The case for a sector based approach to impact investing

Report by Matt Bannick and Paula Goldman, September 2012, Omidyar Network: USA

Arguing that the current global social impact investment market has to date been driven by the emergence of individual firms, this report suggests that how focusing on building industry sectors is needed to bring the social marketplace to scale.

A focus on individual investors, funds and organisations has dominated the development of social impact investment to date. Many investors appear to be ready to invest in individual deals, especially those rare ones that hit the jackpot on strong financial and social return, but few seem ready to invest in the infrastructure that will allow these deals to be created more often. The focus on individual firms and deals may have also caused investors to underestimate the role of policy and political sensitivity. Bannick and Goldman argue that in order to establish the market, investments will need to be made in the gray space between grants and risk adjusted commercial returns, those that will facilitate the infrastructure that the market will need to grow.

The Value of Industry Building Investments

When considering investments that will build the industry as a whole, the authors have developed an approach that captures not only the value creation of the individual firm, but also the contribution that firm makes in establishing some stability in the industry overall. Both elements are then factored into the articulation of the value creation or return on investment. This approach also allows them, as investors, to consider more deeply what would be required to create the industry and not focus only on the merits of a single deal. This is beginning to shift the debate around sub-market returns and needs to be included in the tools that are being developed to measure impact, such as GIIRS and IRIS.

Three Categories of Actors

The authors argue that within the scope of both not-for-profit and for-profit firms, they can make contributions in three ways, namely:

  1. Market Innovation – trail blazing entrepreneurs who believe in their product or service long before its profit potential is obvious to others (eg. Bridge Academies in Kenya).  They de-risk the product for future players and their initial investors are more willing to take risks on the return to prove the concept and understand the long term nature of these investments
  2. Market Scaling – they enter the market after a product has been de-risked, refining and enhancing the original model and scaling the firm or the sector. They do this most successfully by tapping into commercial capital markets
  3. Market Infrastructure – they advance a sector or industry by addressing collective needs such as information exchanges and increasing access to financing. They are rarely profitable in themselves but play a crucial role in supporting the growth of an industry through supporting their member organisations

Investing in an Industry

If industries are to grow, and with them mature deals inside those industries, investment into the three actors is crucial. Investors need to take a long term view, understand how industries are developed and be prepared to value the social return of the players accordingly.  Without a systems view, the market and the risk adjusted deal flow will not eventuate. 

Currently, investment is most readily available for market scalers but innovators find it most difficult to gain access to the financial and human capital necessary to succeed, which ironically is where it’s most needed. Foundations, Family Trusts, high net worth individuals and Development Banks have a critical role to play with funding innovators but even they will need to shift their thinking, policies and strategies to support the growth of industries in this way.

Working with Government

If investment in growing the market is not sensitive to government policy, vested interests and the perceptions of the both consumers and the broader public, explosive situations such as the microfinance crisis in Andhra Pradesh and the No Pay Movement in Nicaragua can result.

Government has a powerful role to play in ensuring there is fair competition keeping prices down, establishing appropriate regulation and encouraging entrepreneurship. When this is done well, markets can be accelerated, such as Rwanda’s bottom up focus on economic development resulting in an 8.4% growth rate over the last decade. Investors partnering with governments to consider the appropriate regulatory environment for emerging markets can reap positive rewards.  

When the considerations of policy and regulation are combined with investing in the establishment of an industry over a single deal focus, the conditions for take-off can be more effectively created.



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