Undp Investing In What Works

INVESTING IN WHAT WORKS

Open replication as a new class of scalable investments

Draft for discussion at:

SOCAP Social Capital Markets 2009

At the Intersection of Money and Meaning San Francisco, September 1-3rd 2009

ABSTRACT It is a commonly held view that the increased rate of private sector innovation is responsible for the great leap in wealth creation of the twentieth century. That is of course part of the story, but while the importance of private sector innovation is unquestionable, the expansive wealth creation of the last century became possible only because there was equally impressive growth in the rate by which private innovation spread throughout the world. When we consider the development of social innovation we find that most social innovation is local and goes unnoticed. Those that do spread require decades or more. This inability of social innovation, in contrast to commercial innovation, to spread rapidly is one of the principal bottlenecks holding back human development. Based on our work at the Special Unit for South-South Cooperation in UNDP, this paper makes the strategic argument that greater prioritization should be given to overcoming this bottleneck. Going beyond identifying the problem, or identification of best practices, it offers a possible solution in the concept of open-replication investing – replicating what works and scaling up replication of models and not necessarily organizations.

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Over the past decade, the rise of the social capital markets is one of the most encouraging and important trends driving global development. Investing in social issues and human development is a complex affair that requires a diversified pallet of investment classes to match both the needs of the social entrepreneur and the interests of the investor. Philanthropy and traditional aid programs will continue to play an important role, but there are now other enticing ways to put your money to work for global development, ways that provide a range of financial returns from traditional philanthropy, to market returns. Microfinance is the most prominent recent example of a new investment class for social investors. It solves an acute need for hundreds of millions of microentrepreneurs grasping for a way onto the bottom rump of the economic ladder and it appeals to a broad spectrum of social investors. Patient capital is another class supporting the wave of social businesses emerging in both the developing and developed world. The rise of patient capital has been seen in the form of effective mission related investing (MRI) by foundations like the F.B. Heron Foundation or trailblazing dedicated funds like Acumen Fund and Root Capital. Within these social investment classes, there is also a wave of innovation driving the diversification of financing models to better match local contexts and investor risk-return appetites. What should be the strategic role of UNDP as the social investment landscape evolves and matures? Although philanthropy, development aid and microfinance are all important social investment classes, at the Special Unit for South-South Cooperation in UNDP, we have launched the Global-South Human Development Investment Exchange (HDSX) as a pilot program to evaluate how to best catalyze another critical class we call open-replication investments.

While private sector venture capitalists seek to scale up their portfolio companies, open-replication investors do not seek to scale an organization but rather the program, process, technique or practice.

OPEN-REPLICATION INVESTMENTS It is widely agreed among social investors that the optimal investment has high potential social impact and financial returns at relatively low risk. However investors differ as to how to best achieve this goal and how to balance the weighting of their risk-return-impact investment portfolios. Open-replication investing can be compared to traditional venture capital investing in that both are tasked with the challenge to find and invest in companies at the inflection point before rapid growth (Graph A). Open-replication investing is a ‘social growth’ investment strategy that identifies, cultivates and invests in the social programs and practices that have an established track record and have proven themselves locally to be successful whether it is at reducing poverty, improving education rates or other human development purposes. The key to understanding this investment strategy requires a more detailed understanding of what we mean by open replication – replicating the model or method not the institution. While private sector venture capitalists seek to scale up their portfolio companies, openreplication investors do not seek to scale an organization but rather the program, process, technique or practice. Open

