Adventures in rural Kenya - building an agri-inputs and livestock-servicing Social Enterprise

Here's some eclectic, and somewhat mundane, yet interesting thoughts and happenings from my time out here in Kenya. I am spending my summer supporting SIDAI Africa Limited, a for-profit social enterprise which seeks to set up a franchise network of agricultural input retail stores tied to veterinary service providers, to transform the way farmers take care of their livestock in Kenya.

I am back in Nairobi, sitting on the balcony of my apartment on a chilly evening, staring at the Yaya Twin Towers in Kilimani - a nice (and wealthy) suburb just 10 minutes away from Nairobi's Central Business District. The Yaya Twin Towers are part of a large high-end mixed-use real estate development, one of the dozens which have sprung up in Nairobi, and pay testament to the city's growing prosperity. What is odd though is that while one twin tower is complete, occupied and fully lit up, the other one is structurally complete, but unfinished and abandoned. In fact, it is an eye sore with its hollow windows and raw grey concrete walls.

The story I've heard is that the contractor had a dispute with the real estate developer, and it got so serious that the contractor poured concrete down the elevator shafts, rendering the entire building unusable. It takes a lot of spite and emotion to do something like that - it just does not seem economically rational at all, no matter how serious the dispute. We're talking about incurring quite a bit of "concrete" cost yourself in order to impose a cost on someone else. I suppose some things are just settled emotionally. Another version of the story has to do with building permits, zoning regulations and regulatory troubles. Whatever the real issue, it reminds one just how risky (and irrational) doing business here in Kenya can be.

I have just spent 3 days "out in the field" - social sector jargon for anything that is outside of an office in a major city (it's seldom an actual "field"). I was in and around Eldoret, one of Kenya's 10 or so large towns, with a population of 200 thousand. Eldoret is right in the middle of the (Great) Rift Valley, and Kenya's agricultural belt, which makes it significant for any agriculture focused enterprise. It was SIDAI's first distribution hub, and in spite of setting up another three distribution hubs, Eldoret still accounts for two-thirds of the company's turnover.

In Eldoret, I was leading two of my four "Strike Forces" - a fancy, action oriented title we have decided to give to the teams I am working with on my four projects here at SIDAI. Just as an example, one of these projects helps SIDAI build systems and capabilities for stock reordering. At the moment everything is done manually and on "gut feel". And while the human gut (or brain) generally does a good job, it has a basic tendency to forget, and misperceive things - and who can blame it when the organization is stocking 1200 or so SKUs (stock keeping units - retail industry jargon for product and pack-size combinations) - that's a lot to manually manage and keep track of! Plus the folks here at SIDAI responsible for stock reordering have never formally learnt lean inventory management principles, even though they intuitively understand and apply many of them. So I get to put into practice some of the real sciency stuff that I have learnt in Base Operations class at Stanford GSB. The MBA's hard learnings do come in useful, after all.

This morning we drove 280 kilometers (175 miles) North-East of Eldoret, to visit and interview 4 of SIDAI's franchisees. That's a lot of driving considering that several stretches of the road were absolutely terrible. It's a beautiful part of Kenya and what made the drive even more pleasant was the inspiring company and interesting places and happenings along the way. Dr. Odede, SIDAI's Operations Manager was in the driver's seat - and our travel companions included Kellen, SIDAI's Store Manager for Eldoret, and Kandia, SIDAI's franchisee from a beautiful little place called Kerio Valley.

Kandia is an incredibly inspiring person. In Kenya, one's status is determined by one's size - both weight and height, but especially weight. The heavier one is, the more presence and importance one typically garners. But Kandia is not particularly tall, and in fact quite lean - yet he has an incredible presence and strong gravitas. He is quite smart and well educated, and when he speaks, people listen. We had rich conversations in the car about everything from his adventures with bee-keeping (he seems to be a self-trained expert), to Kenya's New Constitution and devolved Governance structure - especially what it means for the country's development. We even talked about the social sector and broader development in Kenya, and how some of the Government and social sector projects can be counter-productive, and create dependence rather than sustainable development. I was pleasantly surprised to hear terms like "hand-outs" and "non-market actors" being thrown around. In spite of the country's myriad problems, many smart and educated Kenyans do actually seem to understand what is happening around them very well.

Kandia set-up his franchise store only two years ago, after retiring from a long career in the private sector, working for an agricultural inputs manufacturer. He found a location on a stretch of road, which does not have another agricultural store for at least 30 kilometers in either direction - he literally picked-out "white space". And while he is currently only turning over US$2,000 or so a month (not a lot - an average SIDAI franchisee can turn over US$5,000), he has a bold vision and sees his store's sales multiplying as he helps develop farmers around the area. He claims that the soil and conditions around his store location are perfect for some very high value horticulture crops, like mangoes and watermelons - and he is willing to invest his own time and capital to help farmers learn to plant these crops. It's a great example of how one smart, educated and enterprising local individual, with a bold vision, can help change the destiny of an entire community. And as a pure private sector player he will likely develop a sustainable and mutually beneficial long-term relationship with the community, and is thus likely to be more effective than any non-profit, especially the likes of Technoserve.

