Archive for the ‘Social Business’ category

BOP-focused businesses need to reach 100 million customers

October 6th, 2011

Matt Bishop of The Economist recently interviewed prolific inventor and global poverty innovator Paul Polak about his views on how best to reduce poverty on a large scale for base-of-pyramid (BOP) populations (< $2/day PPP income).

A few highlights on Paul’s comments from the below video interview:

  • We will not make a meaningful impact on poverty without selling useful products to the BOP and making a profit from them
  • There is a big difference between selling something to BOP customer which gives them more value than what they paid than ripping them off (which is mostly what they have experienced)
  • In order to be sustainable, businesses targeting BOP populations generally need to target reaching 100 million customers because of the low profit margins (his previous advice was at least 1 million customers)
  • Businesses need to seek out “radical affordability” and highly distributed last mile distribution strategies in order to be successful in BOP markets
  • To make your product/service attractive to BOP populations, it must double their income in a relatively short period of time in order for them to take the risk
  • He believes that most of the successful BOP businesses will come from new startups rather than multi-nationals who just don’t have the DNA to think about and build these new type of businesses
  • There will be huge failures of BOP-focused businesses — this doesn’t mean there isn’t an opportunity (he noted that the Indian Andra Pradesh microfinance crisis is hardly a wimper compared with the disruption that accompanied the changes in the Soviet Union/Russia starting in 1989)

Thanks to for alerting me to this.

Vidagas raised $1.4M for social business

September 1st, 2009

vidagas truckCongratulations to VillageReach for leading the successful fundraise of $1.4M from Oasis Capital, here a European social venture fund to expand their African social business, Vidagas.

I have previously written about Vidagas and how they have innovatively developed a commercial business to become the largest distributor of propane gas in northern (mostly rural) Mozambique.

Seattle Times has more details.

Rechargeable batteries as a social business

January 18th, 2009

I met up recently with Whit Alexander, a co-founder of board game company Cranium which they sold last year to Hasbro. He has provided the seed funding for a new social business venture called Burro.

Whit believes that there is a huge opportunity to develop quality branded products and a distribution channel optimized for the bottom of the pyramid (4B+ people who live on < $2/day). His goal is to deliver products at reduced cost to these customers which also improve their lives.

Their first business line is renting rechargeable batteries starting in Ghana. Why, you might ask?

  • Long-term cheaper. Rechargeable batteries are cheaper to operate over their life-time than the traditional non-rechargeable disposable batteries.
  • Multiple benefits. Batteries can power lights which lets a shop stay open longer and kids to perform homework when it’s dark. Also, mobile phones and radio … important communication tools … all require batteries. Batteries are a regular budget item for most families globally.
  • Better for environment. Growing issues created by disposed non-rechargeable batteries.

Here’s how their model works:

  • Burro purchases rechargeable batteries from low-cost Chinese manufacturers.
  • Burro sets up centrally located branch offices to store and recharge batteries.
  • Burro hires independent battery rental reps who signup customers to monthly rental agreements which cost the equivalent of 3 non-rechargeable batteries each. Customers are provided unlimited recharging of their AA batteries along with an adaptor case (see photo) to allow batteries to operate as popular D-size batteries.

Currently they are operating a pilot in Ghana to demonstrate the business model and get the kinks figured out. Once they’ve got the model figured out, they plan to expand their branch network plus to offer additional products through their growing distribution channel.

Delivering propane as a social business

January 6th, 2009

Vidagas is currently the leading distributor of propane in northern Mozambique … the least developed and primarily rural portion of the country. It has recently become profitable and is raising additional capital to expand into additional provinces of Mozambique and beyond.

What’s most interesting about Vidagas is that it’s a social business. It was started in 2002 by two NGOs VillageReach and Foundation for Community Development. They raised the initial capital and started this business not because they were looking for a great new investment opportunity, but because VillageReach had a contract to improve delivery of medical supplies to the rural clinics. The rural clinics needed a reliable supply of propane to power their refrigerators (to keep their vaccines effective) and for lights so that they could operate the facilities for operations and at night time. And there was no propane supplier.
Rather than simply funding the delivery of propane with government subsidies (if these could even have been obtained), they saw an opportunity to bootstrap a sustainable commercial business with a strong multi-year client … the Mozambique government clinics. So, they created a separate commercial business and then went about operating it like a commercial business selling propane delivery to other local businesses and residential customers. Today, less than 20% of their revenue comes from the government clinics and their customer base continues to grow as they deliver a valued service.

Triple Bottom Line
Vidagas is delivering a triple bottom line:
  • People. It powers equipment in local clinics greatly expanding their services and effectiveness. Households and restaurants which adopt propane for cooking eliminate exposure to smoke and particulates from burning wood or charcoal … a huge health issue.
  • Planet. Every use of propane for cooking reduces the use of biomass fuels. This means less deforestation and destruction of fragile mangroves which are currently having a significant environmental impact.
  • Profit. It generates surplus which creates sustainability and is reinvested into additional capacity to deliver propane (and, in the future alternative energy solutions like solar) in a socially, environmentally and economically enhancing positive cycle.
They created a business which delivers significant social value to people in an impoverished, unserved market. It’s no wonder the World Bank and UNDP have recognized Vidagas as a distinguished social business.