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replication, therefore, implies the free transfer of the explicit knowledge (operating models and social technologies) from one local organization to another. Although successful models can and must be replicated, we do not advocate a cookie cutter approach. Programs must be adapted to the realities of their context and should be owned locally. That is they should have local leadership and receive local community support. Microfinance is a great example. The microfinance revolution would not have occurred if early movers like Grameen Bank had not embraced the open replication of its model throughout the world. Of course, many great social programs, like Grameen Bank, do get discovered and replicated, but overall social innovation tends to have a relatively slow rate of dispersion. Only with the proactive efforts of the innovators themselves and the force of the social capital markets, can the rate by which social innovation spreads throughout the world increase significantly. The impact life-cycle of most social innovations goes through four stages as described in the Graph B: 1. Innovation (proof of concept), 2. Early replication (proof of replication), 3. Mass replication, and 4. Maturity. In this paper, when we use the term openreplication investing we are primarily referring to the second stage, early replication, when a social innovation has proven itself locally but has yet to be replicated by another civil society organization in a different context. This investment ‘class’ is lower risk than innovation investing that finances new social models that are still unproven. Conversely, it is higher impact than mass replication investing – financing the replication of solutions that have achieved both proof of concept and proof of replication. Open-replication investing for early replication or proof-of-replication requires the following activities:   

The identification of proven solutions Partnership building – finding an appropriate replicating organization and broker the collaboration Social investment, and open-replication

Program implementation, cooperation, knowledge-sharing and learning-by-doing are required to successfully transfer the proven solution.

THE HUMAN DEVELOPMENT INVESTMENT EXCHANGE PILOT (HDSX) In 2008, we launched the HDSX pilot. Analogous to the familiar workings of a financial stock exchange, the HDSX is designed as a social stock exchange for human development projects. The HDSX was designed to encourage open replication partnerships and channel social investors to these high potential investment opportunities. Due to the low barriers to entry now afforded by the Internet, today there is a proliferation of social investment, giving and volunteer marketplaces. HDSX, however, focuses on open-replication projects for which there is not yet a functional market. This focus differentiates it from the direct organization and project funding of existing giving marketplaces like GlobalGiving and other country specific marketplaces like SASIX, Give India, Bovespa Social, DonorsChoose, Help Argentina and Conexion Columbia, to name only a few. Beyond the marketplace itself, HDSX was designed to more broadly identify, forge and promote open-replication investment opportunities. Furthermore, it is a prototype whose

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primary intention is to learn, evaluate and evolve UNDP's role within the emerging social capital markets, taking into account the various other related UN initiatives such as the UN Global Compact, the Growing Inclusive Markets’ Initiative, the Business Call to Action, the Growing Sustainable Business Initiative and the Civil Society Best Practices Network. As a result, we undertook an extensive consultation process with the principal actors in the sector. We organized discussion forums and a survey with leading individuals and institutions from the three critical fields: the social investors, the social entrepreneurs and the online giving marketplaces. Our learnings from the implementation of the HDSX pilot and the feedback received from the sector is helping us determine the proper role for UNDP in catalyzing this important investment class. This paper describes some of these learnings. Semantics aside, open-replication investing is not a new phenomenon. Cooperation and collaboration has always been formally and informally promoted since the rise of the social sector and earlier. Cooperation, however, is widely perceived as a tool for more traditional philanthropic institutions and international development agencies. If it is not new, why then has openreplication not been a larger priority among the rising wave of social investors? The primary reason is that there exists an established perception that organizational cooperation is not highly effective. However, with the healthy experimentation and innovation that characterizes the emerging social capital market and with the proper incentives, tools and social infrastructure in place, there is an opportunity to prove the great potential of open-replication. The emergence of open-replication in the social sector has the potential to catalyze the rate of social development in ways analogous to the rate of development seen over the past century in the private sector.

The emergence of open-replication in the social sector has the potential to catalyze the rate of social development in ways analogous to the rate of development seen over the past century in the private sector.

