By Matt Bannick, Managing Partner and Paula Goldman, Vice President & Global Lead for Impact Investing
At Omidyar Network, we are bullish on impact investing. But we’ve also been frustrated by some of the rhetoric we hear, especially the ongoing — almost ideological — debate about whether there is a necessary tradeoff between financial returns and social impact.
The skeptics argue there is always a tradeoff; the purists argue there is never a tradeoff. In conferences and newspapers and boardrooms, both sides stake their claim, each readily marshalling compelling examples to reinforce their world view. The argument never seems to end.
We believe the answer to this hotly contested question is not yes or no but rather: “It depends.” Our experience at Omidyar Network suggests that there are many opportunities to achieve both great returns and great impact. Indeed, it seems to us that in many cases, the best way to achieve massive social impact is to build a fabulous business that serves a desired market. If a company is highly financially successful, it can use retained earnings and its access to capital markets to serve more people. However, there are also circumstances where commercial returns are simply not possible but businesses can still be highly impactful (and more sustainable than grant reliant nonprofits).
Our recent article in the Stanford Social Innovation Review Winter 2017 edition, Across the Returns Continuum, seeks to address these questions by introducing our framework for investing — with impact as the objective. We also want to challenge some of the “myths” we’ve heard about the relationship between financial returns and social impact.
Myth 1: Solving Social Problems is Inherently Concessionary
This one derives, in part, from age-old beliefs separating charity and business as two completely separate spheres. You can’t possibly make money doing good. What’s more, you shouldn’t make money doing good, especially if you’re trying to help poor people or solve a big public problem.
Reality: Many Investments Achieve Both Impact and Return
A growing set of research indicates that impact investing private equity funds invested for commercial returns have performed in line with commercial benchmarks. Indeed, our direct experience suggests that there are a number of opportunities that marry strong impact and strong returns in businesses dealing with lower-middle income populations and above. A large percentage of our portfolio is invested in this vein with strong return expectations.
So the question isn’t whether you can have high financial returns and high impact simultaneously; it’s when. We need to better distinguish which problems can be profitably solved from those that require more patience or risk tolerance from investors.
It’s worth noting that the deeper the market failure and the poorer the target customer, the more likely it is that investors may need to take risks for which they may not be compensated. We need it to be okay for entrepreneurs and fund managers to make these types of distinctions and thus set appropriate expectations for how to judge success in different circumstances.
Myth 2: Only Super Profitable Companies Have Real Impact
If a company isn’t making money hand-over-fist, it won’t be able to get the financing it needs to scale and thereby touch millions of lives.
Reality: There Are Several Paths to Impact
First, many businesses today may be able to use technology to achieve non-linear scale — at a fraction of the burn rate we would have expected in years past. In some cases, this eliminates the need for raising tons of capital.
Second, there are many ways business can have impact, over and above their direct delivery of a product to a customer. In Across the Returns Continuum, we lay out the notion of market-level impact — the idea that a company can contribute to creating a new market for social impact through pioneering a new business model, providing industry infrastructure, or influencing policy.
Take investigative journalism. It’s no secret that the business model for journalistic endeavors faces all kinds of challenges. But given the critical role of journalism in a healthy democracy, we have funded a number of for-profit startups in this domain. Organizations like NewsDeeply, NewsLaundry, and Rappler are de-risking new business models for independent media; in so doing they may “crack the code” so that both they and others can provide this important social good more sustainably. All of these organizations are also leveraging technology to reach large audiences quickly, thus sizably increasing their impact.
Myth 3: Can’t Reach Two Goals
Companies pursuing both purpose and profit will always have conflicting incentives. A company will be either so focused on its mission that it necessarily compromises its profits or it will be so focused on its bottom line that it neglects its mission. (This latter concern is more commonly known as “mission drift.”)
Reality: In Many Cases, You Can
Mission drift is a legitimate issue and there are absolutely cases where a company is tempted, for example, to serve ever higher income customers in order to satisfy higher returns expectations. There are also cases of businesses missing compelling profit opportunities out of fear of dilution of their mission.
However, there are a significant number of companies where there is no inherent tension; profit and impact grow in lockstep. This tends to be the case when a company delivers a product or service that has a positive social impact and where the best way for a company to increase profitability is to continue to serve the existing market well. In these cases, we say, social impact is “embedded” in the business model.
Take for example All Life, a South Africa based company that provides life insurance to HIV positive individuals (the first company to do so). The company’s unique model links the provision of insurance to an individual’s adherence to a healthcare regimen. This creates a virtuous circle whereby both parties benefit from the increased health and longevity of the policy holder.
Myth 4: “Concessionary Capital” Distorts Markets
Concessionary (or below market-rate) investments will distort the very markets they are trying to help.
Reality: Sometimes There is No Market to Distort
It is important to be careful about market distortion. Over the years, we have on occasion seen well-meaning philanthropists heavily subsidize one company and ignore its competitors. Such picking of winners may ultimately hurt consumers, who end up having to pay more for a needed product in a less competitive market.
But the truth is such instances have been relatively rare. Indeed, in a number of instances — especially for businesses serving very poor customers, or where a market segment is relatively new to a particular geography — there is no market to distort. What’s more, by stepping in and de-risking new socially impactful innovations that can eventually scale to tap commercial capital, impact investors play an essential role in actually developing new markets and market sectors for social change.
The time has come to move past the ideological debate about whether or not there is a tradeoff between returns and impact. Let’s instead focus our efforts towards answering a more productive set of questions: Under what circumstances can one expect strong returns alongside strong social impact? Under what circumstances might an investor need to be more patient, or accept more risk, or indeed lower return, in order to achieve impact? What is the different type of impact one is hoping to achieve when using subsidized investments vs. commercial ones?
In Across the Returns Continuum, we have offered our answers to these questions, and we hope other investors will do the same. For us, a concession on return is justified in specific circumstances: when the investment has the potential to transform not just the lives of its direct beneficiaries, but the whole sector within which it operates.
It’s simply a fact that some markets and market segments are more profitable than others — and we need investors of all stripes engaged. Let’s start a conversation about how to address all types of problems and return profiles, and end the debate about which is better or more necessary.