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The Opportunity to Change Roles Mid-Act: Does Scale Provide Philanthropy’s Cue?

By Tom Watson on October 4, 2007No Comment

The Opportunity to Change Roles Mid-Act by Susan Raymond

 

Being all things to all people is never a viable strategy, except perhaps in the U.S. prior to the 6 am opening of the voting booths on the first Tuesday in November.  By Wednesday morning, however, the flaws behind that strategy become clear even (and perhaps most discomfortingly) to whoever has won the election.

With all of the attention being paid to philanthropy in the press, in conferences, on talk shows, and even (perish the agony of the thought) on reality TV, one fears that the expectations about what philanthropy is and can do are eroding the dividing line between what is appropriately a philanthropic target and what is not.  There is a danger that philanthropy itself is becoming the silver bullet, the answer for all things to all people.

But, how would one know where to draw the line between what is appropriately a philanthropic issue and what is not?  Of course, there are no absolutes.  There is no public regulation or legal parameter to speak of, so, in fact, philanthropy can do pretty much anything it pleases.  But is “anything” always the best use of resources?

One parameter that might be used to define the edge between philanthropy and private capital finance is scale.

First, let us admit one fact and recall another.  The vast majority of American nonprofits are small; 60% or more (one does not know because religious organizations do not have to file financial documents) have less than $100,000 in annual revenue.  Second, the average foundation grant to nonprofits is on the order of $25,000.  So, for much of the sector, small is, if not beautiful, at least something of a comfort zone.

But, it is also true that the number of nonprofits with $10 million or more in revenue has increased by 73% in the last decade.    The sector is growing at the top of the pyramid as well as at the bottom.  At the top, when $25,000 is the average grant, is philanthropy the answer to organizational growth?  Indeed, is it even relevant as a source of capital?  When might philanthropy not only not be all things to all people, but, indeed, appropriately, be nothing to anyone?

The evolution of microfinance teaches that, when what had been a philanthropic initiative matures and proves its worth, alternative capital sources step in and redefine the opportunity.  Is achieving scale, then, the cue for philanthropy to either evolve or exit?  And if so, do we need to rethink what we mean by “philanthropy” for large organizations or proven initiatives in social markets?

First, to microfinance. 

Thirty years ago the Grameen Bank in Bangladesh pioneered microfinance, making micro-loans to 42 poor individuals to start tiny businesses to pull themselves up from abject poverty.  Muhammad Yunus, creator of the Bank, would go on to win the Nobel Prize.

Now, there are 3000 to 4000 microfinance funds around the world, reaching over 100 million clients of whom 80% are among the world’s poorest.  But growth is not the measure of change; evolution is the measure of change.  Commercial financial institutions are increasingly the partners of these funds.  In most cases, it is a local financial institution, but in a growing number of cases the partner is a global bank.  Indeed, in August of 2007, the first microfinance facility was created through the use of global capital markets.  That facility is not in America; it is Azerbaijan.

So, where does that leave philanthropy?  Far from out in the cold, it leaves philanthropy in a very powerful position indeed.  The unique role of philanthropy is the ability to take significant risk, to seed a promising idea and recognize that all promising ideas can be failures.  This tolerance for failure, for working at the edges of knowledge and understanding on problems whose resolution would bring multiples of value added to the societal commons but where the probabilities of success are unknown, is the key playing field for philanthropy.

Once the idea works, once it gets to scale and can attract other types of capital and other sources of intellectual support, philanthropy can (indeed, perhaps ought) change its role mid-act, and in some cases even exit the stage. 

The historic opportunity for philanthropy is not to be present on the social commons. That is tradition.  The historic opportunity for philanthropy is to be able to exit the social commons.  As markets become a viable financing option, philanthropy needs to build the capacity of its grantees to evolve and take advantage of that financing alternative, not compete with commerce for their attention.  This is not to say that the evolution of markets where charity had gone before is not fraught with problems; it most certainly is.  Whether commercial capital entering into microfinance will separate microfinance from the poor or, as is hoped, provide growth capital to grow is unclear.  What we do know from an IMF sample of 190 institutions, however, is that financially sustainable microfinance institutions have twice the assets of those that are not (albeit much higher operating costs), and those assets will need to come from somewhere.  The market is their most efficient source.  In turn, microfinance institutions that are financially sustainable reach over a third more borrowers, yet an equivalent percent of poor women, as those who are not.  So, moving philanthropy to the role of capacity builder to reach market capital, while ensuring service to the poor, rather than the provider of capital in microfinance is an example of the opportunity that comes from not trying to be all things to all people.

