Introduction to Impact Investing – Bad Actors, Intent and Metrics

This is a continuation of a series of blogs to introduce readers to impact investing.  In my previous blog I touched on how social enterprises are leapfrogging weak or non-existent public infrastructure with solutions to basic services that are “off-grid.”   This blog will highlight what distinguishes social enterprises from other private sector-led solutions that are not impact focused.

The private sector has raised our standard of living and lifted millions out of poverty since the time of the Industrial Revolution, but private enterprise needs infrastructure for the “invisible hand” to do its job.  In my previous blog post, I discussed how public sector utilities often fail to provide basic services in the developing world and how this perpetuates a cycle of poverty.

Into this public sector void can step both good and bad actors.  Just as the Industrial Revolution had its negative excesses (child labor, air and water pollution), private enterprise is not always benign when it comes to serving the needs of the poor.   In many water-stressed metropolises for example, weak municipal infrastructure and poor urban planning have given rise to the so-called “water mafia:” private water vendors who deplete local water resources and charge high rates for water to urban slum dwellers who lack alternatives.  These networks of private water tankers obtain water from illicit boreholes, or siphon it off municipal water pipes and sell it, exploiting the poor for profit.  They may provide an essential service, but it is neither ethical nor affordable nor environmentally sustainable.

Financial services also have examples of bad actors, such as “loan sharks.”  While not public infrastructure, financial services are essential for the poor to save and borrow in a safe and efficient manner to manage their uneven, unpredictable cash flows.   In many developing countries however, the poor are seen as un-bankable because they lack traditional forms of collateral or credit histories.  Banks therefore exclude them as customers, even when they often represent the majority of the population.  Loan sharks provide credit to the poor, but at rates that are usurious.  A loan shark does not take the time to analyze the purpose of the loan or a customer’s creditworthiness.  Like the water mafia, they provide an essential service, but their business model exploits the vulnerability of the poor.

In my previous blog I mentioned how diesel generators and bottled water are market-led solutions to the problem of scarce electricity and potable drinking water.  They are not bad actors, but they are not affordable solutions for people living on a few dollars a day, and their environmental impact is questionable.

This gets to the crux of what distinguishes social enterprises from other private sector providers.  They look for and implement solutions to fundamental needs, utilizing innovative approaches.   Moreover, their intent is to solve problems that the poor face in a way that is benevolent to society and the environment.  Technology, which increases efficiency and addresses the issue of scalability, often plays a critical role in forging these solutions.   The ideas social entrepreneurs harness are not “pie in the sky” or based on naïve theories about the poor.  They are real world solutions to real world social and environmental problems.

But is this any different from how the private sector has functioned all along?  Entrepreneurs solve problems and are rewarded with profit when successful.  Necessity is the mother of invention, even in the developing world.  This is true, but the distinction lies in the intent of the social entrepreneur and the business model.   If the intent is to have a positive social and/or environmental benefit, then the business is only truly successful if it meets this goal and is financially sustainable.  It will remain focused on achieving this objective and won’t be persuaded, for example, to move “up market” to serve wealthier clientele in easier to reach areas when the going gets tough.

Social enterprises often use metrics to demonstrate their intent and measure their impact.  The topic of intent and impact measurement is a salient one in the impact investing world.  Future blog posts will be dedicated to this subject.  Suffice to say that impact investors typically want to know what “social returns” their invested capital has generated.   Compelling stories and anecdotes about improving the lives of the poor are not always sufficient.  Without objective measures of your social and environmental impact, how can you prove you are achieving your goals?  More will be said on this topic in later blog posts.

One final footnote: while I’ve thus far emphasized for-profits, there are also non-profit social enterprises that are sustainable.   There are organizations, for example, that receive grants to help cover their start-up costs, but charge for the services they provide.  This “blended” approach has been used effectively, especially with early-stage ventures, or when a social enterprise provides a low cost (or below cost) service to the neediest, while charging sustainable prices to those who can afford to pay.  The main challenge, of course, is scale, as non-profits cannot issue shares to raise growth capital.