Funding Social Enterprises through Financial Engineering

One of the most important features to creating a successful social enterprise is obtaining long-term financial sustainability.  However, it also turns out that this is one of the most difficult outcomes to achieve for many, if not most, social enterprises.  The often sought out approach to this problem is to simply raise enough capital through profits or other means such as charity, donations, and grants.  These are all great means to raise capital but they can often miss the mark.  Profitability is much easier said than done and relying on charity and donations is risky because there is no guarantee you’ll secure those donations the following year. 

This is where financial innovation/engineering comes into play.  The article “A New Approach to Funding Social Enterprises” argued that it’s possible to apply financial engineering to social enterprises to make them more sustainable.  Now of course, not every new financial tool mentioned in the article is going to fit just any social enterprise.  Each social enterprise will need to brainstorm how they want to raise money after assessing how much capital they’ll need and the risk that investors will take on by investing in them.  One of the most innovative, and also controversial of those tools is known as pooling funds.

Pooling funds can be very effective if done right.  One example of pooling is securitization.  Coming from a finance background, I’ve had some experience with securitization and I know how controversial of a topic it can be.  Take credit card debt for example.  Credit card debt from thousands of individuals can be pooled together into a security or a collateralized debt obligation (CDO).  This security is handled by a trust (your bank still handles your credit card account) and is known as an asset-backed security, or ABS.  The trust will then find investors for the ABS such as pension funds, mutual funds, or individual investors.  Once you as a cardholder make payments on your account every month, most of that money will go to the trust, who then pays the investors in the ABS.  The reason this process can be so effective is that it provides the banks/credit card issuers with a source of consistent funding (by selling the debt and they also get part of your payments) and it transfers the risk to the trust and the investors.  Now, this can be an extremely complex process but imagine the good it can do for social enterprises.  The government or some foundation with a lot of capital could give out low-interest loans to these social enterprises.  The debt from these loans, much like in the credit card example above, could be securitized into a CDO and handled by a trust.  This trust could then sell this debt as a social asset-backed security (I just made this up off the top of my head) and sold to investors.  Granted, this is something I just made up off the top of my head and it has drawbacks but the point is that there are numerous ways to use finance to help sustain social enterprises and it makes the private and public work together.  The question is, how do we assess the risk of these social enterprises and how do we get private investors more involved?

Scalability and Sustainability of Social Impact

The case study of GoodWeave as an effective enterprise in actualizing the cause of discouraging child labor was my biggest take-away from this week’s readings. It is easy to imagine that designing a sticker can bring about a paradigm shift in how consumers evolve their preferences, but very tough to plan and execute the logisitics and the manpower required to make it happen. Stayarthi not only addressed the challenges associated with the scalability of GoodWeave, that are described in the article “How to take a Social Venture to Scale” but also built a sustainable business model.

Surely he did not intend to generate profits while coming up with this idea, but his prior motivation to curb child labor from its roots was instrumental in transforming a socio-economic system and customer perceptions. In the course, he not only discovered a new market of consumers who would prefer to buy carpets which are not woven by exploiting children but also opened up a plethora of opportunities for fellow social entrepreneurs to promote the cause by adopting Goodweave’s model.

The impact of this initiative is not confined only to rescuing the children from the exploiters. It improved the literacy rates of the regions where children were freed from this social evil. Thus, Goodweave served as an exemplary institute to encourage education of less privileged kids in addition to protecting their human rights. It now operates in five countries positioned as the only voluntary licensing program. 

Sustaining an impact so vast in nature can be very tricky given the changing market dynamics and never constant customer choices. A new socio-economic equilibrium can arise with inputs from other ventures in rug or carpet industry, which can also boost the economic empowerment of the workers in this industry. This could be one more ripple effect that Goodweave started. However, Goodweave now faces bigger questions of how to sustain on its own without external funding or charity support and yet scaling its impact far and wide. What are the mediums and ideas that Goodweave can employ to strike that fine balance between its sustainability and scalability? What are the challenges and threats for new entrants in adopting this model given its huge scope and demand?