Social business wealth sharing examples

November 9th, 2008
Unitus Leadership Summit 2008

In October, I had the opportunity to travel to Indonesia to participate in a leadership event (sponsored by Unitus) for CEOs and senior managers of some of the world’s most innovative and fastest-growing social businesses. Most of these businesses are in the microfinance sector with a few in other emerging social business sectors. Countries represented at the gathering included India, Mexico, Philippines, Cambodia, Tanzania, Kenya and Indonesia. We had great discussions on bottom-of-pyramid (world’s 4B poorest citizens) topics including: savings products, insurance products, mobile banking/payment, serving ultra-poor and capital raising in our current financial crisis.

I had the opportunity to lead a discussion on the topic of distribution of wealth created by social businesses. There were a number of interesting discussions and examples of how these leading social entrepreneurs are thinking about and acting to implement broader wealth-sharing initiatives. Here are some of the highlights:

Starting as a non-profit operation. SKS Microfinance, the fastest growing microfinance institution in the world with 3M clients based in Hyderbad, India, started in 1998 as a NGO. When they transformed a few years back into a financial company, they setup a trust to hold the cash generated during this process plus shares of the new finance company. The trust is managed by a group of trustees elected by the finance company’s borrowers with a mission of serving the borrower’s community. One of the issues they’ve faced is the ownership dilution of the trust’s shareholding in the finance company as the finance company has raised new equity capital. The trust does not have sufficient cash to invest to maintain their ownership level as the finance company valuations have grown, so by default they would own a smaller % of the outstanding shares after each new financing round. SKS’s management team and earlier social investors have creatively sought to reduce the trust’s dilution impact by issuing stock options to the trust. This has allowed the trust to maintain a 20% ownership stake in the finance company without having to buy new shares. The impact on the existing and new investors (including founders/management) is that they are effectively giving up some of their upside to allocate more upside to the trust. I believe this is a very interesting model for social businesses in similar circumstances.

Starting as a for-profit business. Equitas, a fast-growing (0-100,000 clients in less than 1 year) microfinance company based in Chennai, India, setup from their start in 2007 as a shareholding finance company. The founders were upfront with their investors that their mission was to build a social business. At the start, they setup a separate trust which was granted 5% of the stock of the finance company with the mission of serving the educational and other needs of their target segment of the working poor. In addition to setting up a management stock ownership program, they setup up a employee stock option plan which reaches to all levels of employees. This is almost unheard of in India. Additionally, the founder is planning to allocate additional future options which he is granted by the board to the trust. These are a number of innovations which others can learn from.

Stock options for all employees? There was a lively discussion on whether it made sense to grant stock ownership opportunities beyond the senior management down to the broader employee base (in the case of microfinance, this would include entry-level loan officers.) Some leaders argued that junior staff: (a) were much more motivated by additional cash than stock options; (b) that giving something to employees which they didn’t value and cost the company something didn’t make sense; and (c) would develop expectations that the stock was worth something and if that didn’t materialize they would be angry. Other leaders argued that there are still very good reasons to offer stock options to entry-level employees and these above issues can be addressed through education and setting up share sale opportunities back to the company … with the goal of giving some significant upside sharing to these employees.

How to avoid mission drift. I was asked by one of the CEOs what I recommended they do to ensure that an organization continued on it’s social mission once outside investors got involved. After first stating that I felt like I was the least qualified person in the room to answer that question, I shared an observation … investors are first and foremost investing in the capabilities and potential of the executive team to deliver the results promised during the fundraising process. This means that the social business CEO has a LOT of power. You have the power to set very clear mission and performance measurements with your investor upfront. So, use that power to be very clear in setting expectations about what success looks like. And then make sure your investors are aligned with these objectives.

Please share additional examples in comments of creative approaches that social businesses are taking to share the wealth created when/if their business is successful.

Distributing wealth created by social businesses

September 27th, 2008

There are an increasing number of social businesses which have the opportunity to have both dramatic positive social impact as well as significant generation of wealth. What I’m referring to are what I call “hybrid social businesses” … those which have objectives to deliver social impact and are structured as “for profit” shareholder-type entities. I have written previously that I think that one of the sectors with the most growth opportunity are businesses focused on the world’s poorest and how there is a growing debate on how the wealth created by businesses like Compartamos are distributed.

What I’d like to focus on here is the unearned investment income/assets rather than other wealth that’s created through employee compensation, cash philanthropy gifts of the business, taxes paid and wealth created by customers of business based on the business’ products/services.

Who should benefit from the wealth created by businesses serving the world’s poor?

