Hacking Philanthropy: the Emergence of Markets Can Change the Sector
One theme that dominated a great deal of the discussion was the emergence of markets as an organizing principle in philanthropy. Historically, philanthropy has been dominated by organizations that gather funds from donors based on mission statement and a prior track record and then distribute those funds to those in need. Once the check was written, the donor’s work was done. The nonprofit shouldered the responsibility to identify areas of opportunity, vet the specific need, make the donation, and follow up to measure efficacy and finally report back to the donors on the impact of their gift.
Recently we have seen the emergence of a new type of charity, one that radically changes the relationship between donors and recipients. Nonprofits like DonorsChoose and Kiva behave more like marketplaces than traditional charities. This new model allows people in need to post a request for a gift or a loan to the site, and donors to chose which of those needs they would like to fund.
At Hacking Philanthropy, we spent a lot of time talking about why this is happening now, the strengths and weaknesses of this approach, and how the emergence of these markets might impact philanthropy in the future.
One theory is that the plunging costs of computing and the increasing ubiquity of connectivity has made it possible to create philanthropic marketplaces inexpensively by lowering the cost of transactions within those marketplaces. As transaction costs come down, marketplaces can replace firms (or charities) in more and more applications. Ronald Coase laid the groundwork for a transaction cost-based theory of the firm in a 1937 paper. He hypothesized that firms arose in situations where transaction costs were too high a portion of the economic output. It is more efficient to direct an employee to produce a budget than it is to find an accountant in an open market, and negotiate a price for them to produce your budget. It makes perfect sense that organizations (firms) would emerge to aggregate donations and distribute them to people in need in a situation where it is difficult and costly to identify people in need, to distribute something to them, and then to measure the impact of the donation. Today, however, the accessibility of information is lowering transaction costs in many markets, and if the early success of Kiva and DonorsChoose is any indication, it looks like it will have a big impact on philanthropy.
It is much easier today to evaluate a need in a distant place. We are exposed to lots of information about the need every day in the media and are able to put it into the context of other needs. But information technology also makes it possible to have a much more immediate relationship with the person in need. The appeals to sponsor a child have always had a deep emotional resonance, but it was not possible to put every child’s picture in an ad in The New York Times magazine. Today, it is possible to host hundreds of thousands of pictures and stories on the web and to provide tools for donors to quickly find the appeals that speak most directly to them.
Transaction costs also decline with the increase in available market data. When a market oriented system is delivered online, the interaction between the participants is captured in great detail. Every gesture from viewing an appeal to funding a project is recorded. Making this data available to donors and recipients increases their confidence in the market, thereby increasing their participation. So, if we accept the premise that the increasing liquidity of information lowers transaction costs and increases the viability, how will the increasing viability of the emergence of markets in philanthropy change the game?
For one, markets can be an order of magnitude more efficient than firms in some circumstances. I have talked before on my blog about the phenomenal efficiency of Craigslist. But markets, by pushing the work out to the edge where the individual actors may be more motivated and more empowered than they would be within the context of a firm, does more than just improve efficiency, it can also improve the quality of the experience. Charles Best of DonorsChoose puts it this way.
“We push production to the front-end user in a way that makes them feel like they are partners with us. So that starts with frontline classroom teachers being the ones to come up with the micro solutions that will most help their students. And we actually see that these teachers come up with ideas that are far more innovative and creative than any top-down program would be. And we turn to those teachers to help screen and authenticate proposals submitted by teachers in other regions. We turn to the students who benefited to describe the impact of the project rather than having a staff person go in and record things…. The result is our impact reports are far more vivid than an expert might come up with… And then have donors who do the labor of choosing which ideas ought to be brought to life.”
The efficiency, immediacy, authenticity, and emotional resonance of a marketplace seem likely to have an immediate impact on the structure of the philanthropy sector. Leslie Crutchfield of Ashoka stunned the technologists and entrepreneurs in the group (but not the philanthropists or the nonprofit analysts) when she pointed out that the in the last 40 years, only two organizations, Habitat for Humanity and AmeriCares, have broken into the top twenty-five of the Chronicle of Philanthropy’s annual list of top philanthropies the Philanthropy 400. The stability of this group was a surprise to the folks on the for profit side who are used to a world where one third of the top 25 companies on the Fortune 500 were not in business in 1965 and companies like Google did not exist 15 years ago. The emergence of marketplace oriented nonprofits could well be the disruptive force that leads to a reshuffling of the Philanthropy 400.
