Philanthropy’s business benefit

Stewart J Paperin
16 April 2008

In his article "Philanthrocapitalism: after the goldrush" (19 March 2008) Michael Edwards raises several serious questions about mixing business principles with philanthropic objectives and elevates the debate about the utility of a market-oriented approach to philanthropy. Edwards focuses particularly on the question of whether or not a focus on profits or business principles helps or hinders an organisation to successfully achieve longer-term social objectives, and he is quite critical of the potential outcomes.

Stewart J Paperin is executive vice-president of the Open Society Institute and Soros foundations network A large part of his dissatisfaction with merging business approaches with philanthropy results from Edwards's inadequate definition of when business principles should or should not be used. He paints the question as a stark choice: either conventional philanthropy carried out by the NGO sector of civil society, or a business-oriented and profit-driven approach to change. In reality, the issue is not so clear-cut. In many instances, a business-driven approach with a profit motivation can exist quite comfortably within a social mission. This is particularly the case in the rapidly expanding area of socially responsible investment.

The road to sustainability

Michael Edwards defines "philanthrocapitalism" according to three traits; the availability of outsized resources, the use of a methodology which rests on the assumption that business practices are more successful than approaches used in either the public or third sectors, and the claim that markets can transform society. He then concludes that "while it is possible to use the market to extend access to goods and services", this does not result in social transformation.

Edwards's trivialisation of access to goods and services is unfortunate, particularly because this access may permit economic development that results in employment and consequently in progress from subsistence to surplus. For example, one of the most successful engines of social development - the Bangladesh Rural Advancement Committee (Brac) in Bangladesh - is a social organisation that rests squarely on microfinance and small-business development supported by small-business lending. Around these cornerstone activities, Brac delivers health services, education and programmes that empower women. Brac's activities have created a variety of for-profit businesses including iodised salt manufacture, agricultural-seed development and soft-goods retailing that fund and subsidise other activities.

Donors who have funded Brac do so not only because of its excellent work but also because its business-like approach to microfinance, small-business lending and value-chain creation has made it sustainable. Brac still depends on donor funding for a small part of its operating budget because this offers Brac a window into how other organisations approach similar problems, not because it is incapable of wean itself off donor funds.

Brac's focus on sound financial organisation and profitable services notwithstanding, the organisation has had a transformational impact on Bangladesh. It is important to consider that these changes have occurred on a borad grassroots basis and have led to thousands of "solidarity borrowing groups" and the emergence of a small merchant class. Over time this certainly contains the seeds of a more permanent social organisation, and perhaps of a political organisation. Without question Brac has strengthened the role of women in Bangladeshi society and empowered them economically and socially.

Edwards also suggests that philanthrocapitalism leads to conflicts between social mission and the demands of corporate shareholders. Although this is certainly true in some cases, he seems to imply that businesses focus solely on profitability and cannot have multiple objectives. I think this view is far too narrow. Edwards fails to recognise that corporations frequently pursue many simultaneous and sometimes conflicting objectives by evaluating the net costs and benefits of each.

For example, both Pepsi Cola and Coca Cola have been generous supporters of clean-water programmes, having acknowledged their own heavy water use. They recognised that helping to provide the infrastructure that leads to improved drinking-water supply also improves both governmental and public perceptions. They are investors in filtration and distribution schemes not because they plan to enter the water-filtration business but because they are dependent upon the continuing goodwill that permits them to access this scare public resource. While they could conceivably operate a profitable bottled-water business in certain emerging markets, instead they focus on local development of a public good - partially for social objectives and partially to enhance public perceptions of their businesses. Conflicting objectives can be managed, as long as the corporation or the donor does the work to identify conflicts and think through a reasonable set of tradeoffs.

Rather than regarding returns as the principle objective, philanthrocapitalists often accept lower than market returns. A recently announced venture-capital exercise that brings together financing from Google.org, the Omidyar Network and the Soros Economic Development Fund focuses on for-profit investment in companies that address clients on the bottom of the economic rung in Hyderabad, India. This investment company's explicit objective is to invest in companies serving poor clients, and there is a clear acknowledgment that this will result in return on equity far below venture-capital levels - a result hardly justified by risk-adjusted metrics if social benefits are not taken into account. Nevertheless, the company expects a profit and a full return of capital.

Also, fundamental to the investment strategy of this initiative is the identification of target companies that are driven by profit, but are defined by their interest in poor clients as consumers who will benefit. Whether this can be achieved or not remains to be seen, but philanthrocapitalism certainly aims to use a business-based approach to create social benefits including employment, expanded spending - and its consequent multiplier effect - and the introduction of very poor people to a range of goods and services, including health and education.

The market lever

Michael Edwards also fails to appreciate the leverage effect that philanthrocapitalism can have in providing public goods and services. In a pure philanthropy case, 100% of funding is sourced from scarce philanthropic or public funds. As an alternative, clever risk-assessment and use of business practices can multiply the financing scale by guaranteeing or subsidising only the risky parts of a programme, or by demonstrating that certain beneficial services can be pursued without risk or with profit. Available financing is thus expanded by introducing market funding. Much of the financing that has evolved in microfinance markets has been raised in this manner: institutional investors who expect market returns provide the less risky portions of funding and philanthropic investors guarantee the riskier parts.

Also on openDemocracy in our debate on the new philanthropy:

Michael Edwards, "Philanthrocapitalism: after the goldrush" (19 March 2008)

Gara LaMarche, "Philanthropy for social change" (9 April 2008)

Geoff Mulgan, "The new philanthropy: power, inequality, democracy" (10 April 2008)

Simon Zadek, "Civil society and capitalism: a new landscape" (14 April 2008)

Michael Edwards's essay draws on his book - Just Another Emperor: the Myths and Realities of Philanthrocapitalism (Demos/Young Foundation, March 2008) Philanthrocapitalism can also play an important role in helping to properly assess mispriced risk and demonstrating that market-based contributions to social problems can be quite safe. When the South African government undertook a programme to provide safe and decent housing to poor South Africans, it agreed to provide permanent financing to liquidate development loans. Notwithstanding this permanent financing, few banks would lend to developers and few houses were built because of the banks' perception of risks.

George Soros determined that any such risks were dramatically overstated and could be well managed, so he agreed to make an outsized guarantee to protect lenders. Nurcha, the Soros-funded organisation, conclusively demonstrated that actual risks and losses were far lower than perceived, and mainstream financial organisations entered the market. Ten years later, over 250,000 homes have been built with minimal losses, and banks have stepped in as primary development financiers. If business-based lenders had not made significant commitments of funds, over 1.25 million South Africans would still be living in shacks. Moreover, an important public-policy opportunity to reform the provision of low-income housing would have been missed.

Edwards is correct, however, that market-based solutions and business-based approaches are not the solution to every problem. Matters of extreme poverty require public-policy solutions that focus on income transfer as well as provision of basic public goods - including education and fundamental healthcare. Participants below a certain income level cannot benefit materially from many of the new business-oriented approaches like microfinance unless they are also provided with a full range of social services. Markets alone will rarely, if ever, serve as an organising principle for social transformation, but certain aspects can enhance and strengthen the ability to realise deep social change. In particular, they can create a environment in which the poor can lift themselves, step by step, out of subsistence and into the independence that surplus brings.

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