Of course, there is not one right answer to this question. Here’s a short list of the constituents who could benefit:

  • Investors
  • Business founders
  • Business management team
  • Employees
  • Clients/Customers
  • Local Communities

In most situations, unless specific attention is given, the primary stockholders of any business are the investors, the business founders and the business senior management team. It is important that investors are compensated for the often high-risk capital they provide to fuel the business for without this the business wouldn’t exist. The founders also need to be compensated for the significant vision and sweat equity they have invested in this venture as well as likely other failed ventures (see my overview of hybrid social business for more details). And to attract the right growth-capable senior operating managers, they also need to be allowed to participate in the wealth they are leading the creation of.

Is this where wealth sharing should end?

If this is where the wealth-sharing ends, then the result is likely to increase the wealth share of “the few” creating higher societal wealth inequity. Since most of the countries where the highest potential social businesses are operating already have very high societal wealth inequity, this is perpetuating a severe concentration of wealth. Many people believe that the best approach to creating better societies is to encourage the creation of a very sizable middle class which results in many benefits including more accountable government, fairer laws/judiciary, more resilience to economic changes/shocks, increased freedoms/human rights and less violent communities.

The coming scrutiny

I think that this is going to be an increasingly important issue to address as there is going to be increasing scrutiny of “excessive profits” earned by “the few” which are “generated from the pocketbooks of the poor” by populist governments and political parties/candidates. This is an easy “outrageous” story to sell for votes. So, it is wise to get ahead of this issue.

Going further in wealth sharing

I believe there are opportunities to structure social businesses in order to both generously reward investors, founders and managers AND create wealth for other important constituents. Here are a few thoughts:

  • Employees could have the opportunity to participate in the company’s success. There has been phenomenal wealth generated through employee participation in stock programs in many companies in the developed world. Of course, this has its risks (as we’ve seen with mismanaged companies like Bear Stearns), but there are many more examples of where this has benefited employees modestly or substantially.
  • For certain kinds of businesses it might make sense for poor clients/customers to also have a method to participate in the value being created. This is being done with some microfinance institutions where the clients earn or purchase shares in the company. This has to be structured right though to create a workable governance model. Grameen Bank has done this with board representatives elected by their bank clients. SKS Microfinance has setup a trust to oversee a substantial number of shares owned by their clients.
  • The local communities where a social business works are also a consideration for participating in the wealth created. [I’m not talking here about the common 1-2% of profits given philanthropically by many companies, but rather the enterprise value created.] Since most communities where these social business operate have huge common good investment needs, there is an argument to be made that a success social business could provide significant capital to at least bootstrap these community investments.
  • When a social business receives donation dollars or subsidized capital, there is an increased responsibility to share the wealth generated more broadly.

All of these new “shareholder” groups introduce more complicated governance issues. Some argue if that if you let these less educated shareholders “vote” that this will create problems for the business down the road. In response to this, some social businesses with substantial share ownership with these constituents appoint capable (and hopefully accountable) trustees to oversee the interests of these shareholders. So, yes, this creates more complexity, but then so does democracy!

I’m interested in hearing about examples of hybrid social businesses which are wrestling with the topic of wealth creation distribution and are experimenting with different models/approaches. Please post comments of examples.

Critiquing microfinance, Part II

April 20th, 2008

This is a continuation from Part I which focused on a recent New Yorker article.

New York Times Article

Elizabeth Malkin recent wrote an article in the New York Times called, Microfinance’s Success Sets Off a Debate in Mexico where she outlines some of the issues in the debate on the commercialization of microfinance. This article focuses on Banco Compartamos, a successful microfinance bank in Mexico, which went public in 2007 resulting in a large amount of publicity on investor returns from a bank which serves Mexico’s poor.

First, if you’d like to get a deeper understanding of the Compartamos IPO, there is an excellent case study written by Richard Rosenberg and published by CGAP (Consultative Group to Assist the Poor … part of the World Bank) called CGAP Reflections on the Compartamos IPO. I have read this article in detail and found it very helpful in unpackaging the complexities, nuances and unique circumstances of the IPO which is often lost in the sound bites of both supporters and critics.

Here are a few [of the many!] facts surrounding the Compartamos IPO:

  • Compartamos didn’t issue any new shares as this was a secondary offering. Rather, certain shareholders sold their holdings on the Mexican stock exchange.
  • At the IPO, more than 2/3’s of the shares of Compartamos were held by NGO shareholders who were (and are) committed to reducing poverty.
  • $275M or about 5/8ths of the IPO sale proceeds went to NGOs to reinvest in their missions and the rest (about $150M) went to private shareholders.
  • The IPO made public (and realized in the case of the stock sellers) the investor returns which had accumulated while the company was private. That is, while there likely was some upward bump due to market conditions in the value of the shares through the IPO process, most of the investor returns were not related to the IPO itself.
  • At the IPO, the market valuation of Compartamos was approximately $1.5B which represents a roughly 100% per year compounded return for investors over 8 years.
  • The interest rates charged by Compartamos in terms of yield in 2005 was 86.3% (when you add required VAT, the rate to borrowers is about 100%.)