One of the other topics of discussion was the Watermelon seed shortage in Kenya. Kenya is a big producer of watermelons. Three fruits - bananas, pineapples and watermelons - are served in large quantities in any Kenyan hotel buffet. But apparently the East Africa Seed Company has only managed to import 600 kilograms of watermelon seed this year, and is struggling to source more from its global suppliers. And as the planting season approaches, the demand for the seed is in the tens of thousands of kilograms. It's an extreme situation which necessitates strict rationing - and SIDAI is struggling to source these seeds. Perhaps next years' hotel buffets will be missing one of the three fruits.

But Kandia managed to get hold of some seeds using his connections, which left our SIDAI colleagues dumbfounded, and even impressed. It just underscores the importance of building networks and informal connections in order to be successful in this market. In a similar story, one of SIDAI's suppliers was being difficult, refusing to deliver to SIDAI's Eldoret hub (there's a lot of competitive dynamics with SIDAI's model which make such interactions not uncommon). But SIDAI's CEO had worked at the supplier before, and simply made a phone call to an old colleague there. Within minutes a phone call came back from the supplier and everything was in order.

I often wonder whether foreign or expatriate social entrepreneurs are at a serious disadvantage in places like Kenya because they lack family, and broader social networks which take years if not decades to develop. And this problem is compounded when expatriates stay relatively insulated in their own communities, rather than making an effort to get to know and relate with Kenyans. The problem almost certainly exists, but is perhaps not particularly noticeable from their vantage point. After all, an expatriate entrepreneur would have figured that there were no watermelon seeds to be had, would have played by the rules and constraints, and would have ultimately been plugged out of or ignorant to the kinds of things someone like Kandia could achieve.

Kandia's store is also an M-PESA agent. M-PESA is a mobile money platform which serves as a virtual bank account and a domestic money transfer or remittance service. In fact there are twice as many M-PESA users as there are bank account holders in Kenya, and by some estimates, almost 25% of Kenya's GDP is being transacted on M-PESA. He claims that the M-PESA agency helps complement his core agricultural retail business, by helping provide fresh money or liquidity to his customers. They come and withdraw money from the M-PESA agent, money usually sent by their kids or relatives working in the towns, and immediately spend it on agricultural goods and supplies at the store. Absolutely brilliant!

Kandia also stocks M-KOPO solar lanterns, an innovative new solar solution which combines mobile money with solar, to break down the upfront investment that is required in any solar system. It's sort of a pre-paid solar system that can be topped-up on a running basis using mobile money. In my view, it's the most refreshing of the 100 or more otherwise virtually identical solar products which are now out in the Kenyan market (they're literally all generic - even sourced from the same suppliers up in Shenzhen). He says that they're moving fast (i.e. selling a lot).

But I was surprised to hear of the generous trade and credit terms which M-KOPO has extended to him (at least SIDAI is not that generous - but to be fair, SIDAI's product value chains are much better established). I guess it is important for them to do so in order to help move their products. Yet I see so many social entrepreneurs making the mistake of being too stingy with the terms they provide to their distribution channel partners - and then they complain that their products don't gain any traction. It's a very simple story of push vs. pull driven by channel incentives - there are real and important lessons to be learnt from players like M-KOPO and their distribution outcomes on the ground here in Kenya, which fresh social entrepreneurs often fail to tap into.

As we drove along the winding roads, the landscape was quite scenic. We passed by Torok Falls, a tall waterfall on the edge of a lush green mountain. What was particularly great about this waterfall was that it appeared out of the blue, and was visible from across a long stretch of the road. It was at least 100 meters tall, if not more, and double storied (i.e. it fell onto a ledge or terrace, and then fell again) - a refreshing sight for the eyes. There were many sign boards around it offering guided treks along the hill - when I am back next time, I am definitely setting aside time to hike around.

Some of the views from the hills looking down onto Kerio Valley were absolutely stunning. The middle of the valley is home to a small-sized lake and a game reserve. The lake is home to hundreds of crocodiles - and it is possible to lodge on its edge and spend time with the crocs. From another stretch of road, we could see the absolutely massive and serene Lake Baringo, with its giant island hill in the center. Lake Baringo is one of the dozen or so "Rift Valley Lakes", pools of water gathered up at different spots in the depressions of the Rift Valley.

Acacia trees and shrubs lined the roadside, a quintessential part of the African landscape. At one point we saw a runner dressed in tights, and somewhat proper looking athletic gear running along the road. He was not a school boy returning home, but a proper looking athlete in his 20s, wearing some fairly high end running gear. The first runner was interesting to see, but then runner after runner kept showing up. In fact, there were even Caucasian runners, running along the road.

We were near a town called Iten, which is home to the International Athletics Federation's high altitude training facility. This is the place which tends to produce many of Kenya's marathon World Champions. In fact, all of Kenya's marathon champions hail from a single tribe, the Kalenjin Tribe, which is settled in this part of the country, and is one of Kenya's 14 larger tribes. Kandia is in fact a member of this tribe - and the joke goes that there can never be a heavy Kalenjin because of their athletic genes, which perhaps explains why Kandia is also so lean (in spite of the massive blob of Ugali he ate for lunch - Ugali is a maize cake, which is absolutely tasteless in every way, and heavy enough to induce a comma). And it's not just genetics - the high altitude and rolling hills in this part of the country build breathing capacity and stamina from a young age. These are perhaps the best training conditions in the world for long-distance runners - right in the middle of this part of rural Kenya. Fascintating stuff!

