I decided to write my column this month in Wired about impact investing and the opportunity to bring new perspectives to the space. As I wrote the piece and started to negotiate with my truly great editor at Wired, I got feedback that it was a bit dense, jargony and wonky. My colleague Louis Kang was doing a lot of research for the article, so I decided to move the nitty-gritty details from the Wired piece to this co-authored "explainer" essay. This essay, now a companion piece to the Wired column, is an overview of what impact investing is, describing some different ways that we currently measure impact and some of the concerns we have with these measurement methods. The Wired article discusses my observations of this field and provides some suggestions on how we might better measure impact.
Impact Investment Metrics and Their Limitations
By Joi Ito and Louis Kang
As the pile of philanthropic money aimed at solving the world's problems grows, the desire for assessment and rigor has pushed experts to develop metrics to measure impact and success.
But our world's biggest problems -- climate change, poverty, global health, social instability -- don't easily lend themselves to measurement. Climate change, poverty, global health and social instability, for instance, are complex self-adaptive systems that are irreducible to simple metrics and mathematics. In fact, it's simple math and the hyper-efficient optimizations of the financial markets that have caused most of these problems in the first place. Consider for example, capital markets that focus much more on shareholders than other stakeholders, which has caused extraction and exploitation of natural resources; the efficient production of cheap calories that has contributed to obesity; mass consumption that has led to climate change; and Internet and social media platforms that have amplified hate speech and new forms of adversarial attacks. Are modern foundations and financial institutions armed with quants and global development principles, such as the UN's Sustainable Development Goals, enough to tackle such complex challenges? I don't think so.
Philanthropy as a concept has existed for centuries.The U.S. Internal Revenue Service began providing tax benefits for charitable gifts in the early 1900s, and since then, philanthropy has continued to grow and become more sophisticated.
At the MacArthur Foundation, where I serve on the Board of Directors, "impact investing" emerged in the early 1980s as a way to channel capital to communities plagued by underinvestment and spur the growth of revenue-generating nonprofits and social-purpose businesses. Around this time, Nobel Peace Prize winner Muhammad Yunus founded the Grameen Bank on the principle that loans are more effective than charity to disrupt poverty, and it started by offering tiny loans to impoverished entrepreneurs, which we now know as microfinance. Since then, new types of investment capital and assets, as well as financing and organizational structures and impact measurement practices, have emerged to better engage in the active creation of positive impact. Although the purpose and practice of impact investing are continuously revisited and refined, the core idea is to unlock more traditional investment capital to contribute to solving the world's problems. Today, more than 1,340 organizations manage roughly $500 billion in impact investing assets worldwide.
Many companies now proactively claim to be public benefit companies or are undergoing certification by B-Lab to qualify as B-Corps. These include Patagonia and a company that I invested in, Kickstarter. These companies claim to use, and sometimes disclose, auditable measures of their non-financial societal impact. In addition to companies like these, there is a push among more mainstream businesses to go beyond mere measures of financial success and assess their societal or environmental impacts with a "triple bottom line." Although impact investing has largely been seen as a philanthropic activity, which by definition is prone to accepting little or no return on investment, many traditional impact funds and investors now assert that they are designing investment practices to achieve market level returns on investments and meet positive impact targets. According to one Global Impact Investing Network (GIIN) report, 49 such funds have, on average, achieved an 18.9 percent return on equity-based impact investments in emerging markets. Recently, we've seen more established institutional investors, such as Goldman Sachs, KKR and Bain Capital, to name a just a few now active in the impact investing scene.