Needless to say, with these type of numbers floating around in the same sentence as “the poor” there are lots of opinions on this transaction and whether this is a positive or negative event for microfinance and ending poverty. Supporters (and even CGAP) say that this is going to result in a lot more private capital being directed to the poor resulting in a broader variety and higher-euality financial services being delivered to the poor. Critics highlight the high interest rates as gouging the poor and the amount of profits pocketed by private investors (although somewhat reduced in this situation) as being exploitive. And most everyone agrees that optically high profits in serving the poor could be used by populist politicians to argue for regulations on microfinance which could reduce the availability of financial services to the poor.

Here are some additional facts on Compartamos:

  • To survive the heavy devaluation of the peso and inflation in 1995, Compartamos was forced to raise its interest rates (to its current rate levels) in order to survive.
  • When this macro economic financial turmoil subsided in 2000, Compartamos chose not to reduce their interest rates in order to fund rapid expansion to reach new [poor] clients. CGAP report notes Compartamos’s growth rate of 46% per year post 2000 (vs. 24% in previous 4 years) would not have been possible without the higher retained profits from maintaining these interest rates.
  • The interest rates charged by other Compartamos are about the mid-range range for what MFIs charge in Mexico and there isn’t much difference between the high and low rates.
  • Of the interest earned by Compartamos, about 25% of it is profit. That is, they would make no profit if their interest rate was ~65%. [Note: when I asked the CEO of Mexican MFI competitor why they didn’t charge a lower interest rate than Compartamos, he said that this would only put them at the disadvantage in their ability to fund growth of client reach. That is, they would grow more slowly serving fewer poor clients.]
  • Their single largest cost is “operating expense” which is relatively high because they are continuing to forward invest in opening new offices to expand their client base. They are more cost efficient than most MFIs in Mexico.
  • Most of Mexico’s population still have no access to bank services and credit in particular.

Here’s another interesting perspective on commercialization of microfinance titled “What would Leland Stanford do?” by Jonathan Lewis of MicroCredit Enterprises.

All of this data is hard to get your head around … yet alone come to a clear conclusion upon.

The question in my mind is whether in the long-run the Compartamos IPO will be a net positive or net negative for the poor in Mexico?

I think that on net it will result in a positive result for Mexico’s poor. The main factor is that the IPO has raised awareness of the bankability (investability) of the poor and this will attract more private capital which is the only source large enough to support the development of a broad range of financial services for the poor. While I expect that in the short-run that interest rates for microloans aren’t going to drop much, I do think that competition will drive down interest rates in the medium term as more players enter the market. I do hope that competition comes sooner rather than later in order to avert meddling by populist politicians.

Now there’s lots of fodder in this post for some controversy. So, please post your comments with as much objectivity as possible ;-) Disagreements are fine.

Critiquing microfinance, Part I

April 20th, 2008

It is healthy and expected for any growing trend or endeavor to receive critique and microfinance is no exception. I’ve decided to do a mini-round up of some recent critiques for those of you who might not have seen them.

The New Yorker Article

The New Yorker recently published an article by James Surowiecki called What Microloans Miss. In this article, Surowiecki argues that while microloans definitely have positive impact they are not what poor countries need most in order to get richer. He observes that the majority of people in developed countries are salaried workers, not entrepreneurs, hence we need more new small/medium businesses which hire people (he calls the “missing middle”.) He also states that microloans are often used for non-business activities including providing consumption credit during lower income periods. He calls for more focus on equity investments vs. loans to small businesses in addition to loans. In summary, he says “for some people the best route out of poverty will be a bank loan. But for most it’s going to be something much simpler: a regular paycheck.”

Microfinance network Pro Mujer CEO, Ben Moyer posted a response where he argues that “the goal [of microloans] is not to make “poor countries richer”; it is to bring desperately poor people out of poverty by helping them to become self-sufficient.” He goes on to note that “For now, the impoverished semiliterate and illiterate women receiving microloans won’t benefit from investments in the ‘missing middle.’ Microcredit will continue to offer the best return on investment, because it eradicates poverty one person at a time.”

I think that this isn’t an either/or type of issue, but an AND … that is, we need to encourage the continued growth of microfinance and new growing enterprises which create income for families in poor countries.

Microfinance appears to be the best tool available to quickly grow the income of desparately poor families to the point which they can get above the poverty line. That is, they can become relatively stable in being able to provide for their basic needs. Microfinance requires relatively small amounts of capital and infrastructure which means that it can reach and serve large numbers of families very quickly. And you can start to see income improvements in terms of weeks, not years. So, while I agree that we should not over-hype and over-promise on how microfinance can reduce extreme poverty, I also think we should not underestimate the continued positive impact it is having. More importantly, there are many countries and regions where microfinance is almost non-existent, so we need to continue to encourage increased investment to bring this baseline financial service to these families.