Dr. Odede, SIDAI's Operations Manager was another inspiration. As we were driving down a stretch of road, he suddenly pulled over to the side and reversed back towards a field where a girl in her teens, and dressed in a school uniform, was sitting down. He postulated that she was menstruating, and because she probably could not afford a sanitary pad, she was staying away from school, and hiding out there. It's a really depressing state of things - so many girls drop out of school because of this issue. We drove up to the next store along the road, bought some sanitary pads and brought them back. By the time we got back, the girl had disappeared, and the local community had gathered up and asked us to leave. Apparently girls are forced to sell their bodies, just so that they can buy sanitary pads, and the community suspected that Dr. Odede was interested in taking advantage of the girl. It's a really sad misunderstanding - in the end we could not actually help the girl. Sometimes there are real structural trust issues which hamper good efforts in the social sector. Separating the good from the bad is non-trivial.

Another heart-warming Dr. Odede moment took place in a small market town called Mogotio, where we were visiting another SIDAI franchisee. Now lots of interesting things happened in this town. A massive convoy led by the self-proclaimed Kenyan Prophet, Dr. David Owour made a huge racket as it passed by the store, and preached its message. I had never heard of this prophet before - as I inquired about him, Dr. Odede and Kellen shared stories of people they know who were persuaded to sell all their assets and hand them over to the Prophet's Church in the hope that they would be rewarded with even more. Superstition is by far the most successful Base of the Pyramid business tactic.

But coming back to Dr. Odede's moment - we got back into our car and were ready to leave the town as several kids between the ages of 5 and 10 ran towards us, asking for money. This is not uncommon across Kenya and I have developed a habit of ignoring these kids, because whatever money I might hand over to them will not help them in any structurally sustainable manner, and may in fact incentivize them to ask for more, the next time any foreign visitor is in town. This cycle of dependency and even entitlement is ultimately harmful.

Dr. Odede seemed to follow the same policy - I assume that everyone with experience in this part of the world ignores the kids. But there was one particular kid to whom Dr. Odede handed over 10 shillings, which is a little more than 11 US cents. When I asked him why that kid in particular and not the others, he responded that the kid was actually hungry, and that he could tell this from the way he looked. The rest of the kids, according to Dr. Odede would have just wasted the money on chocolates or Bubble Gum, but this kid in particular really needed the money.

So while the rest of us would have put in place a blanket policy across all these kids, and not even bothered to look directly at them, perhaps out of guilt and perhaps out of the frustration of having to deal with them, Dr. Odede still had the perceptiveness, energy and courage to try to find that one kid who might in fact really benefit from the money. Now some part of me is skeptical of Dr. Odede's ability to pick the right kid out, but his gesture still makes me feel a little ashamed of myself.

As we rushed back to Eldoret Airport to make it in time for my flight back to Nairobi, it was pouring rain. Traffic was slow, and the road was muddy - but all this just seemed to add to the charm of the experience. We made it to the check-in counter literally seconds before it was about to close. And Eldoret has the cutest little airport - the fact that it is so small makes it so refreshing to use - just one little hall divided up into all the little things an airport needs, like check-in counters, security check-points and lounge areas. If only every airport could be like this.

The 35 minute flight to Nairobi was prolonged by another 15 minutes, because Nairobi Airport's runway was congested. The Government wants to invest in a badly needed 2nd runway on land that was originally ear-marked for the airport's expansion, but squatters have settled there. Evicting them will create a huge uproar, and the squatters have an incentive to hold-in and resist eviction as much as possible. I guess, there's a price to pay for democracy, a free press, and societies which value distributive justice - literally in the extra fuel and time spent up in the air. And airlines, which are a critical enabler for economic development, will be less likely to serve the Nairobi route because of these issues - overall output, in the utilitarian sense, will be sub-optimal, which is again a depressing state of affairs, especially for such a poor country.

Finally, as I landed in Nairobi and was waiting for Benson, my taxi driver, to come pick me up, I heard a loud roar and cheer in the adjacent international terminal. Apparently the President, Uhuru Kenyatta, had arrived back in Nairobi. As Benson pulled in to pick me up, we scrambled to try to beat the President out of the airport. Benson told me that if we fell behind, we would be stuck there for a long time, as roads are typically completely blocked out for the motorcades of important public officials. Ultimately we did beat him, and my taxi driver who is generally quite jolly, was especially elated this time. Not only had we avoided "the jam" but we were also taking advantage of open signals, which were being used to clear the roads for the President's approaching motorcade. I guess we were lucky which was a good reason to be happy, but I was more angry that public officials have to be so privileged in this country.

Just another day here in Kenya! I suppose that the little mundane things one experiences here can be quite interesting. These are some of the benefits of living in an emerging market!

The side-effects of Impact Investing – inevitable market complications!

Here’s a piece where I try to showcase “another side” of impact investing – a controversial and less frequently discussed side, where Impact Investing does a fair bit of harm to markets, in the process of correcting market failure.

After 4 years in management consulting, and before going to business school, I chose to invest a full year of my professional life in the Impact Investing or Social Enterprise space. To be completely honest, I was seeking new adventures. But the most important reason for this was the possibility to pursue a different career direction, with the ultimate aim of finding a better path to reach my longer-term goals (which are “social” in nature). But part of me also wanted to understand whether this space is real. Not real in the sense of whether it exists – clearly this space is huge and here to stay, but rather whether it will actually create the impact it claims to be creating, namely the potential to drag millions if not billions out of poverty – in other words, the potential to “Save the world”. Part of me was always going to be a little skeptical – even if it does to some extent, start to “Save the world”, what are some of the side-effects? I wanted to see for myself, and understand first hand.