THE OPPORTUNITY What can we learn from the past experiences at open-replication investing? The experience is complex but one identified challenge is the lack of proper incentives; civil society organizations have little reason to want to pursue the open replication of their programs. Most are under-resourced and therefore cannot take on replication projects without some financial cushion. Furthermore, social entrepreneurs are generally more motivated to expand their own organization's reach as opposed to facilitating the application of their model in other organizations often far away. Even though most social innovators genuinely do want to see their work openly spread throughout the world, they are unwilling to spend the time and money needed to make it happen at the rates that we need to achieve the Millennium Development Goals. It is critical to take the structural steps needed to make open-replication a higher priority for social innovators throughout the world. One principal goal underlying HDSX is to discern the best way to realign social entrepreneurs’ incentives such that the potential for replication is unlocked. Similar to how the Gates Foundation has argued convincingly for a need to create a market to incentivize pharmaceutical companies to develop drugs that treat developing country diseases, there is an opportunity to create a market for open-replication. We need to find a way to properly incentivize the open replication of proven social programs that are today successfully solving societal ills like poverty, education, corruption, crime and infant malnutrition. Traditionally a market exists when there is high demand for a good or service and the transaction required to provision that good or service leaves both actors better off, the buyer and seller. However, when these conditions are not upheld, a market does not form. Nonetheless, when it is in the public

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interest, the rich innovation and cut-throat efficiency of the market mechanism can be nurtured into existence to serve the under-served. In the case of open-replication a healthy market does not exist. It is not common for organizations to proactively seek opportunities to openly-replicate their models or raise money to finance the same. On the demand-side, the replicating organization is generally very receptive to participate because it receives financing and an effective new program to add to their portfolio. However, the originating organizations that innovated and implemented the proven social model must perceive enough benefit to warrant them to be proactively engaged in the replication of their work. The following section goes into some detail as to how to incentivize these originating organizations as well as the other critical components to a successful open-replication investment.

OPEN-REPLICATION: the process and funding requirements Why isn’t open-replication attracting large volumes of social investment? The simple answer is because very few organizations are requesting funding for open-replication and equally few investors are encouraging it. It is rare that an organization go beyond its programmatic focus to pitch investment opportunities of this sort. Nonetheless, there are successful examples of cooperation and replication that should be understood. ‘Doing good’ is a driving force behind the social sector but it is often not enough to incentivize more complex cooperation activity that goes beyond the local scope of the original social activity. To date, open-replication and cooperation has been fueled principally by the reputational rewards associated with such activity, prestige by affiliation and the prospects of a global presence. Of course, there are some organizations for which the scope of its charitable purposes extends regionally or internationally but, for the most part, organizations are local and partake in cooperation to gain visibility, reputation and indirectly funding. This incentivizes participation (affiliation) but not the desired results – successful replication. This type of nuanced and indirect incentive scheme is not sufficient. Social investors interested in open-replication investing are advised to devise more effective non-monetary incentives and consider the structure and the monetary sum needed to increase the likelihood of successful replication. I. Documentation It takes time and considerable effort for the originating organization to document the program or model that it intends others to replicate. Most attempts at replication fall short due to the lack of rigor in this important step of converting tacit knowledge stored in the heads of the social entrepreneur into explicit knowledge that can be much more easily shared. In the private sector a new franchisee will receive volumes of directions explaining very clearly what is required to start a new restaurant. Although open replication is not the same as a franchising growth strategy, the detail they provide greatly increases the probably of success of a new McDonalds' franchisee such that the probability of success of a new franchisee is significantly greater than a normal start-up without the benefit of a detailed blueprint and brand. Many non-profit practitioners are reluctant to explicitly document their programs arguing that the success of their program depends on too many intangibles that are context or culture specific. They are right. Open replication assumes that the organizations seeking to replicate in their respective communities will need to use their localized knowledge and social capital to find an effective way to adapt the original model to their local context. Nonetheless as seen among microfinance institutions, most of the original blueprint survives replication across borders and cultures. A detailed understanding of the original model is critical to successful replication.