There is indeed a dirth of financing options available for new small business … even high-potential ones … in emerging economies. I wrote previously about this “funding gap“. Also, there is a good article by Vinay Ganti which dives further into this topic. The reality though is that this is a medium to long term contributor to emerging market income due to the nature of starting and growing these businesses. It doesn’t mean we should not start investing now!

Also, to get perspective on the reality of timelines for dramatically changing systems, I recommend Hernando Desoto’s groundbreaking book on the history, state and importance of adequate property rights described in his book, The Mystery of Capital. Desoto reviews the history and complexity of the development of property rights in the USA (and other countries) not to discourage more acceleration in property rights in other countries, but on the contrary to help articulate the lessons learned in order to accelerate property rights in emerging countries. We want to deconstruct (in order to understand) the accelerated success of new business starts in certain Asian countries over the past 50 years in order to better encourage similar growth in countries which have not yet participated in poverty reduction growth.

Read Part II

Please post your thoughts in comments.

The funding gap for BOP businesses

April 18th, 2008

Well-run microfinance banks are now starting to attract new and interesting sources of growth capital from investors including Legatum, Unitus Equity Fund, AAvishkaar Goodwell, Vinod Khosla, Accion Investments, Sequoia Capital and many others. This is great news as the “elephant in the room” issue for microfinance is that globally microfinance is currently serving at most 15% of the demand. That is, 85 out of 100 families who could benefit immensely from microfinance have no access to microfinance. And most of those served are only provided basic microcredit business loans, not a range of helpful financial services. The only way this supply/demand gap is going to be narrowed any time soon is for global capital markets to be tapped … there just isn’t nearly enough philanthropic dollars to fund this expansion.

As I’ve written about earlier, I see microfinance banks as providing a new and large-scale, low-cost distribution channel to the world’s poorest families (aka as “base of the economic pyramid” of “BOP”) for products/services which provide opportunity for these families to step out of the multi-generational disease of extreme poverty.

The question is who is going to provide the most helpful and widely available new products and services for these distribution channels? History has shown us that it won’t be the current large incumbent corporations which almost never innovate and have a very difficult time prioritizing investments in emerging market segments due to the high opportunity cost compared with their current businesses. So most of the innovation is going to come from entrepreneurs forming new companies to bring their innovations to market.

So who is going to fund these entrepreneurs? Most of the venture investors (like those listed above) start investing once a venture is off the ground with product in the market. These investors want to make an initial investment of at least $1-3 million and often higher as their investment funds are structured for these size of investments. [This is often referred to in venture speak as Series A round or later.]

What about an entrepreneurs first $25,000, $100,000 or even $500,000 capital to build out a solid business plan, attract the right key talent, build the first generation product offering and other investments required in order to attract these institutional-type investors? These monies are often called seed or angel investment monies and are critical for the bootstrap and startup phase of any business which is seeking to build a meaningful high-volume business with necessary upfront startup investments.

Traditionally, these seed funds either come from the entrepreneurs own savings and some of their close friends and family members. Essentially, people are betting on “you” the entrepreneur. Another source of seed capital is from individuals who seek out very early stage venture investing opportunities. These “angel investors” often invest on the order of $10,000 to upwards of $100,000 in promising new ventures. Often the angel investors also become active advisors and networkers to help an entrepreneur get their business off the ground.

This seed/angel pool is working ok (not, great) for established business segments like technology and pharmaceuticals, but there are very few seed investors for businesses targeting the BOP market. Additionally, many of the highest potential entrepreneurs focusing on BOP businesses live in the markets where they will be building their businesses and have both limited personal and personal network resources as well as limited options for angel investor capital.

There are a few pioneering organizations which are targeting early seed stage investments in BOP businesses including Ashoka, Echoing Green, Acumen Fund and Mercy Corps’ Phoenix Fund. All of these funds are backed by philanthropic monies so they are quite limited in their fund size meaning that they can make either only very small investments or a few larger ones. They are also not setup to help their investees raise additional necessary capital which is often crucial to realizing the business (and impact) potential of these businesses.

Hence, there is a significant funding gap for seed level investment capital necessary to build the next high potential social businesses. I believe this provides a significant opportunity for developing venture-oriented seed funds which focuses investment in high-scale potential BOP businesses. Please post comments if you are aware of any additional seed investment funds in this category.

Businesses focused on the world’s poorest

April 17th, 2008

I am increasingly convinced that businesses focused on serving the world’s poorest 4 billion citizens are a very good investment whether you are looking for financial return and/or positive social impact return. That is, for those of us who seek to end poverty, the scale and sustainability potential of businesses focused on this “market segment” have enormous potential for doing good AND doing well. We don’t live in a zero sum world.

Due to the recent increase in non-charity capital flowing to entrepreneurial microfinance banks, we are seeing continued and exciting new growth levels in access to microfinance for the world’s poorest. Correctly, I would argue, most microfinance banks are focusing primarily on client base expansion with basic microcredit products. One of Unitus‘s microfinance partners, SKS based in India is now adding more than 100,000 new client every MONTH! This is creating a new large-scale, relatively low-cost distribution channel for delivery of products and services to the world’s poorest families.