That opportunity has come about for two reasons.  First, there is now a multiplicity of approaches to organizational finance in the nonprofit sector, emerging in no small part from the influence of commercial finance experts who have brought their skills to the nonprofit sector.  The ranks of nonprofit professionals have been joined by investment bankers, equity traders, commodity traders, and MBAs of all persuasions.  The rising consciousness of shared societal problems has attracted their attention, and they have brought their penchant for self-reliance, sustainability, and (yes) profit to the stage.  When risky ideas are proven to promise success, they have developed mechanisms to spread the remaining risk and attract commercial capital to the sector.  Often, the resulting level of finance is unlike any that has ever been available to social problems before, and hence represents a booster rocket on scale.

Vaccines provide a perfect example.  Prior to the creation of the International Finance Facility for Immunisation (IFFIm), the Global Vaccine Initiative raised just under $820 million in government and philanthropic contributions for the purchase of vaccines for the poorest nations of the world, or about $150 million per year.  The IFFIm is not, however, a philanthropic approach.  Based on forward contracts, it issued government-backed bonds to private and public investment funds to generate funds for vaccine purchase.  In the single year 2007, the bond purchase strategy is expected to generate over $830 million for vaccine purchases, more in one year than the previous six years.  “Donors” took on the role of guarantor rather than funder, and the resources flowed at levels that donations would never have been able to sustain.

The second reason that institutional scale is being achieved and allowing philanthropy to exit is the globalization of communication.  The opportunity for success has not escaped the attention of Azerbaijan.  What works and what doesn’t is widely disseminated, and good ideas that are replicable do not await the convening of annual conferences and the plodding publishing schedules of professional journals.  Available funding and funder creativity chase good ideas almost immediately.

Indeed, in the case of microfinance, there is some evidence that rate of increase of  available funding has exceeded the  rate of increase of microfinance funds.  When both fund sources and programs are pushing the edges of scale, philanthropy can move on to look for new and even riskier ideas. 

There are always alternative uses for financial resources.  Consideration of alternative uses is particularly important where resources are scarce, as they will always be for new ideas on the societal commons.  It is critical for philanthropy to constantly ask itself about the opportunity costs of its commitments.  If innovations are succeeding, then success could be passed off to new financing mechanisms, and scarce philanthropic dollars can return to seeding the cycle of innovation in other areas.

Of course, this means letting go.  Letting go is always difficult. 

This is not to say that all innovative commercial funds flowing to all ideas on the social commons results in value.  Creative commercial funds can and do make investment mistakes.  Nonprofits and social enterprises can and do come up with bad ideas.  Indeed, in the case of microfinance we know a great deal more about size, scale, and location than we do about ultimate macroeconomic impact.  It is difficult to say at this point whether, in terms of pure economic growth, microfinance really does have a measurable effect.  Microfinance may be able to scale up in terms of the numbers of poor people reached and the numbers of micro-businesses started, but the long term viability of those businesses and their contribution to larger economic prosperity is currently unknown.

The point, however, is that philanthropy is not and does not need to be all things to all people.  Philanthropy’s sweet spot is getting good ideas through proof-of-concept and into organizational viability.  For many, many (but certainly not all) ideas, scale will come with creative private capital finance.

What stands in the way?  Certainly not money; by nearly any measure there is more than enough creative commercial finance to take viable nonprofit and social entrepreneur ideas to scale.  Indeed, money is chasing good ideas, not the other way around.

What stands in the way are skills.  We will turn to this barrier in Part 2 of the series.

Sources

International Fund for Immunisation

Internal Revenue Service

State of the Microcredit Summit Campaign Report 2006

Microfinance: A View From the Fund.  International Monetary Fund, January 25, 2005.

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