In recent years there has been an explosion of interest from both the international development and business communities in “impact investing,” an umbrella term for efforts and approaches that share the specific goal of bringing about social and environmental benefits through investment mechanisms that, at minimum, aim to return investors’ principle. The actual expectations of groups that self-identify as impact investors can vary significantly, however, with some investors expecting commercial-rate returns and others expecting a return of principle or nominal, below-market returns. The vast differences in expectations, among other factors, have led to an intense and ongoing debate on “impact investing tradeoffs” – the idea that you cannot have both significant social impact and significant financial returns on investment simultaneously. In other words, achieving significant social impact through investment deals means that financial return expectations must be reduced (often significantly), while investors seeking higher financial returns must settle for lower social impact resulting from their investments. This tradeoff is captured by the now widely used terms “Financial First” Investors and “Impact First” Investors.
Some people dismiss this idea and believe that investors can have their proverbial cake and eat it too, while others argue that tradeoffs are inevitable, especially if you are trying to explicitly benefit base of the pyramid (BoP) populations who are in greatest need of improved access to affordable basic services and employment opportunities but who are also the most difficult and expensive to effectively serve.
My colleagues and I at S3IDF have been frustrated by those “have it all” impact investing groups who emphasize impact for the poor yet maintain unrealistically high expectations for financial return. Perhaps it is no surprise then that a recent report, From Blueprint to Scale, by the Monitor Group and Acumen Fund finds that impact investors are struggling to find opportunities that defy the social-financial tradeoff.
Businesses that serve and employ BoP individuals and intend to scale are dealing with a complex set of challenges that often make business success uncertain, arduous, and expensive. Some of the most significant issues include underdeveloped or nonexistent markets and supply chains, high pre-investment costs that cannot easily be passed on and thus recuperated due to the poor’s limited ability to pay, and the complexities of developing and/or meeting the specifics of consumer demand in relatively more complex sectors like energy, healthcare, and drinking water. To put it bluntly, the odds, more often than not, are stacked against BoP social enterprises. This reality leads to the case for integrating philanthropic monies into the impact investing process.
S3IDF has been leveraging philanthropic and development capital for a decade as a means to more effectively reach BoP enterprises and their customers by using these sources of money to underwrite the often significant pre-investment costs of developing and strengthening explicitly pro-poor micro-, small-, and medium-sized enterprises. This, in turn, allows S3IDF to bring in local financing to help support the actual investment necessary to create or grow a business; local banks then also share the risk and make philanthropic and development dollars go further and achieve more than would otherwise be possible. Yet, this hybrid model that brings together philanthropy and business has been, and continues to be, a hard “sell” to potential funders and partners, including impact investors.
This is why From Blueprint to Scale, mentioned above, was such a refreshing read. The Monitor Group and Acumen Fund report is the first that I have seen emerge in response to the current impact investing climate that actually argues for philanthropic support. The authors, Harvey Koh, Ashish Karamchandani and Robert Katz warn, “Buoyed by the commercial success of the microfinance model, we risk overlooking the role of philanthropic support in developing the inclusive business models that are emerging today.” After all, the authors remind us, the microfinance sector received billions of philanthropic and development dollars to reach commercial maturity, scale, and significant numbers of poor. Why should we expect anything different from the impact investing sector?
It is my hope that as the impact investing “tradeoff” debate continues, more and more earnest discussions will take place about the role philanthropic capital can and needs to play in bolstering impact investing in BoP enterprises. This would greatly expand the “learning through doing” process that was so critical in the development of the microfinance sector, making it more cost-effective to overcome the challenges in BoP business development. Ultimately, this approach to BoP enterprise support would lessen financial-social tradeoffs, so that we get closer to actually having our cake and eating it too.