The (Real) Trouble With Impact Investing

I had the opportunity to co-lead a discussion at the Aspen Institute this summer (with Seth Goldman, CEO of Honest Tea) where we read Part I of Kevin Starr's provocatively written piece in the Stanford Social Innovation Review, titled the "Trouble With Impact Investing: Part I".  This, and his follow up this past week (Part 3) are a clear and skeptical voice in the debate about impact investing, and a sober reminder that impact is indeed hard to measure.  While I agree with much of what Kevin writes, I disagree on what he thinks is the real trouble with impact investing.

But first, I have been working for the past eight years to measure and manage the performance of Acumen Fund's 70+ investments.  It is not easy, and we have been the first to acknowledge the challenges of balancing competing demands of returns and impact, uncertain interest in the results from donors, and, at times, deep reluctance from our entrepreneurs to expose their business to a level of scrutiny not required of their pure for-profit competitors, or for that matter, their pure non-profit counterparts.    

Often, the link between business growth and impact is in lock-step.  For example, Husk Power's renewable energy business grows as it adds new customers, who are accessing formal energy services for the first time.  And while we don't measure impact at the household level, we have gotten comfort with the evidence in the academic literature that demonstrates the solid link between access to formal energy services and increases in household incomes.

In other cases, the link is harder to define and therefore, even harder to measure.  In those cases, we continue to look for evidence, and/or invite researchers in to truly understand the impact of the business intervention.  And as Kevin notes, the problem with this is the cost and time of actually measuring impact, which no one is really truly willing to bear.  In the US, we spend about 1% of a nonprofit's budget on a financial audit that gives donors comfort that the organization is legitimate. What if we sent that as the bar for spending on some assurance that claims of organizational impact are not simply made up?

But, back to the main argument... the trouble with impact investing is not that there is no universal measure for impact to compare one intervention with another, but rather, the challenge with impact investing is that there are no nodal points on which to rest our conception of impact.  Instead, anyone doing anything vaguely impact-oriented is all lumped in together, from place-based economic development to paradigm shifting investments like the One Acre Fund.

On the financial side, there are some clear mental models, or nodal points, where returns congregate.  What do I mean?  Consider the financial axis in the two by two of "returns and impact". The nodal points include but are not limited to: "risk adjusted market return" (which is in the 10%+ range); "below market returns" (which is in the 0-9% range, depending on which market); "get me my capital back" (which is a 0% real return); and "philanthropy" (which depending on your tax bracket is effectively a negative 70% one time return).  What kind of financial return you have is an absolute measure, but also reflective of which nodal point, or strategy you pursue.  If you deliver a 5% return and were aiming to deliver "below market returns", that is pretty good... if you were aiming for "risk adjusted market returns" that is not so good (but still better than the average VC firm over the last decade!)

On the impact side, let me propose four nodal points, all conveniently starting with the letter "P".

The first is process impact.  A fund like DBL in the Bay Area often helps purely for-profit companies improve their community or environmental footprint, engaging employees in local charities, or thinking about the carbon footprint of the office.  A company like Pandora would fit that bill, where DBL helped the company think more strategically about non-financial stakeholders.  Indeed the GIIRS rating system is largely about "process" measures of a company's impact, including governance, worker training, environmental health and safety.  It is a very good start.

The second point of impact would be around place.  Any economic activity in some places is a good thing.  Think of investments in entrepreneurial activity in New Orleans or Cleveland or Detroit or Oakland (where Pandora is based).  The majority of SBA money and CRA money in the US is "place based" investing.  Whether it is a ball-bearing factory or rugged courier bags (like Rickshaw Bags in San Francisco, supported by Pacific Community Ventures), employing people in economically disadvantaged communities has real impact.

In fact, our first investment at Acumen Fund in A to Z was NOT to solve the malaria distribution problem, but was to bring private industry to Arusha, Tanzania; 7,000 some jobs later, we are proud of the economic impact of that investment.  And our second investment in the same company was to help the company solve the distribution problem,.  With the support of the Exxon Mobil Foundation, we worked with Pascaline Dupas to run a randomized control trial on pricing from which we concluded that private distribution would require large subsidies to become viable.

The third node would be product.  There are products like Embrace's infant incubator or d.light's solar lantern that in theory, when widely adopted, could lead to substantial impact.  Now, this is where impact can get much harder to truly measure, and where the marginal social value of the product is critical, not just the absolute value.  For example, Honest Tea, is a healthy product that should lead to marginal health benefits, particularly if it is replacing highly processed and very sweet soft drinks.  There are plenty of products that combine profit and impact, but Kevin is right to point out that many of the highest impact products do have some subsidy built into the R&D, marketing, or distribution.  Our "Blueprint to Scale" report went into great detail about the important role of enterprise-grantmaking.  

