns while creating positive social or environmental change.

In April 2012 the Monitor Group, in collaboration with the Acumen Fund, released a paper called “From Blueprint to Scale: the case for philanthropy in impact investing”. The report builds on Prahalad’s idea of utilising market forces to tap into “the fortune at the bottom of the pyramid,” thereby driving social change. However, they acknowledge that markets alone cannot drive social change and small businesses must be supported in the early stages by philanthropic grants. This blog sums up that report and will be followed by a second blog outlining some of the challenges and limitations to impact investment.

Inclusive businesses

The authors identify inclusive businesses as key to eradicating poverty. Inclusive businesses are identified as ones that do not rely on donations and benefit the poor by engaging them as customers and suppliers rather than mere recipients. The Monitor Group suggests that from their research in India and Africa there are some serious shortages in opportunities for inclusive businesses helping the poorest in society. This they attribute to a lack of intermediation and infrastructure, but most importantly to a shortage of proven successful business models. The Acumen Fund, for example, has considered investing in over 5000 companies in the past ten years but has only invested in 65 of those companies. 

The start up phase is often difficult for small businesses that are seeking social investment. The time scales are long when it comes to generating returns and the market is extremely unpredictable for new products. Therefore, investors are not keen to heavily finance upfront expenditure without a guarantee of success. The Grameen bank for example, arguably the most successful microfinance institution in the world, took 17 years just to break even. Furthermore, the microfinance industry took over $20 billion in grants in the first two decades. This initial funding allowed them to experiment and improve through trial and error. The Monitor Group sees the role of philanthropists as helping small organisations with early stage grants to become sustainable and therefore reach a level of investability.

The Pioneer Gap

The Monitor Group lays out four stages of pioneer firm development; blueprint, validate, prepare and scale. The first three stages represent the stages at which most young inclusive businesses are at and where most help is needed. The gap in funding at these stages of development is referred to as the “pioneer gap”.

The blueprint stage involves an idea that meets the needs of customers with a new technology or product. It consists of creating an initial business plan and proving that the concept or product can work.

The validate stage consists of conducting market trials to validate the viability of the model. The trials expose weaknesses and therefore identify areas that need refining. With inclusive businesses the actors have to validate both the financial aims and the social aims of their model.

Once the model is validated preparation for the market launch can begin. To launch a product a suitable environment must be established. This can involve stimulating awareness and demand by educating customers, training staff or developing various supply chains.

It is these three stages of development in which very few funders like to invest. Monitor Africa found that only 6 out of 84 funds investing in Africa were investing in early stage ventures. The process is time consuming, risky and doesn’t offer many upfront returns on ones investment. Therefore, this is the area that the Monitor Group suggests philanthropists can be most effective. Grant money can be used as risk capital as it can tolerate a higher level of uncertainty. The paper gives the example of Vodaphone’s M-PESA mobile banking system in Africa. DFID funded the program with early stage grants which helped develop blueprints and refine new ideas. These early grants were vital in allowing it to scale into Tanzania years later.

Case Studies

The report goes on to analyse four case studies at the “validate” and “preparing the market” stages. Two of them show the positive effects of early development support in the form of grants, training and consultation and two of them show where early stage support could have made an important difference. A very telling comparison is made between an irrigation project in India and another in Pakistan and how they prepared or failed to prepare the market.

International Development Enterprise India (IDEI) aimed to increase productivity of small farmers by selling them drip irrigation units. These units increase their productivity by dripping solution directly at the base of each plant. Acumen helped fund the project and create a new company called Global Easy Water Products (GEWP). With a $100,000 grant and assistance from Adrien Couton the GEWP was able to validate its business model, in particular proving that it could be sold at a market rate to smallholder farmers.

However, the IDEI and GEWP still had the problem that no farmers knew how to use the technology. The break came from a $16 million grant from the Bill & Melinda Gates Foundation with the sole purpose of preparing the market. The money was spent on widespread publicity and teaching farmers how to use the product. Following the campaign the companies growth rate went from 40-73% as the farmer began to accept the product. This case study is a success story of how early stage grants and early stage technical assistance allowed a small business to flourish.

In 2007 MicroDrip attempted to replicate the success in India by bringing low-cost irrigation to Pakistan with the Acumen Fund and the Thardeep Rural Development Program (TRDP) funding their project. However, they missed out some important aspects. Firstly, TRDP was a charity and therefore not concerned with  proving their product could be sold at market prices. They subsequently subsidised their product up to 80% so farmers could buy it very cheaply. This was quite clearly not a sustainable business model. Second, they had failed to prepare the market. Farmers were extremely risk averse and knew nothing of the technology and not willing to invest in it. And, those who did buy the product were not adequately trained in maintaining it and many ended up scrapping it soon after.

The contrast between the two projects is extremely interesting as they were selling a very similar product. The importance of early stage support in the form of development grants and technical assistance cannot be overstated.

Closing the gap

The Monitor Group concludes its findings with a set of recommendations for philanthropic funders as well as impact investors. They encourage philanthropists to embrace risk and consider moving into enterprise philanthropy in different ways to support various actors. As well as vital players in the embryo stages of small businesses philanthropists should also act to create intermediaries to help link small businesses to larger groups and foundations that might become interested in enterprise philanthropy.

The advice for impact investors is to help in the early stages and not to wait for a suitable investment. With clear communication between the investors, philanthropists and businesses, criteria can be set to help move towards investability. Finally, they stress that the investors must be realistic, they must accept trade-offs and not expect high level returns immediately, rather they must aligning their vision of investment with that of the business.

Picture taken from mishox at flickr