The initial benefits of having microcredit loans have been HUGE for these poor households. Even while paying loan rates similar to their middle class fellow citizens (ranging from 25-75% in various countries), most borrowers are comfortably paying back their loans with significant growth in net income. And this occurs with generally nothing more than the loan … that is, no business training, no additional education, etc. That is, the women (most borrowers are women) are putting their existing knowledge and skills to work with a very positive income growth result.

I believe that there are at least two additional categories of significant benefit for these poor families which are on the verge of taking off: (1) products/services which increase the earning potential of the families; and (2) products/services which increase the purchasing power of the families. The first category includes many new opportunities which enable families to earn more for the same labor input and/or protect their existing assets. Examples include skills training, micro-franchises, new tools, supply chain integration, insurance products, savings products and many other products/services optimized for these families. The second category includes leveraging the aggregate demand of these families to attract the R&D, manufacturing and distribution investments to bring new, better and cheaper products to these families thereby enabling their money to purchase more. Examples include affordable mobile phones and better/cheaper food and other staples.

And when you combine these new economic growth and stabilization products/services with a the microfinance financing mechanism, you open up even more opportunities. One example would be a small scale renewable energy electricity generation system which could be operated as a business by a micro-entrepreneur (e.g. micro utility), financed by a microfinance bank and resulting in decreased cost of energy for a family in a rural village.

These new businesses serving the world’s poorest have huge scale potential … that is, an extremely large potential customer base. This means that if operated well even a small profit per customer could result in a large total profit over time. So, you’ve now got an attractive destination for capital combined with potential for significant social impact.

Now, I know that some people are concerned that these businesses will end up earning profits from these poor families and they feel this is morally wrong. I ask though what a better alternative is? For I think it is at least as morally wrong for us to withhold (or delay) the benefits of opportunity for these families in the name of protecting them from potential abuse.

Please post your thoughts in comments.

Social business model

February 1st, 2008

There is a growing interest in a new kind of business that is now being referred to as a “social business” or “social enterprise” (I am going to use the former terminology.) I’d like to explain and unpackage this idea a bit and contrast different definitions/perspectives.

The key difference between a social business and a traditional business is that a social business explicitly sets expectations with investors (usually in its bylaws) that it will simultaneously pursue two objectives — (1) specific positive social impacts/”returns”; and (2) financial returns. Generally, social businesses “warn” investors that the financial returns may be negatively impacted by the social objectives and therefore they seek investors who understand and support these dual objectives when they make their investment. By definition a business must be ultimately self-sustaining … that is, generate a profit/surplus which can allow the organization to continue without indefinite infusions of investor capital. I say “ultimately” because many businesses have periods of operating losses as they startup or pursue periods of forward investing with the goal of being more sustainable long-term.

So far so good. Then the definitions of social businesses by different people start to diverge.

Non-Profits and Earned Income. There are a few people which consider non-profit organizations which have income generating activities to qualify as social businesses, but most agree that while these may be good activities they are not in themselves social businesses as they continue to rely on donor income to be sustained. I think it is increasingly important for the viability of most non-profits to have a diversity of income sources which include earned income.

Self-Sustaining Non-Profits. There are a number of institutions which have explicit missions to “do good” and have sufficient resources/income to be self-sustaining. These include private foundations, endowments (e.g. universities) and, more recently, operating businesses organized in a trust-type format. An example of the latter are a number of successful microfinance banks which generate profits, often are subject to tax, but are run by trustees (as there are no shareholders) who by law cannot have a personal benefit from the organization. Generally, the foundations and endowments are not considered social businesses even though some of them do have some operational components. For true operating businesses run inside non-share capital structures, these are increasingly viewed as social businesses even though they may face future limitations due to their inability to accept investor equity capital.

Corporate Philanthropy. Many companies have initiatives to “do good.” Some organizations commit a specific [small] % of corporate profits to these initiatives. Examples of companies which have institutionalized this are Ben & Jerry’s, Google (1% of equity, 1%profits) and RealNetworks (5% of profits). These come under what’s known in the business world as the “corporate social responsibility” category. Generally, these initiatives are separate and unrelated to the company’s business. There is much debate about whether these are essentially public relations efforts vs. serious attempts to make a meaningful/optimized social impact. See my post on Bill Gates on Creative Capitalism. Most people agree that simply having some “do good” social programs do not make the business a social business.

Yunus Definition of Social Business. In Muhammad Yunus’ latest book, he argues for a much narrower view of a social business. He proposes that only two types of businesses are true social businesses: (i) businesses owned primarily/exclusively by the poor; and (ii) businesses where investors are limited to only receive back their invested capital and no more. He says that type (i) provide social impact through the returns they provide to the poor through shareholding and don’t necessarily need to have a social mission (although having one would make them an even better social business.) For type (ii), he argues that if the investors have any potential for return above their investment that this will always trump any social objectives.