The final node would be paradigm-shifting products or services, like One Acre Fund or Revolution Foods, both of which are trying to take an unsustainable equilibrium and fundamentally reinvent  agriculture extension or delivering healthy school meals.  Kevin is right that most seismic shifts that have lead to substantial changes in the quality of life of low income people have historically not been investments.  Social change is often the purview of individual action, political initiative, philanthropy or civil disobedience.  But that does not preclude the possibility that some truly transformative ideas might in fact allow for compelling investment returns.

The trouble with impact investing is that we are still talking at a very high level about process, place, product, and paradigm-shifting impact.  Until we invent the universal impact ruler, we need more sophisticated vocabulary to understand and measure what is working and what is not within each node.  It's great that Kevin continues to stoke the embers of the debate, but he needs to work with the field to keep pushing for more accurate, standardized and transparent measures.  It's a collective action problem, so only if we join forces will we make any progress on the trouble with impact investing.

From CSR to CSO?

Despite increasing number of business cases where corporate social responsibility (CSR) has led companies to build substantial competitive advantages, generate higher revenues, or lower costs substantially, the skeptics of CSR still abound.  Milton Friedman wrote in 1970 that the “social responsibility of the corporation is to generate profits”.  Today, many business leaders echo the view that a business’ principal, if not only, responsibility is to its shareholders.

The logic behind Friedman’s argument endures.  First, the principal-agent theory, which binds managers to act solely in the best interests of their investors, still applies.  Second, any diversion of resources from a company’s core business for social purposes would amount to an undemocratically levied tax on the investor is still a legitimate objection.  (Of course, I assume that Friedman’s scorn for diversion of corporate resources would also apply to excessive executive compensation or the lavish trappings of the C-Suite). And finally, Friedman’s point is that even if it were acceptable to commit to social causes, how is a manager to know where to invest, as he writes that “one man’s good is another man’s evil.”

But if the logic has endured, the context has not.  A lot has happened since 1970 that challenges Friedman’s critique of social responsibility.  The first is the sheer number of companies that have embraced “CSR” as a core part of their strategy.  Companies like Whole Foods or Honest Tea have moved beyond the “window dressing” that Friedman mocks to strategies that integrate concern for employees, suppliers and the environment into the products they sell in ways that translate into strong market share or a robust bottom line.  Measured by sales per square foot, for example, Whole Foods is the most profitable grocery store in the country, and a commitment to CSR is a central part of their strategy.

Second, a small but growing group of investors has started to look for options that combine financial returns with positive social and environmental outcomes.  Moving far beyond the “screened investment” portfolios of the 1990s, funds like Generation Investment Management or Parnassus believe that publicly traded companies with strong environmental, social and governance practices will outperform the markets in the long term. 

And moving from public equity into private equity and venture capital, a new generation of impact investor like DBL and the Calvert Foundation are raising money from investors who want to see it invested in privately held companies or socially responsible projects that generate positive social and environmental returns.  So while Friedman’s principal agent theory may still be a legitimate concern, there are now a large and growing number of investor who would be willing to back business managers who aim to deliver more than just financial returns.

Third, while it is true that “one man’s good can be another man’s evil”, the emergence of new ratings systems like the B-certification, GIIRS and IRIS promise to enable managers to track and communicate non-financial performance measures in clearer and  more comparable ways.   We still have a long way to go to get to a single, coherent measure of social and environmental performance, but we are making progress.  There is also increasing consensus on the urgency of certain national and global priorities, from the jobless recovery to a stalled public education system to the threat of global climate change, that have allowed many business leaders to make clear and measureable contributions that go well above and beyond what is required of them by law. 

Finally, Friedman’s concern that the business executive’s social initiatives would amount to an undemocratically levied tax was a legitimate concern in an era when government worked.  But in the United States, at least, tax policy has become a dangerous game of partisan brinkmanship and double-speak, where ending tax cuts is considered a tax increase and no one seems to want to take the long-term fiscal health of the country seriously.   Many entrepreneurs, social or otherwise, are tired of waiting for the government to get things done.  Code Academy, a start-up education company, and IBM’s P-TECH partnership in New York City are just two examples of businesses finding ways to train more people for the technology jobs of tomorrow.  And consumers are also voting with their wallets, feeling more informed and empowered to express a clear preference for local, healthier, or more sustainably sourced products.

So maybe it is not the responsibility of a company to act socially or environmentally, but these and many examples certainly highlight the opportunity.  Perhaps the only enduring objection of the skeptics is the word responsibility, which implies a moral obligation to do something beyond tend to the bottom line.  Corporate social opportunity, instead, points to the new and growing markets, the vibrant and healthy communities, the patient investors, and the talented and committed workforce open to managers who take off the green eye shade that has long blinded them to the new capitalism taking shape just outside their window.