References

GoodWeave: Creating sustainable jobs and employment for the world’s poor
How to take a Social Venture to Scale

Two keys to Sustainable Enterprise

Profits at the Bottom of the Pyramid

How misinformed ideas about profit are holding back the worlds poor

Karishma Shah

Social Enterprise vs Foreign Aid

Social Enterprise vs Foreign Aid
       
    Poverty eradication has proven to be a decisively stubborn problem. Despite programs like the Millennium Development Goals (MDGs) from the UN, 836 million people still lived in extreme poverty in 2015 compared to 1.9 billion people in 1990 (MDG Monitor, 2016). Although this improvement is substantial, it is still unclear to practitioners what exactly works in reducing poverty and what does not (Starobin, 2013). What is clear is that the rise of the social enterprise  could be a mutually beneficial practice to instigate economic development in poor populations globally and gain profit for its operators.
       Social enterprises operate similarly to traditional businesses, and, as Whalan suggests, business like these enterprises have several advantages over charities. For example, charities struggle to attract investment (Whalan, 2013). In other words, a charity has no more potential to be impactful than the money it receives. Since charities have are constrained by a fluctuating money supply, being impactful becomes a difficult goal to plan and pursue. Moreover, charities are not really accountable to the constituency it may want to help. Interestingly, foreign aid given to developing areas from multilateral organization like the UN operate under similar constraints to these.  
    However, business do not have these constraints. Instead, businesses are incentivized to make products or generate services that will diffuse and, as a result, make a profit.  If businesses were incentivized to create or be social enterprises that target poor populations, these same constraints apply. A social enterprise wants to diffuse its products or services and can also attract considerable investment to do so. Additionally, social enterprises would be interested in cultivating ecosystems to help meet its goals (Bloom, 2012). That could mean teaming up with local decision-makers to help understand and develop a product or service to meet the constituents’ needs and wants.
    Thus when considering methods to eradicate poverty, it may be useful to compare the incentives that drive both processes. While foreign aid or charity can help short term liquidity problems in developing areas, the creation and proliferation of social enterprises may more effectively lift people out of poverty by generating business conditions comparable to those in the developed world. Consider what would happen if the World Bank was replaced with an institution that helped developed social ventures? Instead of working with governments and nonprofits on the ground in developing nations, the World Bank would help nascent social enterprises target populations, who are poor, but are in need of what the enterprise is selling. Could this method be more effective a reducing poverty?

Bloom, P. (2012, June 18). How to Take a Social Venture to Scale. Retrieved September 20, 2016, from https://hbr.org/2012/06/how-to-take-a-social-venture-t
MDG Monitor. (2016, September 14). MDG 1 - Eradicate extreme poverty and hunger. Retrieved from http://www.mdgmonitor.org/mdg-1-eradicate-poverty-hunger/
Starobin, P. (n.d.). Does It Take a Village? Retrieved from https://foreignpolicy.com/2013/06/24/does-it-take-a-village/
Whalan, H. (2013, May 8). How Misinformed Ideas About Profit Are Holding Back The World’s Poor. Retrieved September 20, 2016, from https://www.fastcoexist.com/1682004/how-misinformed-ideas-about-profit-are-holding-back-the-worlds-poor

How Less can be More

Should social innovation be measured by their impact or the succes of the social entrepeneurship itself? Kimberly Dasher Tripp argues in her article „It`s Not All About Growth for Social Enterprises“ exactly that: Instead of asking how do you grow the organization, you should ask how do you scale impact. She identifies a way to make a bigger impact on the problem your social enterprise is trying to solve and it`s called franchising.

Rather than trying to grow your organization and therefore transporting your idea to a broader audience, you should cultivate the ecosystem and let others help you in making an impact.