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II. Partnership After successfully documenting a proven program, the likelihood of successful replication increases considerably with hands-on guidance from the original organization. Before a model has been replicated a number of times, partnerships are critical. This is partly because they steepen the learning curve, enabling the replicating organization to quickly develop the skills and internalize the knowledge needed to successfully operate the program, but more importantly, it enables the innovators from the original organization to combine their deep intuition with the local expertise of the replicating organization to come out with an adaptation that fits the local context without losing the key components needed to make the program work. It is therefore important for social investors to take that expense into consideration, funding the costs incurred for the time, travel and opportunity cost involved in these temporary partnerships. The incentives need to be sufficient to warrant efforts that do not relate to their local program and community. III. Program implementation and evaluation The program must be implemented in its new location. As mentioned above, there should be an expected adjustment period during the first stage of implementation. It is during this period that the replicating organization and the innovating organization experiment and learn how to adjust the original model to the local context. Therefore the original financing of the program is advised to sufficiently fund this formative stage anticipating the additional time required to adequately adapt the model. The program costs must also include the cost of monitoring and evaluating its progress of the program. Why should a social investor bear the burden of these extra costs -- documentation, partnership and opportunity cost – all of which add up considerably on top of the basic costs of implementing the program in its new location? It is more efficient to pursue replication opportunities that do not require all these additional steps and costs. Must the replicating organization always seek a partnership to assist the process? These are all valid questions that can be answered by remembering the typical life-cycle of an open-replicated social innovation (Graph B). Graph C emphasizes the fact that the social impact of each subsequent (marginal) replication remains fairly constant while the costs of replication decrease. In other words, the clone of a social program generates similar levels of impact – assuming the context not the region is held constant – as its parent while the fifth clone will be much easier than the first. The natural instinct again is to invest in the replication of a program after its cost of replication has diminished, and indeed that is what most social investors do – more bang for the buck. However, when looking at the bigger picture the true social return of investment should not take into account only the direct impact of the program but the overall impact of the investment. An investment that advances a social innovation from proof of concept to proof of replication is responsible in large part for the chain-reaction of replications of that model thereafter – stages three and four. Social investors today are captivated by the prospects of the first stage, proof-of-concept, because it is easy to grasp the massive importance of such an investments. If the innovation is successful and replicates throughout the world then the investment resulted in enormous impact. Social investors are equally interested in mass replication investments, after proof of replication, because the risk is low and the model is proven to generate impact. However, this paper

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underscores the importance of early replication investing which is equally important and not very popular. In order to scale up human development, proof of replication is as important as proof of concept and often unfairly neglected due to the risk-averseness of the majority of financing sources, grant-making foundations and government. In fact, the dearth of social investors participating in this stage of investing makes for great social return on investment opportunities. Without more early-replication financing, social innovation will remain well below its potential.

PROPER INCENTIVES However measured the degree of social impact generation in the social sector pales in comparison to the wealth creation experienced in the private sector over the last century. Although a complex phenomenon, this historical bifurcation can be largely explained by the differing incentives offered to the respective innovators in each sector. Private sector innovators pursue the prospects of vast amounts of earnings and are protected by intellectual property law and their associated government enforcement agencies. Social innovators have neither. Properly incentivizing open-replication in the social sector will open the door to a new class of stage two open-replication investing. Today, for the most part, social innovators with proven programs are not proactively seeking the financing needed to openly replicate their models to other organizations throughout the world. Similarly social investors are not pursuing stage two open-replication opportunities. The result is a vicious cycle that is directly responsible for the slow pace by which great social innovations disperse throughout the world. Monetary incentives are critical, but it is equally important to emphasize non-monetary rewards. Calling this class of social investing open-replication makes the obvious parallel to the open-source movement, a collaborative approach to the design, development and distribution of software that makes the source code openly accessible and usually makes the final product free to anybody in the world to download and utilize. The open-source movement has proven, now over decades and often up against the most powerful companies in the world, that people can be very effectively motivated by non-monetary means like reputation, self-actualization and peer pressure. Both monetary and non-monetary levers must be creatively utilized to systemically increase the rate by which proven social innovation spreads throughout the world. It is impossible to discuss the importance of proper incentives without discussing intellectual property rights, as the spread of private innovation would have never attained such rates without them. Large numbers of social innovators will only take the risks associated with replicating their model with the assurance that they will benefit sufficiently if successful – if their innovation is adopted globally. Patents and trademarks are critical to commercial innovation, but exact clone of the success of the private sector is not the answer. Creative Commons is a nonprofit organization that has developed new copyrights and trademarks that expand the range of creative works available for others to build upon legally and to share. Their trailblazing work demonstrates a different system can be developed that is appropriate for the context of the global civil society. There might be need for some form of official recognition, possibly a social patent of sorts similar to that of the Creative Commons standard emerging in the context of the open source movement mentioned briefly above. Much more research and experimentation is needed on this topic.

