The Virtuous Venture Cycle — How Impact Wins
by Teddy Kim and Henry Wigan
There was a time when common sense truth held that the Earth was at the centre of the universe.
Considering that the bulk of human progress has occurred through radical breaks in received wisdom, what might be possible if we applied the same lens of disbelief to today’s prevailing financial wisdom?
Although the notion of considering the social consequences of business has likely been around as long as business itself, the traditional view has been that this consideration is either imposed from without or practiced sporadically by individual investors and companies based on idiosyncratic personal moral commitments. In recent decades, however, there has been a revolution quietly gathering steam regarding the relationship between business and society.
Impact investing, which seeks a measurable social return alongside a financial one, emerged as a defined concept in the mid-2000s amidst a Babel-like tower of buzzwords (social investing, mission-driven investing, ethical investing, double-bottom or triple-bottom investing) describing the broad and largely uncoordinated spectrum of social finance. As these disparate phenomena have begun to converge into a coherent investment sector, social finance has shown robust signs of growth across the board. J.P. Morgan and the Global Impact Investing Network (GIIN) surveyed 146 impact fund managers, foundations and development finance institutions, identifying over $60 billion in investments under management, with expected growth of nearly 20% in 2015. Having outgrown their origins in the philanthropic sector, impact investments now boast increasingly significant allocations in the portfolios of major financial institutions like BlackRock and Goldman Sachs, with retail investors increasingly becoming incentivized to participate.
It is Mustard Seed’s contention that understanding the social dimension of business in a millennial age will be to key in assessing competitive differentiation, and as such, economic outperformance.
The Problem with Impact
As the idea of corporate social responsibility (“CSR”) has drawn increasing attention over the past several decades, both the academic and corporate worlds have struggled to define the relationship between profit generation and public benefit. Perhaps the most lasting influence has come from the theoretical perspective of Milton Friedman, where a business’s responsibility is synonymous with increasing shareholder profits and pursuing any other objective can only interfere with this duty. But even more empirical and research-oriented approaches have more often than not presumed a fundamental disjunction.
Academic perspectives regarding the relationships between social objective and firm performance generally fall into one of three schools of thought. 1) The negative camp — Vance (1975) presented evidence of a negative relationship between share price and social responsibility, while Hirigoyen and Poulain-Rehm (2015) determined corporate social responsibility objectives to negatively affect financial performance metrics such as returns on equity and assets, and market to book ratio. 2) Neutrality — McWilliams and Seigel (2001) have held that the relationship between CSR investment and profit is neutral, as the revenue benefits of CSR efforts are offset by their increased costs in an equilibrium state. 3) The cheerleaders (Mustard Seed included) — CSR investment increases a firm’s bottom-line performance due to the goodwill it generates among employees, customers, and external stakeholders. Thus, the beneficial side effects and minimized firm risk associated with being socially responsible have a positive impact on a firm’s bottom line.
Investment horizon is key. The past several decades have seen a shift from longer-term views on growth and market share to short-term focus on shareholder value and share price. This emphasis has led managers to exercise bolder forms of financial entrepreneurship while decreasing discretionary spending on valuable but less immediately tangible assets.
The effects of short-termism have not been insignificant, as companies like Enron, once praised by academics and consultants for their perceived growth, have crumbled as a result of short-term profit maximization strategies. Furthermore, the cost of these strategies has been born by those furthest removed from the decision making, as cost minimization has often coincided with significant negative externalities, ultimately maximizing return for shareholders at the expense of the rest of society.
At the same time, the concept of CSR has emerged largely as a counterbalance to these sorts of practices. Amidst the conversations taking place in the media and the boardroom, those in favor of CSR have tended to centre their arguments around four central themes — moral obligation, sustainability, stakeholder approval, and reputation. These conversations tend to feed into a double bottom line approach that separately measures monetary and social performance. Thus, there remains a fundamental disconnect between social conception and operational execution. Not only does this pose difficulties for profitability, but the social impact itself is intrinsically limited by incongruity between the CSR objective and firm’s core objective.