“Hybrid” Social Business. Then there’s a form of social business which has clear objectives for both social impact and financial return. One of the most prominent examples are the many “for-profit” microfinance businesses sprouting up around the globe. These businesses explicitly operate as businesses (with investor capital) and focus on providing valuable products and services to the poor (if not the poorest) citizens/communities. Some argue that these are simply “regular” businesses which happen to focus on a certain market segment … the poor. In some cases, businesses which focus on the poor/vulnerable are exploitive … e.g. moneylenders and their re-branded breathern, pay day loan providers. While there definitely are exploitive business models, there are a growing number of examples of businesses which genuinely seek a material positive social impact. [I will cover some controversial examples of highly profitable microfinance banks in a separate posting.] There are a growing number of social investors who are seeking out quality social businesses of this nature … a good example is Good Capital.

[There are some businesses which have a more indirect impact on a population … example is mobile telcom operators which appear to increase GDP in emerging markets as subscriber penetration increases … Merrill Lynch report 0.59% increase in GDP for every 10% increase in mobile penetration … but generally these are not seen as social businesses.]

Why I Like the “Hybrid” Social Business Model

While I have a lot of respect for one of my current day heroes, Muhammad Yunus, I disagree with his narrow view of a social business because I think it is too limiting on the potential for social impact through the social business construct. Here are a few of my thoughts:

  • Investor expectations do matter. If you select investors who are incompatible with your objectives (e.g. they don’t value your social impacts), you’re going to have a challenge keeping focused on your social objectives. But, this is true for any business … you need to find the right investors and set expectations very clearly.
  • Investors take a portfolio approach. Almost all investors seek to have some diversity in their investment portfolio in order to mitigate risk. If I want to be a social business investor, I’m going to want to invest in multiple social businesses realizing that returns/results will vary. So, if I invest in 10 social businesses and 5 fail (no return, not unusual), 3 have modest returns and 2 have strong returns, I have less risk. I also potentially receive my capital back plus a return (both financial and social.) This means that the successful social businesses are overcompensating me in return (financial and social) and the unsuccessful social businesses are undercompensating me. If I agreed to only received my invested capital back with no financial upside, then I would be losing 50% of my invested capital in this scenario and this should be structured a charitable donation.
  • Social entrepreneurs may serially fail. As noted above, it is not uncommon for 50% of businesses (any type of business) to fail. Let’s say we have a very eager social entrepreneurs who starts 5 social business which fail and it’s only her 6th social business which succeeds. Let’s say that she creates huge personal indebtedness in starting the all of these businesses. Why shouldn’t she be able to have a reasonable financial return on the 6th business in order to compensate her for the risk and expense she took in developing all of these businesses? Aren’t we going to dissuade social entrepreneurs from the necessary risk-taking if they have no financial upside from their personal investment?
  • Accessing investment capital. While there is a considerable amount of money in foundations, donor advised funds and other like pools, these funds represent a very small amount of the overall investment capital pool. Most people need/expect to earn a financial return if they are going to commit monies from [their much larger] investment capital “pocket” (vs. their much smaller philanthropic pocket.) So, if you want to attract this capital, you need to offer a financial return even if it is potentially somewhat lowered due to the additional social impact return objective.

Since I believe that social businesses should not be artificially limited in their ability to provide financial returns to investors and staff, I am going to use the term “social business” (with the “hybrid” adjective) going forward to refer to businesses which have an explicit and material social objective in their DNA.

Creating a World Without Poverty book review

January 29th, 2008

Creating a World Without Poverty: How Social Businesses Can Transform Our Lives
by Muhammad Yunus

Muhammad Yunus, 2006 Nobel Peace Prize recipient, has recently released his second book, Creating a World Without Poverty. The centerpiece of this book is Yunus proposal for a new kind of institution called a “social business” which is a for-profit business which has as its top objective a social objective/mission. Yunus makes a passionate argument for the benefit and role of social businesses in helping us move extreme poverty to museums.

I have written a fair amount on Muhammad Yunus, Nobel Peace Prize winner and his first book, Banker to the Poor on my blog. Yunus is an incredible innovator and one of my current day heroes who has made a huge impact on addressing global poverty. So, I was eager to read his new (and second) book.

While I do recommend reading this book, I would call this less of a book and more of a collection of stories and speeches on topics with a little more detail thrown in than a speech generally allows. So, don’t be expecting something “integrated”, but a bunch of Yunus’ current thinking and favorite topics.

Social Business. The centerpiece of this book is Yunus’ concept of a social business. His argument is that humans are actually interested in more than self-interest … they are also interested in helping others. Traditionally, there are 3 primary organization types: (i) for-profit businesses; (ii) non-profits/NGOs and (iii) government. He is proposing the need (and opportunity) to launch a new entity, a social business, to serve the needs of the world’s poorest citizens.

