# When donations and profits meet, beware

David Roodman raises the concern that Kiva capital could be effectively “padding profits” at a profitable microfinance institution. He concludes,

If social investors provide capital at prices below commercial rates to enterprises with “double bottom lines” (profit and social benefit), how do the investors assure that their cheap capital isn’t being used to boost just one of those bottom lines?

We feel that this is a major concern, and one that also applies to larger-scale social enterprise investment (see last week’s discussion of Acumen Fund, particularly the part about VisionSpring).

With a for-profit, everyone is looking to get their investment back. With a nonprofit, everyone is (ideally) looking to achieve social impact. But an organization that has both charitable and for-profit investors can get caught in the middle: taking donations, but measuring its success in terms of profits instead of lives changed.

The situation is particularly dangerous when profits are viewed as a “proxy” for social impact, and thus become the only measure looked at. Imagine an enterprise that could sell food below market prices, thanks to support from donations. It could be distorting the local economy (by outcompeting local farmers), failing to reach those truly in need, and ultimately failing to accomplish anything besides selling food for less than it costs to people who turn it around for a profit. And yet, all of this could be consistent with a good bottom line, which would make both the investors and the donors happy.

One way to avoid this problem is to refuse to use profits as a proxy for social impact – to insist on rigorous assessment of whether an enterprise is changing lives, rather than settling for the logic of “if it’s selling it must be helping.” But such rigorous assessment costs money, and exacerbates the already great challenge of turning a profit. Jim Fruchterman’s recent comment illustrates the low likelihood that you’ll see much of this approach working in practice.

Another possible approach is to get very specific about how donations are and aren’t being used. Any sort of “hybrid” organization ought to be able to show a history of using donations to absorb risk, but ultimately creating ventures whose profitability and sustainability does not depend in any way on continued subsidies. Our basic feeling is that demonstrating such a thing would be harder than it sounds, and that we have not yet seen an organization that seems capable of doing so.

Bottom line: it’s difficult to hold an organization accountable unless all its investors are on the same page about what it’s accountable for. Blended value makes perfect sense in theory, but in practice, it seems like a huge challenge that nobody is clearly up to. In the meantime, it may make more sense for businesses to be businesses and charities to be charities.

• Lately, I have been thinking about this from a slightly different angle. If I think about how much good my $1 does, why should I only think about that with not-for-profits? If I buy something, my dollar does not disappear. Often it will go to pay someone’s wages, or at least keep a company afloat providing whatever good service I was happy to pay for. Thus, I should also spend my money in a socially responsible way. I do not necessarily mean supporting stores that spend profits on charity, but at least giving money to companies that do not incur negative externalities that society will have to pay for later. It seems silly to not be bothered by generating negative externalities while transacting with for-profit companies, but being so concerned about maximizing positive externalities while transacting with for-profit companies. Yet, for the most part, this is what I do. • Ian Turner on December 2, 2009 at 7:01 pm said: Grant, Holden has covered this topic here. It’s possible that making socially conscious purchases can have an impact, but if you have to pay more money to get that impact, then the endeavor becomes subject to the cost-effectiveness evaluation of any other philanthropic endeavor. • Ian, I had read Holden’s previous post and was mindful of it when I posted my comment. This is why I used the example of “negative externalities” and not positive ones like the RED campaign. You are indeed correct that if you have to pay more to get that impact, then it is probably not worth it. However, this begs the question: when are you paying more for that impact, and when is it a good deal? Green campaigns are an easy example (though I am more interested in others, like Walmart). Say I can buy a polluting moped for$100 and give $20 to a green charity, or buy a clean one for$120. What is the better choice? Well if the pollution I create costs $10 to clean up (or offset), then I am better off with the first option; however if it costs$30 to clean up, I am better off with the second. If you just think “green” you may make a poor choice, if you just think “go capitalism, if its not illegal it must be okay” you still may make a poor choice. The choice depends on the facts, and the facts are case by case, and usually not to easy to ascertain. I think these are important questions that don’t often get serious answers, just ideological ones which are not very helpful.

• Ian Turner on December 3, 2009 at 4:28 pm said:

Grant,

Actually, even in the case of the pollution that costs $30 to clean up, you might still be better off giving$20 to the charity, if the results of that charity’s work is to take more than one such moped off the streets.

I’m not saying that you shouldn’t consider the consequences of your actions (such a philosophy would be hopeless) but rather that anytime you are spending extra for the public good, you should carefully evaluate the possible ways to allocate the extra spending and the impact you expect to achieve by exercising it.

Cheers,

–Ian

• Ian, I think Grant understands the conceptual issues and is asking what is actually the case: can he accomplish more good by consuming responsibly than by using the extra money that would cost him to give to charity? I think it’s an open question.

A few years ago, I would have favored putting all your altruistic efforts into giving, because when you give you can think hard and learn about one area and direct all your funds to it; “responsible purchasing” means a lot of small decisions about issues you probably don’t know much about. Having learned about the state of information in the nonprofit sector, I’m no longer as sure of this position – I wouldn’t be surprised if you can help the environment more by paying extra for “greener” products than by giving to environment-focused charities. I’ll have a stronger opinion once we’ve spent more time looking into that area.

• David Roodman on December 7, 2009 at 2:26 pm said:

I just want to point out that the quote from me was not so much about Kiva. In the specific instance that prompted that thought, the Mongolian microcreditor says that it is giving the savings from Kiva’s cheap capital to individual clients in the form of starting balances on new savings accounts. This shows that Kiva is aware of this problem and is working on it creatively. The broader issue does stand, though, and was novel to me.