A version of this post was written by Dennis Price and originally appeared on ImpactAlpha.

Companies often get fined for poor behavior. Now, some will get rewarded for behavior that serves the poor.

A pilot program funded by the Swiss government will pay bonuses to Latin American businesses that can prove that they are improving the quality of life of their poor customers. The enhanced revenues should make such high-impact businesses more attractive to private investors. That capital, in turn, should enable the businesses to expand sales, reduce costs and serve even more low-income customers.

To address the most pressing social and environmental problems, it is vital to find financing models that reward real, measurable impact. Tweet This Quote

The model, called Social Impact Incentives, is a response to the challenge facing market-based solutions to social problems: most high-impact businesses that serve the poorest of the poor often are not investable, and therefore are starved of the capital they need to grow.

Take for example, a Chilean business that sells affordable toilets to low-income customers in Santiago’s slums. The company contracts with a social-impact incentives payer concerned with the social conditions of slum dwellers. For the actual impact contribution of the firm’s product, a reduction in average days of diarrheal disease per household, for example, the business might get an incentive payment on top of its normal revenues. This supplementary income increases the profitability of the business, making it more attractive to those investing capital.

“To address the most pressing social and environmental problems it is vital to find financing models that reward real, measurable impact performance and thus prepare the ground for scaling outstanding solutions,” says Dr. Peter Beez of the Swiss Agency for Development and Cooperation, or SDC. “For us, it’s a proof of concept.”

Social Impact Incentives boost the viability of businesses serving the poor by aligning impact with profitability. Tweet This Quote

The $1.6 million pilot program, to be run by the Inter-American Development Bank, or IDB, aims to support four companies and “crowd-in” between $6 and $10 million in private capital. If the program is successful, the SDC will deploy the model in other regions, including sub-Saharan Africa.

“We have seen a vast number of outstanding social entrepreneurs worldwide who created high-impact solutions but struggle to raise the funds that allow them to scale,” explains Bjoern Struewer, founder and CEO of Roots of Impact, the German impact investing consulting firm that helped develop the social impact incentives model.

Roots of Impact, with the SDC, will manage the pre-investment process for the pilot program, and measure and validate the impact of each investment. The social entrepreneurship network Ashoka, with 6 offices across the region, will work the IDB’s 26 field offices to help identify the social businesses.

Tough Business

A body of evidence is emerging that it’s tough to build a business serving only the very poor. In a 2009 study, “Emerging Markets, Emerging Models,” Monitor Group reviewed 270 enterprises in India serving the poor and found less than 20 percent operating at or near scale and ready to take on investment. In a followup study in 2011, “Promise and Progress: Market-Based Solutions to Poverty in Africa,” Monitor consultants reviewed 439 enterprises targeting the very poor in sub-Saharan Africa; only 31 fit the bill as “investable.”

impact investing

These low-margin businesses operate in difficult, unproven markets serving customers with minimal and inconsistent livelihoods. It’s no surprise the enterprises are often unattractive, even to impact investors.

Once a business attracts capital, it’s able to build capacity, increase revenues, and achieve a proof-of-concept. Tweet This Quote

The Social Impact Incentives scheme boosts the viability of businesses serving the poor by aligning impact with profitability. Once a business attracts capital it’s able to build capacity, increase revenues further while lowering per-unit costs, and achieve a proof-of-concept.

At this point, in theory, the business will have demonstrated its social impact and can sell its services to a public agency such as a local health authority, an education ministry or a city council. Or the business will have proved out its value proposition to customers and can attract investors to scale up operations.

Pay-for-Success

Social impact incentives are the latest experiment in so-called “pay-for-success” financing in which public or philanthropic funders reward enterprises for their social contributions. Pay-for-success models have caught on as cash-strapped governments seek to enlist private capital in local and global development efforts. Social impact bonds, for example, are being used to finance non-profit service providers, with private investors repaid, with interest, by local governments if the service provider achieves its impact milestones.

“Pay-for-success” financing happens when public or philanthropic funders reward enterprises for their social contributions. Tweet This Quote

Struewer says the there are two major differents between social impact incentives and social impact bonds. “One, our model works with social businesses with revenue streams, which massively reduces costs for the outcome payer,” he says. “And two, the incentive is not just about achieving a benchmark, but outperforming one.”

Government and philanthropic funders can also attract private investors to sectors ignored by commercial capital markets by using tools such as first-loss or loan guarantees, or low-cost loans. But pay-for-success models may provide the best mix of incentives.

A 2015 report from the Center for Global Development argues that models that raise investor returns (e.g. pay-for-success) are more efficient and effective than other catalytic public and philanthropic funders such as guarantees or low-cost loans.

Pay-for-success improves incentives for investors to choose and manage projects effectively. Tweet This Quote

Pay-for-success contracts “improve incentives for investors to choose and manage projects effectively, promote more contestable markets while reducing the costs of optimism bias, build public support by paying for success rather than failure, and reduce the need for policymakers to try (and too often fail) to pick winners,” write the authors of the report, “Guarantees, Subsidies, or Paying for Success? Choosing the Right Instrument to Catalyze Private Investment in Developing Countries.”

In growth markets across the developing world, low-income earners graduating to the emerging middle class are demanding services that outstrip governments’ capacity to provide. Market-based businesses and private investors may be able to help meet that demand—with the right incentives.

