Who wants impact investment? Part A

Joe Ludlow and Jo Casebourne - 07.11.2012

As we discussed in the first of these blogs, the UK impact investment market developed initially through a desire to see better access to capital for registered charities and other traditional social sector organisations.

These organisations have typically been non-profit distributing legal vehicles, and low profit making business models - with revenues from grants, donations, tightly specified public contracts and some investment income.

In this blog and the next, we want to expand on some of the key trends we see as driving a different sort of demand in the UK impact investing market, namely

shifts from buying products and services to buying outcomes;
shifts from central procurement to localised purchasing;
increased application of technology to address social needs.

We think these trends are supporting a new breed of social venture to emerge that could sit comfortably in any of the traditional public, private or social sectors. It appears that the traditional sector boundaries are blurring, especially as the focus of customers and investors switches to outcomes achieved over legal form and service specification. These social ventures, motivated by maximising their impact, have business models that intend to be profitable because generating profit is seen as essential for sustainability and growth of the venture, leading to an increased scale of impact. And there is early indication that the impact investment market is designing responses to these trends.

From buying services to buying outcomes

There is a growing recognition that old models of delivering public services are failing to meet our growing needs in a cost-effective way - and plain outsourcing services doesn't appear to be the answer. The basic outsourcing 'Fee for service' contracts assume that service delivery and the buying of outputs automatically leads to positive social outcomes (such as jobs for the unemployed, reduced reoffending, and improved education and skills levels).

In reality such contracts often don't achieve those outcomes and so public service purchasers are looking to 'outcomes-based commissioning'[1] to do better. This move potentially drives demand for impact investment in two distinct ways:

Firstly, as payments for outcomes are often paid in arrears and only when outcomes have been shown to be delivered (potentially years after service has been provided), this creates a particularly higher risk working capital need - social impact bonds are one way impact investors are financing this need;
Secondly, outcome-based commissioning creates an opportunity for innovative products and services - outside of standard service specifications - to be purchased. This we think will create an incentive for earlier stage investment to develop social innovations with the potential to be a purchased on a high scale.

Outcomes-based commissioning is in its infancy. It represents a radical change in the way public goods and services are provided, and a substantial change to this model is going to take many years to take hold.

But we already see specialist products (like social impact bonds) and specialised investment funds being developed to address this market (e.g. the recently announced 'Results Fund' cornerstoned by Big Society Capital and a group of charitable foundations[2]) - a clear sign of confidence that demand for impact investment of this sort is on the up.

See the full impact investment blog series:

[1] Cumming, L; Dick, A; Filkin, G and Sturgess, G (2009) Better Outcomes. 2020 Public Services Trust at the RSA. http://clients.squareeye.net/uploads/2020/documents/Better%20Outcomes.pdf

[2] http://www.thirdsector.co.uk/Finance/article/1142096/Big-Society-Capital-launch-fund-will-invest-charities-seeking-contracts/