Yunus has a rather specific and narrow definition of the term/concept of a “social business.” Yunus defines two kinds of social businesses: (a) a business which is owned by the poor; and (b) a business where investors are only allowed to receive back their capital invested (that is, no additional return whatsoever.) He primarily focuses on (b) where the primary objective of a social business is a specific social objective plus it must be self-sustaining (i.e. generate financial surplus) in order to provide on-going and growing fulfillment of its social mission. Type (a) social businesses can be pure profit-making machines with the benefit to the poor provided through the profit surplus. Or social businesses could be both type (a) and (b) like Grameen Bank.

Yunus sees no room for businesses with owners/investors (other than poor people) which earn a profit (he calls them profit-maximizing) calling themselves social businesses or having any long-term potential for delivering much social benefit to the poor. He believes that the profit motive will always win-out and these hybrids will ultimately not serve the poor. He also assesses other examples of organization formats to help the poor including coops and NGOs. [See separate response to Yunus’ social business concept.]

Social Entrepreneurs. Yunus defines social businesses as a subset of the larger social entrepreneur segment. That is, all social business operators are social entrepreneurs, but not all social entrepreneurs run social businesses. That is, what they do is either not run as a for-profit/sustaining business and/or it doesn’t meet his criteria for a social business per above.

The Grameen Bank Story. There is a whole section/long chapter dedicated to succinctly telling the story of the Grameen Bank. For those of you who who haven’t read Banker to Poor, this hits many of the story high points (and some later additional points) in much fewer words.

Grameen Companies. Yunus provides one of the first overviews (that I’ve seen) of the 24 (!) companies/entities that Grameen Bank has launched in the last 25 years. He describes what they are doing and identifies some as successful and others as work-in-progress. All of them are intended to help the poor in Bangladesh with just one, Grameen Trust, which is seeking to help the poor outside Bangladesh today.

The Grameen Danone Story. Yunus tells in detail the story of how the new Grameen Danone venture in Bangladesh transpired. [I wrote about it here a while ago and got it mostly right ;-)] This is Yunus’ posterchild example of a social business (except it does pay 1% dividends). It is a very compelling and interesting story of how Danone, the world’s largest yogurt company created a new JV with Grameen in Bangladesh to deliver nutritious food products to the poor of Bangladesh. Their first product is a tasty, healthy yogurt product aimed at children which is priced right and is run as a business. Grameen Bank borrowers provide the milk through the cows they have financed. Danone designed a new micro-yogurt factory that supplies a local area and is sold door-to-door by women entrepreneurs from Grameen Bank in their villages. This is a great example of a social business.

The Poor Lack Capital. Yunus has a strong belief that the first place to start with helping the poor is to provide capital. He argues that at the core of poverty is that the poor lack capital so “the poor work for the benefit of someone else who controls the capital.” He says that “poverty arises from the fact that they cannot retain the genuine results of their labor”, so “the poor work for the benefit of someone else who controls the capital.” Sounds like Marx, huh? Yunus is very much a democracy advocate and capitalist though and encourages a business (not socialist) approach to addressing poverty. In fact, he is quite negative about the ability of non-profits/NGOs and government to provide much help to the poor without the contribution of business.

Microcredit Interest Rates. Yunus has a very simple test for whether interest rates charged for microcredit are fair. He grades interest rates that are up to 10% above cost of funds as “green” (best), 10-15% above as “yellow” (warning) and >15% as “red” (he calls them “moneylenders”). He then has a few footnotes which admit that there should be some exceptions. While I agree that philosophically that there should be more transparency and accompanying scrutiny on interest rates charged by MFIs, his formula is very centric on Bangladesh and other like countries like India and are not reflective of the realities of the cost of doing business in most other emerging market countries. So, unfortunately, I think his test is more the exception than the rule.

International Capital for Microfinance. Curious to me, Yunus picks a fight and argues that international/foreign equity and debt capital for bad for MFIs. Some of this comes from his perspective that these investors have for-profit objectives (counter to his social business criteria) and some from the additional cost due to currency risk issues. He argues for national, subsidized megafunds to provide the capital to MFIs along with urging governments to authorize MFIs to collect and then re-lend savings (currently prohibited in most countries with Bangladesh being a notable exception.) I think his first point is too restrictive as there just isn’t enough subsidized capital to go around. I am fully in support of his second point on savings and think that this would be a huge benefit to the poor.

Technology for the Poor. Yunus is a big proponent of the power of technology to transform and uplift the poor. Grameen Bank has launched companies which have brought cell phones and internet services to villages across Bangladesh. And yes, the poor have very productive means of taking advantage of these services. He encourages the development of new technologies which are targeted at the poor. Probably his most interesting idea is a handheld device which provides simultaneous translation so the poor can more easily communicate with the globally important economic languages.

So, quite a bit to chew on from an economist from Bangladesh!
UPDATE: Here is Grameen Foundation’s blog on this book

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