This Impact Investing or Social Enterprise space is absolutely humungous now. Between 25% and 50% of my business school classmates are showing some interest in it – many of them will fill the talent gap in this space, and will likely take huge pay cuts for “the greater social good”. There are hundreds of funds now and billions and billions of dollars to invest in this space. At the recent SOCAP Conference in San Francisco this momentum was present in full force. There was much fanfare on display, and plenty of coolade available for those who chose to indulge. At the same time there were also many serious questions raised – Will our small ticket-size fund economics ever be financially sustainable?; Can we ever measure the second bottom line using a standardized methodology that minimizes the potential for manipulation?; Why is there still such a massive talent gap in this space, and what can we do to address it?; Why do we have billions of dollars to invest, but still so many social entrepreneurs complaining about lack of capital? The list of serious fundamental questions is very long, and the dozens of conferences which now take place around the world do not seem to provide sufficient time or space to address them all.

And these are all good questions – but here’s a set of even more fundamental questions which I have been asking, which are almost never raised. In our quest to be market driven, are we doing damage to the very markets we are trying to create? How much of what we are doing is good, and how much is harmful? Can we ever figure out where to draw the line? Do we even have the right structural incentives to draw the lines in the right places, or will we likely get carried away? And why don’t we openly acknowledge these harmful side-effects or distortions? Why can’t there be a healthy debate or discussion on them?

I recently visited a microfinance institution in Kenya, one which has successfully raised and deployed capital from impact investors to reach strong profitability. Now, let’s be very honest and clear here – the capital this institution raised from impact investors is at least 10 percentage points cheaper than the capital it would be able to raise through the markets, either by building a deposit taking capability, or borrowing from local banks. In essence, the impact investors are providing this institution with a 10 percentage point subsidy – presumably, in order to help it get on its feet. Even though it was in the red last year, its most recent financial results show a 4 percent return on assets, a level which many banks would kill to reach (of course no one is willing to subsidize pure commercial banks, even though the likes of Equity Bank have positioned themselves as social enterprises, and received cheap capital in return). So if the impact investors were to leave tomorrow, this institution would be 6 percent of assets in the red.

Clearly philanthropy is supporting this institution – but in this case there’s a tension between philanthropy and market-driven profit which seems to be creating an interesting situation, especially with all the unique objectives and incentives of each of the players involved. So while this institution has reached 4 percent return on assets, the impact investors do not want it to become too profitable. In fact, they have declared an acceptable range of return on assets, which is between 2 percent and 5 percent. In other words, while they do not want to see this institution make a loss, or even a very low profit, they do not want to see their subsidized capital generate what some might deem to be an excessive profit. They have capped profit at 5% return on assets.

Even though it has already reached 4 percent, the institution still has plenty of room to further improve its return on assets. As it continues to grow and build scale, fixed overhead or head office costs will be spread over ever larger field operations. Also, there is potential to make field operations more profitable at the unit level by focusing on the operating level drivers of efficiency or the basic nuts and bolts of a loan officers day e.g. optimal geographic zoning, efficient route planning, providing more efficient transportation through motorbikes, etc.

So what will happen next? If the subsidy is withdrawn, i.e. if the impact investors exit, the institution will drop to 6 percent of assets in the red. But I would argue that the Impact Investors do not really want to exit – they certainly don’t want to see this institution fail. In fact, they want to continue to see this institution grow, and would like to showcase it as a successful example of their investments (in whichever way they might measure or demonstrate this). So they will not exit in the foreseeable future.

So, then! What does the management team do?! They could continue to rapidly build scale and become more efficient. But will they want to do this? I hate to be a cynic, but there are easier ways for them to spend their working days, and this highly profitable subsidy cushion will diminish the need for them to focus on accelerating growth or achieving greater efficiency. They could reduce the interest rate at which they lend to clients. This could be a reasonable way to pass on the subsidy from the philanthropists to the end beneficiaries. But the interest rate which the institution charges to end users is already at the lower end of the broader market, so this “distortion” is likely to make the lives of all the other “market” players more difficult. Alternatively or in addition to this, they could invest their excess earnings in buying top quality expensive equipment, deploying top-notch technology, hiring expensive people, etc. or in other words bloating their operating costs in order to keep net returns low. I suspect that they will do a combination of all the things mentioned in this paragraph – none of which should be done in a more perfect world.

In a more perfect world, I would love to step in and take an equity and management stake in this company and make it as efficient as possible. I am one of those people who can be incentivized by financial upside, and would like to use my strategic inclination and managerial ability to create and capture some of the upside potential. I would strongly argue that efficiency ultimately lowers costs at an aggregated societal level, and creates the greatest possible greater good. When companies operate efficiently, their end users benefit through lower prices and lower costs. Efficiency wakes up the competition and forces them to spend their days and nights also worrying about how to be efficient or innovative. Ultimately, everyone wins. But the objectives, incentives and decision levers here are so misaligned, that there could be no real role for me or the current management team to play, other than that of a bureaucratic fat-cat.

In business school, we celebrate disruptive players like Wal-Mart, Capital One, Jet Blue and Amazon by reading about and discussing their success stories in class. Profit in the market driven sense is a great motivator – for one thing it is easy to measure – unambiguous, and not distorted by subsidies. And when these players push out the cost quality frontier, we celebrate them, because they ultimately do us all a great service. The make the economic system more efficient, and increase our collective wealth.