Texas Pacific Group (TPG) has created an impact investment fund called the Rise Fund with the help of The Bridgespan Group. The Rise Fund has devised a method that attempts to calculate the economic value of impact called the Impact Multiple of Money, or IMM. IMM is one of a growing number of models and protocols, each of which comes with pros and cons, used to assess non-financial impact. The Rise/Bridgespan method generates an economic estimate of the social impact of an investment by first estimating the number of people impacted by it using relevant scientific studies and multiplying that number by the U.S. "value of life" of $5.4 million, as calculated by the U.S. Department of Transportation to quantify "the additional cost that individuals would be willing to bear for improvements in safety (that is, reductions in risks)." This dollar value of the investment's impact is then adjusted by multiplying it by something called the "probability of impact realization," which is an estimated probability of achieving the expected impact calculated based on a review of relevant scientific studies. Using this number, Rise then projects the investment's Net Present Value, or NPV, using an estimated annual discount set by itself. Finally, the NPV is multiplied by the percent of the company's overall equity owned by Rise to figure out how much of the impact Rise is accountable for, which is then divided by the investment amount to determine the IMM (see this HBR case about an alcoholism program that is part of the Rise Fund as an example). For example, if Rise invested $10 million for 50 percent of the equity in a venture, when the NPV is $100 million, Rise determines $50M ($100 million multiplied by 50 percent) is the value of the impact for which it can claim credit. So its IMM would be five times its investment, or $50 million divided by $10 million, the amount it spent to make the investment. In this example, the IMM was five times its investment, exceeding the three times minimum IMM for the Rise Fund.
Robin Hood, which claims to be New York's largest poverty-fighting organization, takes a similar approach to the IMM. It uses a Benefit-Cost Ratio (BCR) to "assign a dollar figure to the amount of philanthropic good that a grant does" and focuses solely on improving the Quality-Adjusted Life Year (QALY). Robin Hood's metrics are demonstrated over 163 different cases, which can be found here. For example, the BCR of Robin Hood's support for a substance abuse treatment program was calculated by first counting the number of individuals who received the treatment as reported by their grantee. Robin Hood staff then estimated three factors: what percent of these individuals received the treatment solely because of their support; how much the QALY was reduced due to substance abuse, and how much the QALY was improved due to intervention. Suppose the treatment program reached 1,000 people, and Robin Hood estimates that it is only accountable for 10 percent of them. Of those 100 people, QALY reduction due to substance abuse is 10 percent and QALY improvement due to intervention is 20 percent. Robin Hood multiplies 100 by 10 percent, then by 20 percent and finally $50,000 (the QALY value as determined by its staff) to argue that the BCR of the program is approximately $100,000.
Not all of the new approaches attempt to measure impact using a dollar value. My college classmate and collaborator on many projects, Pierre Omidyar, has been an influential leader in impact investing through the work of his organization, the Omidyar Network (ON). The ON funds companies and intermediaries that also provide some social benefit. Over the years, the ON has developed and articulated a variety of methodologies to describe how it measures and categorizes opportunities and risks in funding socially beneficial companies. It has also recently experimented with Acumen's "lean data" approach which seeks to allow rapid iteration in social enterprises in the same way start-ups iterate. Acumen has developed software tools to survey beneficiaries of impact investments and calculate an average Net Promoter Score (NPS), which reflects a combination of many factors. NPS is a method originally developed to measure customer satisfaction in marketing. Via Acument's platform, the ON surveyed 36 investees and 11,500+ customers the investees reached across 18 countries, meaning it received an NPS score of 42 (For comparison, Apple's NPS is 72). And with its surveying capability, the ON contends that its investments improved the quality of life of about 74 percent of its customers.
Having reviewed various impact measurement techniques that are practiced today, now ask yourself: IMMs, BCRs, and NPSs -- do these numbers truly reflect what impact means? Understanding impact through measurement has importance, but we must be careful not to oversimplify complex systems into reducible metrics and lose sight of the intricate dynamics of the world. "Of course, many of us who want to see impact investing attain real scale would welcome the simplicity of an 'Impact Earnings Per Share' calculation or other simplified way to compare relative impact of competing investment opportunities -- but being able to advance a simple metric and having a metric framework that actually helps us assess our true impact and value contribution are two different things," Jed Emerson, who invented the framework Social Return on Investment (SROI), recently told me. "As we know from the history of economics and finance, a single metric can't reflect more nuanced aspects of value or impact. Simplified metrics tell us how we are thinking today but not what we truly seek to know."
Impact measurement is still a nascent field. Understanding impact is fragmented, sometimes misguided, and often inadequate. This makes evaluating and generating impact highly inefficient. We need more clarity and transparency, as well as robust scholarship to study and maximize the impact of philanthropy and impact investing. To address this, I've started to discuss and develop new methods to measure impact. My early thoughts and suggestions are introduced in this upcoming Wired article.