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ImpactAlpha

ImpactAlpha

Led by David Bank, formerly of The Wall Street Journal, ImpactAlpha is establishing a major new media brand for the growing number of people who believe our most pressing social and environmental challenges represent the biggest business opportunities of the 21st century. ImpactSpace is the world’s largest open impact database of ventures, funds, deals, people and organizations.

  • Ben Heiserman

    This is absolutely fantastic news, and one of the most exciting articles I have read on Unreasonable. I always thought that great ideas should be rewarded, and this program is aimed to do just that. The $1.6 million pilot program is a good start, but hopefully if the pilot is successful there is plenty room for this program to grow and provide even more support for businesses making a social impact. The investor model is also logical and gives incentive to anyone involved. Great work, keep us updated. Maybe the success of this program in the future will lead to its implementation in the US.

  • Rachel Rodriguez

    I think this article is great news for the social enterprise sector, because if it works it will motivate more people to enter into this sector. I think this is exactly what this sector needs because currently many people would rather enter into a different market sector because the challenges of social enterprise can be difficult, but with government programs like this people will be motivated to do good for the poor, and also receive some help from the government for doing so.

  • Nicholas Carter

    Rachel, I like where you are going with this, but I disagree with your idea of waiting for governmental programs to step in and help. It is important for large businesses to take initiative in the social enterprise sector because it goes a long with the idea of the trickle-down-effect. Businesses employee the people and many of which those who are classified in the low-income category. We need to see large business take initiative in social enterprise and lead by example to benefit their community as a whole.

  • Michael Kaelin

    This article is great to hear in terms of companies trying to make the world a little better for as many people as possible. Companies being rewarded for improving the lives of the people they impact will give them extra incentive to carry out good business practices. Thank you for the write.

  • Jessica

    The reason I love this idea is because big, corporate businesses are not (always) going to assist the poor without the incentive being offered. For companies, the poor do nothing for them; they are not able to provide the company with money, so why should the company assist the poor? This is a great idea, as it shifts the paradigm of big business greediness. The business has an incentive, and the poor have the help that they need, everyone wins here.

  • Taylor Lonsdale

    I think that (unfortunately) this has the potential to be really impactful. I say unfortunately because we have to incentivize the big businesses to take part in assisting those in need. However, I do think it’s awesome that those behind Social Impact Incentives were able to identify and act on this. I really like the idea of being able to get a company like the one mentioned, the Chilean toilet company that already services the poor, the ability to continue their work and make a profit. In the long run, a company like this has the potential to continue to service those in need but become a sustainable business that potential investors may buy into in effect helping a larger number of people. Without this program, they may have been able to continue on the scale they began operating, but this program gives them an opportunity to grow.

  • Kevin Marshall

    I completely agree Jessica, you see time and time again larger corporations hiding from the fact they do nothing for the poor or less fortunate. Because they don’t believe they have to… The aren’t making money from it, as isn’t that their only purpose? To make money? With that being said, this idea does shift the way businesses by the shift of the paradigm. Because larger businesses do have the right and the obligation to support the poor, because in the long run they will return the favor in possibly giving back to the company that supported them.

  • McKenna Solomon

    This is an interesting approach to social entrepreneurship that I’d really like to see implemented. I can’t help but feel that this would give for profit entities a greater motivation to act as we’d expect nonprofit entities to act. Nonprofits are very rarely associated with profit making despite the fact that their profit and funding goes to a social cause. By providing social incentives to for profit entities we encourage them to take a nonprofit approach to for profit business. This doesn’t eliminate the nonprofit market but rather creates a third business model – a for profit business model with a social incentive; if businesses operate ethically when implementing this sort of system we can create corporate entities with stronger ties to social issues making social welfare programs stronger than they could be if they may have been if there were simply nonprofits. There’s an incredible potential for something like this in our social and corporate landscape.

  • Kade Hanson

    I agree with what your re saying here. I agree that this opens up and new market for non porfits and new alleyways for them to interact. The potential of this is huge in my eyes because of how our society and social structure works. Good ideas here McKenna.

  • Amanda

    I think this article has a great idea that has really been thought through. If companies follow this plan, I believe that there could be a high success rate but I think more people are going to need to know about it in the hopes of maintaining an effective outcome.

  • danlorusso

    I think that it is important for businesses whose target market is the poor to have a social impact incentive program. In order for businesses to continue to serve the poor they need some capital to grow. The Chilean business making toilets for slums in Santiago is doing something very important for the community. Affordable toilets prevent diseases from spreading amongst poor communities. Hopefully the IDB will be able to fund more than four companies’ in the future in order to give support to companies trying to make a difference in other parts of the world.

  • Adam Bundy

    I think providing incentive in the scenario of the Chilean Toilet company is great. It is ensuring that those who are doing good things receive proper compensation. What I worry about though is the potential for companies to look at this as money making opportunity, which will cause them to act for profit and not for the good of the people. Then rather than companies serving the under privileged, companies are using them as a secondary income source and they wont have the peoples intrests in mind.

  • Logan Coffman

    As many of the commenters have already stated there exists a low incentive for large corporations to invest or even think about assisting in the social impact sector because to them it feels like charity. When we reframe this practice into an investment is when we grab the attention of the biggest players. Great piece!

  • Katie Frank

    I also thought the same as Adam, it seems like companies could easily take advantage of the system. I feel like there is no foolproof way to prevent this. Otherwise, I think the incentive program will be effective.