But I have shown you a real example in the Impact Investing space where we hit a dead-end. Whenever there is philanthropy involved, outcomes are likely to be sub-optimal relative to the market. The whole mantra of markets and philanthropy co-existing ignores the fundamental tensions or side-effects this can create. We often like to assume away problems and trade-offs – it is human nature to do so. It shouldn’t be surprising that most of us are currently doing so in the Impact Investing space.

You might turn around and tell me that I have only provided you with one somewhat peculiar example, or for the more statistically inclined, only one data point. It’s a rare company in this space, which is both profitable and pricing at the lower end of the market. Some might turn around and argue that the Impact Investors should have never capped profit at 5%. Another frequent response which I hear is that it all depends on the “people” and how they manage each particular situation – I do believe that good people can make a big difference, but I would also strongly argue that it is more often much more than people. It is the structural dynamics, incentives and broader norms which determine what happens.

So how about another example, which is more simple and begins to show a generalizable trend or pattern across this space? A family run hybrid maize seed company received an investment from an Impact Investor. This institution pitched itself as a social enterprise, because it works with small-holder farmers helping them boost their crop yield, and also operates in a market where the biggest player is a state owned giant, exercising significant market power. So the family run hybrid maize company gets a subsidy from the impact investor to improve farmers’ lives and take on the state owned monopoly. It is a profitable, for-profit business both with and without the subsidy.

A multi-national seed company, with presence in dozens of markets, expertise in hybrid maize seed production, and a very serious understanding of distribution to base of the pyramid considers entering this market. But it decides not to enter. It will never be able to obtain subsidized impact investment capital, because it is highly profitable in virtually every market that it operates in – in fact, many consider its giant market-driven profiteering ways to be the evil force that fleeces farmers. The subsidy or market distortion created by the Impact Investor to support the family run player, makes the long-term ability of the multi-national to compete on a level playing field uncertain, to the detriment of efficiency in the overall market. Real example!

I have so many Social Investor and Entrepreneur friends, who on the one hand benefit from some of the many forms of subsidies easily available across this space. They access them both directly and indirectly – straight grants; below market rate capital; grant funded technical assistance provided by third party service providers; volunteers coming in and supporting the organization; etc. So while they receive all these benefits, they start complaining any time one of their existing or potential competitors receives a subsidy. And most of them claim to be “market driven” – does anyone else see the contradictions? And can you imagine the uncertainty that a real market-driven potential investor has to live with? Are we not inducing real long-term market failure in this space?

I have described what is happening, but ultimately want to understand why it is happening. There are no clear answers, so I will end with a series of open questions:

Why is this problem not acknowledged and openly discussed in any of our many industry conferences? Do we have a blind spot? Is it too complicated, and requires an understanding of the economics on the ground, which only folks like me who have been there and seen it can bring? (There is a serious criticism which has frequently been written about in industry publications like the Stanford Social Innovation Review, that most of those who attend these conferences have not spent any real time on the ground, and thus do not understand what is really happening). Do we lack the right incentives to bring these problems up? Are we afraid to be really critical, especially when matters are really complicated? Do other people in this space see this problem, and become disillusioned by it? Are they not being listened to? Do they exit back into the real for-profit world and never speak up? Do the ends justify the means, so we cover up or choose to ignore many of our issues and even our detractors?

Or is this just too fundamental a critique of this space and thus makes everyone really uncomfortable? After all, who could possibly imagine that players which are correcting market failure are actually the ones perpetuating it, albeit in different ways.

Why good is not great in Social Enterprise, and how to fix it

I was having a drink with a friend recently, who has been leading one of the most well-known impact investment funds in this region. He remarked that this space (Social Enterprise and Impact Investing) is a “bubble”, one which will take a little longer than traditional bubbles to deflate, because of all the structural issues (some of which I will outline below). The word bubble is not the most elegant one to use here – finance types like to use it for asset prices, and get uncomfortable when it is used to define the state of a rather unusual industry. For the sake of greater clarity or even accuracy, I will state that Social Enterprise might be “over-hyped” – it is in the midst of a marketing and communication bubble. But my overall perspective is that regardless of the over-hype, this space is a very important piece of the overall development puzzle, and that we need to shift towards greater rigor across leadership in this industry to help ensure that it does not “deflate”.

From Bill Easterly to Jacqueline Novogratz, the leaders who created this space will tell you that Social Enterprise is an unequivocal improvement on traditional aid and philanthropy. Whether they describe it as “bottom-up development”, “market-driven development”, “searchers succeed while planners fail” or “a new approach to development, combining business & philanthropy”, what is clear is that they see this as a distinct new approach – one that is superior to more traditional approaches with the same fundamental development or poverty eradication goals. Now, charismatic, path breaking leaders often need to hold extreme views in order to get noticed – Bill Easterly would not have sold thousands of books if his views were balanced. And as bland as this might sound, I will go ahead and state that they are all right to some extent – each approach has its place depending on the situation or context, and we need a combination of many approaches across the overall development sector.

