Talking to key protagonists in the still-nascent impact investment field quickly reveals that it is still subject to many interpretations. Government leaders, for example, might search for public infrastructure investments that have the impact potential of creating new businesses -- such as the original GPS deployment did -- while development banks have made supporting job creation their impact priority.
Photo Credit: Md. Khalid Rayhan Shawon, CGAP Photo Contest
The flavor of impact investment that I find most intriguing is the one that seeks to address pressing societal issues by catalyzing novel approaches that are based on market principles. This intrigue comes from my experience with financial services for the poor and is not based on an ideological pro-market bias. What attracts me is the underlying logic that the success of sustained, market-based solutions by definition means your initial impact investment will have achieved manifold leverage.
But how can we identify investment areas where new models based on market principles are most likely to succeed? And at the level of the individual investment, how should we think about the likelihood of success of innovative business models? A number of lessons based on my experience in financial services for the poor might be helpful in other sectors.
The financial inclusion experience to date, corroborated by others through a broader lens, suggests several plausible criteria for assessing the degree of difficulty for broader investment themes:
1. Is there already what economists would call demonstrable, latent demand or will demand need to be stimulated? For example, pioneers of microcredit a few decades ago knew there was unsatisfied demand for a better alternative because poor households in the informal economy had, for ages, turned to the moneylender. By contrast, there has been less uptake of formal microinsurance, where there is little informal demand to tap into. Meaningful, latent demand also indicates whether there is enough potential for scale both from an impact and from a viability perspective.
2. Are the key elements of the required infrastructure already in place or do they need to be built? Going back to the microcredit example, standalone, monoline credit businesses were possible because local and often subsidized global, wholesale markets developed in parallel to refinance microcredit loan portfolios. By contrast, while there was always known latent demand for formal savings (witness the popularity of informal rotating savings schemes in virtually all developing countries), before the advent of relatively low transaction costs via mobile money, most formal sector providers saw no viable business model for handling high-frequency, low-denomination savings.
3. What are the inherent business economics and resulting likely industry structure? New businesses might be characterized by economies of scale and network effects, which imply larger investments and space for only a few viable players. This would be true, for example, for new payment or money transfer services which grow more attractive to customers as they increase reach.
4. What are the boundaries on the role of government -- is there room for a meaningful private sector contribution or does government view the provision of specific services as its obligation and prerogative? This aspect is a bit trickier because it strays into the field of political economy, but it's probably safe to argue that important parts of "social safety nets," such as security in old age, require intergenerational and large-scale solidarity mechanisms that only the public sector can bring about. Private sector financial solutions might only be complementary.
5. Lastly, what are the policy and regulatory regimes that are either already governing the target area or likely to emerge in a new space? In financial services for the poor, for example, regulators apply higher safety and soundness demands on ventures taking money from the poor compared to those giving it. Deposit-taking microfinance typically requires more equity capital and has higher compliance costs than non-bank microcredit refinanced in secondary markets.
Impact investment success in any given area typically requires both industry infrastructure and demonstrated success in business model innovations for others to pick up and replicate. Far-sighted impact investors such as the Omidyar Network see the need for sector-wide approaches and consequently also fund the pieces required for industry development that are more public good in nature. Most are largely interested in funding specific business model innovations.
For such retail-level investment, there are similarly a number of considerations across client reach, delivery economics and business set up that are likely to make innovation success more or less probable.
1. Success in addressing latent market-level demand relies on being close to your customers and meeting the true underlying need. For example, remittances services are critical for recent migrant communities and physical presence where they congregate on days off is key to easy access. In financial services for the poor, being trusted in the community and conveying a sense of, "We are here to stay," are paramount.
2. Getting the pricing right is important to ensure affordability and suitability. Product and pricing features, for example, must match the catch flow patterns of poor households in the informal economy.
3. Supply-side economics can be improved by using back-office technology to ruthlessly cost-optimize service delivery. Standardize the core processes as much as possible to improve service quality and reduce errors. This improves both revenues because consistency and predictability drive customer satisfaction and lowers costs. Process standardization also allows you to "right-skill" the workforce along the delivery process. KGFS in India, for example, focused on developing a set of frontline customer interaction protocols that help them understand client needs and give product-agnostic advice. Behind that front end processes are highly automated and set up for straight-through transaction processing to enable sophisticated analytics and facilitate secondary market transactions.
4. Successful base-of-the-pyramid innovations reduce start-up investments and capital intensity by "borrowing" other companies' assets, such as physical distribution sites or even brand. For example, many new "pay-as-you-go" businesses that deliver access to water or solar energy in East Africa, leverage mobile money providers' agent networks to gain a sense of trustworthiness and name recognition from M-PESA by branding their new services, "M-something or the other." Mobile money, in and of itself, became a viable value proposition not least because mobile network operators had already invested in an agent network for prepaid distribution and airtime top-up, and in many developing countries, mobile network operators were among the most respected and trusted domestic institutions.
New solutions for pressing societal issues based on market principles are powerful because they can sustain and scale beyond what public purse or charity could ever fund. To think "a priori" about the likely market and business model characteristics will maximize the likelihood of success or, at least, make the challenges more explicit and therefore help manage expectations.