Problems to this approach can be to maintain the quality of your idea and to get enough funders on board of this, because most of them want to see direct revenue of their „investment“.

However before you can even think about getting bigger, your product or service should prove to be a sustainable innovation and can therefore be taken to the next level. In „Two Keys to Sustainable Social Enterprise“ the authors wrote about what leaders need to create sustainable financial models, which are able to make a real impact on the recipient and the problems they face. They defined type of difficulties that need to be changed: the economic actors involved and the enabling technology applied. If a social venture is able to shift the existing economic system including those two features mentioned above it is more likely to suceed in its mission and ergo be more sustainable.

Being a social innovator and targeting the BoP (Bottom oft he Pyramid) market is not an easy tasked as hinted above, but it is definitely worth it. In contrast to charities sustainable social enterprises have the advantage of not being dependent on the money of others, but rather earn money themself and for that reason offer a better and more reliable help fort he beneficiaries. As well as operating in the existing market and not levering it, by just giving it tot he people. It also creates more competition on the market, which brings down the prices. In some cultures it can even have a dignified aspect to it by being able to pay for what they own and not having to take charity.

Overall I think that social innovators and ventures should be aware of the problems they will have to face but don’t forget to „keep their eyes on the price“, which here is the positive impact they’re trying to create in the world.

Is It Exploitative to Profit From The Poor?

“Putting profits first is the most effective and sustainable way for companies to make a positive impact on the lives of the poor.” On face value, this claim by Simanis in Profits at the Bottom of the Pyramid seems exploitative. However, I personally agree that in order to achieve long-term sustainability for social ventures, effort from the community should be incorporated by asking for something in return.

My own experiences resonate well with the aforementioned claim as well. Last year, in Pakistan, I was working for a non-profit that was trying to encourage civic education in public schools. All costs of the curriculum/material supplies and training of teachers were borne by the organization. Consequently, the program did not cost anything to the public schools being targeted. Additionally, the program was also implemented in some private schools, with these institutions paying a fraction of the cost involved. The real challenge at private schools was to convince the administration about the benefits and merits of the program being proposed. In contrast, convincing the local government about implementing the program in various public schools was a much easier first step. This gives credence to the notion that when there is ‘nothing-to-lose’, people generally tend to adopt more quickly, and perhaps even carelessly. This might also result in a casual laid back approach that might be detrimental to the impact of the product/service being offered. Analogously, the impact I saw in the schools was drastically different between the public and private ones. Some of this has to do with the fact that private schools in the region were in general more efficient than the public ones. However, I felt that a portion of the difference in impact could also be attributed to the fact that the private schools wanted their investment to bear fruit.

This also goes in line with the “Money Maker” video seen in class last week. Despite a $100 price that required the people of that region to actually plan and save for months, the locals were willing to make the effort because of the impact they knew they could generate. This probably would not have been the case if the Money Makers were handed to them for free.

Another example that I feel all students will be able to relate to is the cost of attending graduate school. My undergraduate education cost approximately one-fourth of the Carnegie Mellon fee structure. Bearing this cost has increased my motivation to make most of this opportunity and made me more conscious about how I spend my time over here, compared to my undergraduate studies.

Hence, whether you make astronomical profits or barely break even from the revenue generated by social innovations, I feel it is important to involve the community being targeted. A sure-fire way to do that is to make them give up something – this ‘payment’ could range from financial resources or time to even services, varying from case-to-case. But it’s an element that definitely increases ownership of the social innovation and helps more in long-term sustainability as compared to the practice of free charitable giveaways with no accountability.

As Whalan points out in How Misinformed Ideas About Profit Are Holding Back The World's Poor: “Coke is the biggest employer in Africa, and you can often find a bottle of Coke in a village where basic medicine is not even available…If Coke can make money selling sugary soda at 40 cents a pop to villagers who don’t need it, there is plenty of room for companies selling much more meaningful products they actually do need.”