But what I have found to be true in my work on the ground here in Kenya is that the two approaches or spaces are remarkably similar – and that many of the criticisms applied to traditional aid and philanthropy can in fact be extended to this space (Social Enterprise or Impact Investing). The following phrase might be interestingly paradoxical, and summarize my key thoughts:

When you’re doing good, it’s hard to do great

First of all, the economics of an impact investment fund are extremely challenging. The deal ticket sizes are quite  small (around USD 1 million on average), and with heavy internal deal team and professional services expenses required on each and every deal (from the accounting due diligence to commercial due diligence to the drafting of lengthy legal documentation), these funds typically end up costing at least 15% of their Assets Under Management (several times a traditional PE or VC fund – a cost base which is too high to cover across any investment asset class, let alone risky young social enterprises) –  and this is just to maintain a steady mid-sized portfolio (I won’t list any hard facts here: the Acumen Fund and Grassroots Business Fund Annual Reports are available on their websites, and list specific figures; also I won’t share any specific stories or anecdotes about deal team associates flying half-way around the world five times over the course of a four month deal, or staying at the fanciest hotels).

None of these funds have reached serious scale (barring one or two which are tapping into Private Banking channels for funding, and are a little more commercial in nature) – this is unlike a traditional service business which, if successful, can be scaled exponentially by focusing on growing and training its talent base. Most of these funds have had stagnant and relatively insignificant deal flows, never more than a few million dollars a year – “a drop in the ocean”, if I might describe them as such.

Now, I don’t know exactly where the key constraints or pain points are in terms of reaching scale – there could be more than one which are significant. Finding investible companies is hard; finding philanthropists to donate must be hard, especially with the challenging economics and still relatively nascent state of the industry; and finding talent must also be hard, especially when it is necessary to focus on keeping costs low because of the challenging underlying economics of the business.

But the economics of the funds themselves are only a small piece of the overall issues in this space. One of my major observations from on-the-ground here in Kenya is that while these investments or companies are arguably doing a lot of good, they are very clearly not doing the best they possibly could. Governance is quite weak, and is clouded by the “double-bottom line”. When you’re doing good, it’s hard to set and enforce the bar for great – especially when what you’re doing has never been done before. There is frequently a lack of strategic focus – almost an inability to understand strategic fit. Anything that sounds good, sounds right, and needs to be done. As a result nothing is done effectively or efficiently. When you’re doing good, ideas rarely go through tight scrutiny. Even if the funds’ Investment Committees are doing a great job up in New York (which many in this space will tell you are in fact doing the opposite – holding up deals, largely for trivial, even egotistical reasons), the companies on the ground in Kenya and elsewhere frequently veer off course.

The fundamental issue is that when philanthropic capital is deployed anywhere, whether in a social enterprise or through traditional aid, there is insufficient ownership. The company, or more fundamentally the cause is somewhat orphaned. It’s exactly the same issue across this new Social Enterprise or Impact Investment approach, as was the case across the more traditional aid or direct philanthropy approach. In contrast to this, private capital, driven by the profit motive, creates a very strong and direct sense of ownership – profit is such a great motivator; and so easy to measure and reconcile.

This is a broad criticism, and one which is certainly not new – and even though it is a structural deficiency, I am by no means suggesting that we should do away with this industry all together. After all, profit-driven capital is not comfortable taking the risks inherent to this “patient capital” approach, so Impact Investing is extremely important and here to stay. But it’s a shame that the self-perception of those currently in this space (the marketing machines in some of these funds are remarkably strong) is quite different to the reality myself, and others (including one of the leaders of these funds I was having drinks with) see on the ground – bridging this gap is extremely important.

And to add to why this industry is so important – a bit of business rigor is better than none. I would not want to see any of these social enterprises run as pure NGOs (the acronym often means - "Nothing Going On"). Also, avoiding hand-outs preserves dignity and creates ownership – so there is value in making people at the base of the pyramid pay for goods and services, even though these goods and services are almost always “subsidized” within this space. I state that these goods are “subsidized” because most of these social enterprises are only in business, because of the lifeline which is low cost philanthropic capital provided by impact investing funds (in spite of the fact that both sets of players almost always claim to be “for-profit” or are at the very least shooting for sustainability). And precisely because this capital is subsidized or philanthropic, no one takes serious ownership of how efficiently it is used or how quickly it is deployed to achieve scale – “orphaned capital”, which is the core issue.

But at least the people who eventually buy the goods or services don’t know of or understand the subsidies or the way the philanthropy is being channeled, and retain their dignity and sense of ownership. (Overall comment: there have in fact been JPAL and other studies, carried out e.g. around mosquito nets in Kenya, which show that paying for something creates no difference in terms of eventual usage behavior or utility, but I do believe that dignity alone is extremely important to the human spirit, and that hand-outs can create “a sense of entitlement”, which can be very harmful).

Ultimately, I want to see Social Enterprise companies and funds managed to the same level of rigor and overall standards, as profit-driven companies. As always, people in leadership really matter – they can fill the gap in ownership, and move the industry from the mediocre standards where it currently seems to be stuck, towards a much higher bar. I am not saying that all leaders in this space should become extremely critical hard-asses, because no one likes to follow a critical hard ass. But we should be critical enough to know where we currently stand and use our charisma to inspire everyone to higher standards.

Overall, I think we need to see a shift in leadership from the old charismatic, even dreamy path breakers, to those who are a little more critical and pragmatic in their management approach. We need individuals with strong private sector experience, but those who are fundamentally geared towards driving social change. Those who are independent minded and bold enough to take on the risks inherent in pushing for higher standards. There’s much to be done, and choosing to follow the next generation of leaders wisely is the right place to start.