EVOLUTION OF THE MARKET Once the proper incentives are put in place, the market for open-replication investments would need time to evolve and develop. The first important step would be the entry of sophisticated, institutional social investors into this field -- large grant-making foundations and other respected strategic investors including governmental and intergovernmental agencies.

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Similar to the investment banker and private equity investors, the social investor plays an important role at this stage of the market not only as a source of financing but also as a dealmaker identifying potential social innovations to replicate and brokering the replication. The establishment of specialized actors accomplishing well-defined roles and networks of repeat players among them is also an important step to ease transactions in these markets. After these initial phases, retail investors want to get into the fold and a marketplace forms to facilitate mainstream, retail investing. Indeed, this is how the microfinance market evolved. The success of large institutional social investments does not go unnoticed in Bangladesh and elsewhere, albeit it took decades. After the UN proclaimed 2006 the year of microfinance and Mohammad Yunus won the Nobel Peace prize, sufficient demand grew among retail social investors who wanted to invest in microcredit also but they could not afford the deal-making costs involved. It was at this moment, when there was latent retail investor demand and when open-replication partnership projects are easily sourced (sufficient supply) that Kiva was born, a marketplace for retail microcredit investing. Similarly eBay’s MicroPlace is being rolled out.

CONCLUSIONS The key to the great leap in wealth creation of the twentieth century was not just innovation but the ability to identify and replicate innovations throughout the world. Industrialization and globalization has fueled this trend but only enabling profitable innovations to spread. The social sector is not lacking innovative solutions to address social ills. The slums of Bombay or the Favelas of Rio de Janeiro are vibrant hubs of innovation. In fact there are many more entrepreneurs in developing countries than developed ones. But social innovations do not spread globally like private sector innovations. This results in too much effort put reinventing the wheel instead of capitalizing on proven practices that can advance human development globally. An opportunity exists to realign organizational incentives on a systemic level such that social innovation does spread, so its champions are self-motivated to replicate their successful programs and practices to neighboring communities and regions. Creating a platform to foster open-replication investing is a step in that direction. The HDSX pilot seeks to nurture underlying conditions needed to create a market whereby openreplication multiplies, incentivized by third party institutions and financed by an emerging field of social investors – the social capital market. The road to this end is long but the first step is concrete: small scale proof of concept. It needs to be concretely demonstrated that early stage open-replication, is feasible when properly incentivized and supported. More specifically, more work should be done to unlock the potential of proven models trapped among local organizations currently unaware or uninterested in the possibility for open-replication. One of the objectives of HDSX is to provide greater visibility to this opportunity and strategy. First-mover social investors in this investment class should be encouraged and assisted. The identification and vetting of potential open-replication opportunities is costly as is the evaluation and monitoring required. One role we are evaluating for UNDP is to lower this burden on social investors by assisting in these activities via the HDSX pilot or other future programs. With the right collective effort, strategic leadership and the support of a platform that articulates and coordinates across key networks, open-replication investing could emerge in the next decade as a very important tool helping us take major strides towards achieving the Millennium Development Goals.

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Authors: Francisco Simplicio is Chief of the Division of Knowledge Management at the Special Unit for South-South Cooperation in UNDP. He launched and manages the HDSX pilot. Ines Tofalo is a Specialist at the Division of Knowledge Management at the Special Unit for SouthSouth Cooperation in UNDP. Lloyd Nimetz is an entrepreneur soon to launch his next social venture, Blitz Bazaar – an online platform empowering an emerging class of citizen changemakers. He is the founder of HelpArgentina an online giving marketplace for the Argentine civil society. Celso Grecco developed two social investment exchanges within traditional stock exchanges, Bovespa Social and the soon to be launched Euronext Lisbone social stock exchange.