For Profit Social Innovations in Developing Markets

For Profit Social Innovations in Developing Markets

For profit solutions to social problems, rather than charitable solutions, may seem at best inconsiderate, and at worst callous. However, in my view these solutions are the ideal answer to social issues for two main reasons.

1)   If social innovation is a for profit business venture, there is much more of an incentive for the project to be a viable addition to the market.  Essentially, it is less likely an organization would come up with a product like A Laptop for Every Child. The laptop project seemed cool in theory, but was not an item that consumers really wanted or needed. As an academic conceptual pursuit the laptop project worked but without demonstrated demand for the product it would not be a successful business venture. With for profit social innovation there is more pressure for the innovation to actually work because people need to be able to justify paying for it. This is especially relevant in emerging markets because consumers have very slim margins for their disposable income and tend to be very discerning consumers.

2)   Taking the time to create products that address social problems in emerging markets and consumers in these markets value can foster innovative ideas that enhance products in other markets. For example, even though The Tata Nano was not a huge financial success, the car’s design process demonstrated that certain design innovations were possible on a tight budget. For example, even though The Nano retailed for a couple thousand dollars, and on The Indian Market it still met the rigorous crash test safety standards and emissions standards placed on cars in European markets. To meet these standards, Indian engineers for the Nano pushed German manufacturers to innovate create top notch products at a much lower price point than was typically demanded by European consumers. This kind of pressure demonstrated inefficiencies in more established markets and pushed down the price on goods that the Tata Nano engineers needed, and the innovations created through the Tata Nano design process could be used on European market as well.

Basically, providing for profit solutions to the social problems experienced in developing markets makes financial sense as it encourages firms to provide products and services people in these markets need (and people in these markets collectively have massive spending potential). It also makes technological sense as the frugal engineering process encourages rethinking the way products are created and distributed and when these ideas diffuse the concepts from the frugal engineering process can be adapted to benefit consumers in emerging as well as developed markets.

How to measure and scale outcome of social enterprises

How to measure and scale outcome of social enterprises

When I took the Financial Analysis course in Heinz College, I found that the analysis for public and non-profit sectors are the most difficult part. In the beginning where we learned to read and build financial reports of for-profit companies, all of the terms in Balance Sheet, Income Statement and Cash Flow are easy to understand. All that we have to do is to make calculations. When it comes to non-profit organizations, however, I constantly got confused when I have to read or report “profits”. Unlike normal financial reports where we can just calculate debt ratios, assets and flexibilities and draw conclusions by comparing results with bench marks, reports of activities make me feel aimless. What indicates the operation status of a non-profit organization? How can we measure the risks it faces and the potential it possesses? What should we adjust to make the organization generate social welfare more efficiently? Those are questions that no easy to answer.

The article It’s Not All About Growth for Social Enterprises provided us some perspectives on how to scale the impact of social enterprises. Since we cannot take some certain ratios as benchmarks to measure the work, impact may be a good measurement for social enterprises. The author put it that social enterprises should multiply impact rather than just grow the organization[i]. And there are many methods, including distributing successful models and helping other organizations to effectively achieve accomplishments.

From the business perspective, however, the approaches are more various. The article Profits at the Bottom of the Pyramid shows us that for-profit companies can generate profits from targeted marketing opportunity, product redesign, distribution extension, new channel creation, new product development and so on[ii]. Similar actions can be taken by social enterprises. Social innovators can try to learn people’s needs, redesign products, explore wider areas, utilize technologies and design new models to generate more social welfare.

Reporting and scaling of social enterprises’ outcome are not simple tasks. There is still not a certain standard for us to follow. Compared to for-profit enterprises, social enterprise is still in its early stage.

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[i] https://hbr.org/2013/01/its-not-all-about-growth-for-s

[ii] https://hbr.org/2014/10/profits-at-the-bottom-of-the-pyramid