Efficiency at the Base of the Pyramid

Efficiency doesn’t come naturally to the Base of the Pyramid. Everyone needs to understand it. Someone needs to champion it. Our low income customers eventually benefit.

Let’s start by decoupling funding and operations. Operations are often treated like a black box – money goes in, and money (also let’s not forget social impact) comes out. Funding is often the focus – “Given my operating model, and my social mission and social impact, can you provide me with funding?” said the CFO to an impact investor – or even a grant funder. Some impact investors will turn around and say, “I think you need to tweak your operating model to become more efficient”. Time for the CFO to move on to the next investor or funder – according to one CFO in the sector, there’s a list of 300 investors they can approach, and basic funnel dynamics tell you that at least a handful can be converted, no matter what the underlying model looks like. Blame it on the ego of that particular impact investor – some of these conversations do tend to degenerate into pissing contests, and it takes incredible soft skills to manage some of the people in this otherwise well-meaning space. But it’s very easy for things get murky – and inefficient.

At a recent dinner conversation I heard the inside story of a ‘Social enterprise’ with USD 7 m in costs, and USD 500 k in revenues. It is a large and well respected organization, doing some terrific work and it has been around for 20 years. For each of these 20 years, costs have exceeded revenues by at least 4 times, and this gap has been plugged by grant funding. It sells an engineering product to deep rural customers. Deep rural distribution can be very costly, especially when it’s for a new innovative product, one which requires a large capital outlay on the part of the end user – not just soap, shampoo and SIM cards which are readily sold in standard mini bite sized chunks.

But the organization is engineering and technology centric, with a good, charismatic and well-connected fund raising team. They are able to excite grant funders year after year and keep the operating model going. The painful exercise of reviewing the operating model and bridging this enormous gap between costs and revenues requires an operations and business strategy centric ex-consultant (not that I am offering my services here) to come in, and make a few game changing changes. There has to be a lot of latent value which can be captured to bridge this gap – geographic footprint optimization, partnerships with other players e.g. MFIs (not that I am offering Juhudi’s support here), performance management systems, etc.

On this note – as an MFI we get many requests for partnerships. In fact we get so many, we are often a little under water. On a given day at least 2 people will walk into our offices and pitch their product or idea to us. On some days we get to do nothing but meet these social entrepreneurs and potential partners. They want both, access to our deep rural loan groups, and want us to administer the loans, which makes sense because as an MFI we have the systems and processes to do this very well. Many of these conversations have resulted in new products, some of which have been tremendously successful – a win-win for all.

But I often wonder why players try to over specialize in rural distribution at the base of the pyramid. It is just so inefficient – and emanates from an urban ‘complexity economics’ mindset, where greater complexity and specialization has been the key source of our collective expanding wealth.

In my view, sales and distribution across multiple players, products and functions has to be consolidated at the base of the pyramid, if we are to deliver efficiency to our low income customers. We have to learn to be good in two or three areas, if we want to realize our true potential. I like to use my cricket analogy. Traditionally, or even as recently as back in the 80s and 90s, a typical cricket player was either a good batsman or bowler or just a specialist a wicket-keeper. Fielding was never really considered a key skill until Jonty Rhodes from South Africa showed everyone in the late 90s just how much of a difference good fielding can make (and he could do nothing else but field). Over time the Aussies realized that if they could push every player to be good in at least two of these four disciplines, they could hold a very serious edge over any other team. They found many players, who were meeting these standards, and this set the new bar – they dominated cricket for the best part of a decade. Now every player in every good team, be it India, Sri Lanka, South Africa, England or even Pakistan has to meet this bar. Australia has finally been unseated – cricket has never been this exciting or competitive.

Similarly, we need to have organizations at the base of the pyramid which, for example, can both administer loans, and build rural value chains – often getting directly operationally involved in both areas. As social enterprises, we often don’t have a natural incentive to consider efficiency. But if we look at the for profit sector, there are plenty of examples of efficiency emerging naturally from the system. For example, it’s what the traditional seed and fertilizer input providers have realized holds enormous value. They have to go out and visit all these farmers anyway – why not finance their seed in addition to selling it to them as well?

Simple MFI is another beast. It’s an incredible innovation, and I am currently trying to catalyze its business development, so that the sector can benefit from it. It’s an Android smartphone application designed to transform Microfinance operations. Deployment of Simple MFI, along with a broader streamlining of systems and operations can shave 3 to 4 percentage points off the interest rate charged by MFIs to their clients – and at the same time reduce clutter, reporting errors, fraud, and other operational risks. Yet, it is a very hard sell. For some MFIs, it brings out too many legacy systems and operational issues – skeletons they would rather keep in their closets. For others, efficiency is just not a concern – especially when they are satisfied on the funding side, and the model is “sustainable”.  In fact “sustainability” is one of the most dangerous terms in social enterprise – I shall cover it in another blog post on another day.

In the meantime, I feel like a door to door salesman with my pitch pack and little IDEOS phone. I am sure it will take off eventually – buts lots of hard work is in store until then. And it was always going to be a challenge. Championing efficiency requires both leadership within an organization and also collaboration across organizations. I was recently reading a great, super insightful book by Antony Bugg-Levine and Jed Emerson, titled “Impact Investing”. According to the authors the social enterprise space is maturing, where the old charismatic cheerleaders are being replaced by people with hard and soft business skills, who will eventually bring things like efficiency to the sector. It adds a bit of clarity to the first part of my previous post on Social Enterprise and Impact Investment (http://mambojambosalama.blogspot.com/2011/09/on-social-enterprise-impact-investment.html). This is the start of the age of the less visible champions – but champions nevertheless. Keep championing.