There are, however, significant challenges facing this new type of philanthropy. A market only works if there is a reasonable balance between supply and demand. In financial markets this is called liquidity. Kiva recently found that they had more willing lenders than properly vetted borrowers. DonorsChoose has the opposite problem. Their site has a number of worthy appeals that have not found donors. Both are working on ways to keep both sides of their market in balance.
Another challenge for markets is managing fraud. In a world dominated by firms (charities) that distribute aid, the firm accepts the responsibility for making sure that the aid reaches the right people. In a pure market structure, that burden shifts to the buyer (lender/donor). Today, DonorsChoose and Kiva both work very hard to protect their donors/lenders from fraud, so in that sense they are managed markets or lightweight firms. Their commitment to minimize fraud is, however, both a cost and a constraint to growth. It is a cost because most nonprofit marketplaces have decided that they need to invest resources to protect their donors from fraud, and given the breadth of their reach (and the efficiency of the other parts of their business) this can be a considerable portion of their total budget. It is a constraint to growth because every time they enter a new state, city or country they must either find and vet new partners in those markets or find and vet individual recipients.
We spent a lot of time at the event exploring the possibility that philanthropies could use a peer produced fraud management system like Craigslist. But Craigslist is able to achieve its efficiencies because it does not promise that it is perfect. It assumes that there are more good people than bad, and they depend on the good people to tell them about the bad people when they find them. So they cannot prevent fraud, but given enough transactions (and data about those transactions) and enough loyal users they can do a remarkably good job of minimizing fraud. The problem is that unlike Craigslist, not all of the participants in philanthropy marketplaces are online, so there is not as much data available to combat fraud.
In the third world many potential recipients don’t have electricity much less computers, so no matter how liquid information is in the west, the lack of electricity, computers, and literacy in the third world makes it difficult to provide feedback about results back to the donors. Even in the U.S., DonorsChoose sends teachers a disposable camera so that they can take pictures of children taking advantage of the donated item and then develops those pictures and sends them hand written notes from the students by snail mail to the donor. The donors who receive these packages are effusive about the emotional connection to the students, but still, some “market data” is lost in this analog process.
Without enough data, it is very difficult to use computerized or peer produced mechanisms to manage fraud. If there were perfect information, lenders and donors could look out for themselves. Micro lending sites like Kiva are closer to financial markets, because if a borrower stops making payments on a loan, it is immediately obvious there is a problem. That information is fed back into the market in the same way a default becomes useful market data in traditional loan markets. With a donation, it is sometimes hard to define a positive outcome, and when you can it is often difficult to quantify. In financial markets, the success of every transaction can be measured, and because every transaction can be tied to a currency, it can be compared to other transactions in other markets. This makes it possible for investment to move between markets easily. In philanthropy markets, it is not easy to provide meaningful information about the impact of a loan or a gift and there is no way to compare completely different transactions – there is no currency.
Jonathan Soros pointed out that the lack of standardization in philanthropy markets also makes it difficult to create a marketplace for micro finance securitization. Investing in a security (instead of a person) may seem at odds with the direct relationship that philanthropic or micro finance markets make possible, but it does offer another way to mitigate the risk of fraud. Ideally we’d find a way to preserve the relationship but to protect the lender from fraud by pooling risk.
Philanthropy markets have a number of significant advantages over traditional nonprofits but they will need to find ways to increase the amount of information available to donors and lenders if they are going to continue to grow. Cell phones may become the portal through which the third world participates in philanthropy markets. As the Facebook/Craigslist generation becomes a larger part of the donor community, they may be willing to exchange the radical efficiencies of the marketplace approach, for a less perfect, retrospective, Craigslist-like approach to fraud. If more transaction data is hosted on servers located in the developed world, there may be enough market data to use the same computerized techniques the credit card companies use today to spot fraud. Kiva and DonorsChoose captured the imagination of the folks at our event, I think, because most people instinctively believe that the immediacy and emotional power of engaging directly with a borrower or recipient and the inherent efficiency of a lean market place approach to philanthropy already outweigh the risks, and that the balance between opportunity and risk will shift further to opportunity as information and information technology becomes more broadly distributed in the developing world.
Editor’s note: The full transcript of Hacking Philanthropy, hosted by Union Square Ventures at Columbia University, can be found here. Participants included a wide-ranging group of technology leaders, entrepreneurs, and observers, including Tom Watson, publisher of onPhilanthropy. For more photos, click here.