To have lasting, truly sustainable impact, corporates must align CSR activities with maximizing profits through their core business. Our hypothesis is that such a relationship between social responsibility and financial profit is not only possible, but that companies who commit to this approach can ultimately outperform those solely focused on revenue generation.
The Solution — the Future
In the last half-century, the world has witnessed heady expansion, with the global economy growing sixfold. But as the population ages, growth will significantly slow and governments will struggle to meet debt and social obligations. The Brexit Vote is a clarion call to meet such obligations. The Vote is as much a reflection of disgruntlement on EU mis management, as it is on the woeful state of present day capitalism, with richest 1% now in control of 99% of global wealth. Even assuming that productivity increases at an annual rate of 1.8%, the rate of GDP growth could still decline by 40% over the next 50 years. Yet there exists a major unmet opportunity for capital markets, and the key to it lies in rethinking how we pursue solutions to the world’s toughest social and environmental problems.
Social enterprise and shared value offer an alternative and more equitable system of sustainable growth and development. While the common view still holds that the objectives of seeking profit and pursuing social impact are at worst fundamentally opposed or at best unrelated to each other, Mustard Seed exists precisely to help change this outdated paradigm. Not only does Mustard Seed reject the inevitability of a tradeoff — it believes that the two can ultimately be made synonymous and mutually reinforcing through what we term the Virtuous Venture Cycle (VVC). In this process, the vicious cycle of negative externalities is replaced by a system of value creating positive impact aligned with commercial return, whereby the bottom line and impact are not only strongly correlated but also mutually reinforcing.
Many companies are able to create real, lasting value by aligning their social and environmental activities with rigorous commercial strategy designed to mitigate risks, promote sales and decrease costs. We believe this is at the heart of a sustainable and effective model for social change, and presents compelling economic logic.
The key stakeholders in a business can broken down as follows — consumers, employees and shareholders. In very crude terms, consumers are stronger advocates for causes they care about, driving higher returns. Employees work harder for businesses that do something they believe in, driving higher returns. And shareholders are more willing to help businesses with some form of social mission, further improving returns. As impact grows, willingness to engage by these stake holder groups increases further, which in turn drives more impact, and so on. The whole activity does, in effect, become profit maximising, mutually reinforcing, and virtuous.
By way of example, Mustard Seed portfolio company Winnow Solutions seeks to help reduce the 1 trillion dollars of food that is currently wasted annually. Yes, 1 trillion dollars. The Company is paid for every unit of food waste it reduces. It does so by measuring kitchen waste in way that has never been done before. Winnow is in fact so effective (and the problem is so bad), that Winnow reduces, on average, food waste by 50% for every kitchen it helps. This is an enormous gain when one considers that commercial kitchens typically have net margins south of 5%, and food makes up a big chunk of their costs. The impact is ‘lock step’ — that is, the bottom line scales with impact. There is no trade off. In fact the two are mutually reinforcing.
What3Words is another Mustard Seed company, which provides addresses to the unaddressed — there are 4bn people who do not have access to an effective address system. Think about what this means. If you do not have a functioning address, how do you register to vote? How do you get piped water? How do you get an Amazon package delivered, and how do you call emergency services? What3Words has worked our how to split the surface of the planet into 57 trillion 3x3 metre units, and assign 3 simple words to each such unit. Good-bye complex 15 digit alpha-numeric GPS co-ordinates, unintelligible and rife for error when used by anyone other than those with super natural memories. What3Words integrates with national post operators, geolocation services and local courier companies. Their bottom line is driven by integration, and this drives impact.
As global supply chains cross borders and promote participation from an increasingly interconnected populace, all macro trends point to the emerging potential of a more conscious capitalism — applications of investment that marry technological innovation, integrated reforms, and ultimate return to growth in order to uniquely align investors, policymakers, and the public. And over the past 30 years, this trend has become increasingly evident across all industries, as leaders of multinational corporations play a vocal and visible role alongside governments and nonprofits in addressing a spectrum of social, environmental, and governance issues.
Ultimately, we are all stakeholders in this global phenomenon — with tangible short and long-term interests in optimizing the positive impact of technological and social change while minimizing the detrimental impacts that emerge alongside socio-economic progress.