On Social Enterprise & Impact Investment

Readers – Here’s my first, one hour, 1,000 word, blog post. I will be examining a couple of facets of social enterprise, based on two sets of separate yet insightful conversations with friends out here in Nairobi. Hope you also find them to be interesting and insightful.

Posture on social enterprise

Social enterprise or impact investment is hot. There are obviously those who disregard it as “hippy stuff”, but among those who are part of the industry, or deeply interested in it, broadly speaking, there are two extreme positions (with lots of ground in the middle of course):

i)                    Strong belief and passionate advocacy

ii)                   Skepticism with highly critical judgment

Jacqueline Novogratz, the CEO of Acumen Fund, is firmly in Category I. Someone like yours truly is closer to Category II, but believe it or not, not all the way to the extreme. Both sets of positions are valuable – both sets of players have a contribution to make to this space.

Acumen Fund has attracted millions (and in the future it shall probably attract billions) of dollars of capital into this space, and inspired thousands of man-hours of top end talent to contribute to this broad cause. Jacqueline Novogratz would not be able to achieve this if her speeches in, for example, a large Acumen investor event, positioned her somewhere in the middle.

For someone like me, it would be counterproductive, if not downright immature to show strong intellectual discourse in these forums, even though some sweeping statements on social enterprise cause me to instinctively and reflexively cringe. And many enterprises would not get valuable counsel; help, advice and support were it not for the critical thinking and push which truth telling individuals like myself try to drive across the organizations that we support and serve (in a politically and diplomatically effective manner of course).

So there are the “marketeers” or “cheer leaders”, and there are the “critical thinkers” or “part-curmudgeons”. Intrinsically, the former set values fairness as an end more than anything else whereas the later set values truth-telling as the means more than anything else (notwithstanding the other many strange characters in this space e.g. those who are completely blinded by the coolade, or those who are chronically contrarian). I say – pick a position and fulfill your role.

What defines a social enterprise?

There can be many definitions for social enterprise. I don’t think even any of the large and well established impact investment organizations working in this space have a crystal clear definition. It varies by the individual you speak to. Here are two possible and fairly common definitions:

i)                    Any enterprise which serves customers or works with suppliers at the base of the pyramid

ii)                   Any “sustainable” enterprise  which solves a well-defined social problem

“II” is the more classic social enterprise, the kinds of investments you would associate with the Acumens and GBFs of the world. It includes entities which solve “in your face” social problems, such as financial inclusion, healthcare, clean water, sanitation, clean energy, housing development, etc.

“I” includes everything from telcos, to FMCG distribution companies and FMCG procurement companies to even SMEs– in addition to some of the enterprises which solve “in your face” social problems. Let’s throw in Celtel, MTN, Coca-Cola, Unilever and Nestle, a few unknown SMEs, along with some microfinance organizations, or healthcare service providers. These organizations are all creating jobs, and/or providing goods and services which consumers at the base of the pyramid demand and value, thus impacting the lives of the poor.

The big buzz-term is social enterprise is “double bottom-line” i.e. profitability and social impact. “I” are by definition truly sustainable and subsidy free. But for “I”, even though profitability is clear, social impact is often very hard to measure and market to the rest of the world – thus not even considered. These organizations therefore, often slip through the radars of the Acumens and GBFs of the world, even though they do not always have easy access to finance. As some of my friends working in this space will tell you, many of them are SMEs with good truly sustainable business models, but which are unable to get the financing they require, and thus not able to scale up and succeed.

For “II” true profitability is often missing, but they do tend to be “sustainable” – funded through indirect subsidies. Because their social impact is well defined and easy to measure, these organizations are able to market themselves very well. They are thus able pull on a lot of low cost impact investment capital, an indirect subsidy, and are also able to attract many volunteers and below market rate top talent, also often a significant indirect subsidy.

It’s not that their business models are necessarily flawed or cannot be made truly sustainable, even though sometimes this is the case. But because marketing “in your face” impact is relatively easy, they are able to attract value and transfer it to their customers at the base of the pyramid – tangibly this translates to reaching more customers and/or being able to provide a lower price. As one friend in Nairobi, who is heading one of these enterprises once remarked, “We now have access to so much low cost capital; we don’t need to charge higher interest rates, even though our customers would probably still pay.”

I am not saying that it is a bad thing to transfer value to the base of the pyramid – often it makes a huge difference in people’s lives, and that too very subtly. Instead of giving them simple handouts which destroy dignity and create a culture of dependency, we provide them with what they perceive to be a market driven service, thus preserving their right to choice and their dignity. It’s a very powerful and ingenious route to charity. And let’s not even use a strong word like “charity” – it’s at least partially market driven, so let’s just call it a “value transfer”.

Those funding the subsidy, either through the opportunity cost of their time, or the true opportunity cost of their capital are providing a valuable and selfless service. But let’s recognize these subtle differences, so that we are truly aware of what we are doing and what we are not – who we are able to support, and who gets left out – and thus be able to better accomplish what we set out or strive to do.