Government tools (2/6): Innovations in public procurement and financing – can social impact bonds keep their promise? | Social Impact Markets & Policies

in an earlier blog we provided reasons for why government should support the development of impact entrepreneurship and social innovation.We also provided a framework for government action and introduced a number of tools (here) including thedevelopment of government social investment vehicles.

Work with the public sector helps impact entrepreneurs generate reliable income streams and build their capacity. In the UK, for 23% of social enterprises trade with the public sector is their main source of income (Social Enterprise UK 2013). In Germany, social enterprises earn on average 36,2% of their income from government sources, in some areas such as social services is it as high as 47% (Spiess-Knaff, Schues, Richter, Scheuerle, Schmitz (2013).

Effective public demand for the entrepreneur’s goods and services can support social innovation throughout the innovation cycle: in the concept phase, (where markets do not yet exist for a particular good or service), in the market introduction (where demonstration of goods’ or services’ feasibility is needed) or in the market maturity phase (where a critical mass is important to bring a social innovation to scale).

Public procurement reforms

In recent years, reforms in public procurement and commissioning worldwide have aimed at removing barriers for social impact organisations (e.g. size or capital adequacy), atincluding social and environmental criteria alongside price and technical criteria in the tender documents or at specifically designing tenders targeting social organisations or small businesses.

For example, the Public Service (Social Value) Act 2012 in England and Wales requires all public bodies to consider the social value created when commissioning services. The European Commission included social clauses in their 2004 Directive on Public Procurement, issued a Buying Social and Buying Green Guide and is currently discussing proposals to clarify and to elevate social criteria to the same level as more advanced green criteria.Outside Europe, the 2003 Black Economic Empowerment Act in South Africa is a prominent example of actively promoting the inclusion of disadvantaged groups, the country’s black population through targeted government procurement.

Another important improvement in public procurement has been the introduction ofperformance-based contracts between government and external organizations. Government identifies desired social results and commits to pay the external organization an agreed upon amount of money once these results are achieved.

Social Impact Bonds

One of the most significant innovations in the area of public procurement (and raising public finance for social impact, see above) are Social Impact Bonds (SIB). SIBwere originally developed in the UK and have been adopted in the US as Pay for Success Bondas well as Australia as Social Benefit Bond.

SIB build on earlier reforms public reforms in that performance in relation to social and environmental criteria is at the core of this new instrument. SIBs improve the social outcomes of publicly funded services by making funding conditional on achieving results.

However, SIB also aims at attracting additional capital for social impact. Investors pay for the project at the start, and then receive payments based on the results achieved by the project. As a result, while under a traditional impact investment, the investor’s return is dependent of the financial performance of the investee (See example A in Figure 1), under a SIB arrangement the return depends on the outcome achieved (See example B and C in Figure 1). How does it work in detail?

  • An intermediary issues a bond to a (social) investors (step 1);
  • The intermediary transfers the money to one or several social organizations (step 2);
  • Social organizations use the funds as working capital to scale and improve the outcome of a preventive program. The work can be coordinated and monitored by an intermediary (step 3);
  • At the end of the contract period (3-10 years) an independent evaluator determines whether the agreed outcomes have been achieved based on the government contract. If they have the intermediary is paid a an previously percentage of government savings. If not, the government does not owe anything (step 4).
  • Only in case of success would the intermediary then pay the investor the equivalent of the principal and a return of investment which may vary depending on the service providers performance (step 5). The capital is expected to yield anywhere between 2.5% and 13%, but the investor may loose their full (e.g. UK Petersburg Prison) or part (Australia Public benefit bond) of their principal should the agreed outcome not be achieved.

Figure 1 illustrates the process for a outcome-based instrument such as an SIB (with and without intermediary) compared to traditional investment based on the financial performance of an organisation.

Figure 1: Main structure of a social impact bond

SIB

Source: Based on Social Finance (2012), p 12; Impact in Motion (2012), 5

Elements that set SIB apart from conventional procurement and go beyond performance-based contrasts include:

  • Focus: Funding for upstream prevention or early intervention programs that significantly reduce the need for subsequent and more costly remediation.
  • Outcome orientation: Success is measured by outcomes rather than outputs in a performance contract or the financial performance in a typical investment, thus focusing the intervention towards results that ultimately matter for beneficiaries and the government.
  • Risk capital: SIB are expected to raise capital for innovative programs which involve risks that governments are not able (or willing) to assume and budget for.
  • Innovation: Government agencies do not specify required inputs, thus leaving room for innovation and creativity in addressing social challenges.
  • Up front working capital: Social organization are provided with up-front working capital.
  • Long term predictability: Funding is predictable and available over a longer period of time reducing the need for costly fundraising.

With the first bonds being launched only recently, it is still early to draw conclusions on the success of this program. Interim figures released by the British Government end of October 2013 on the pilot SIB in the UK, the Petersborough SIB, which aims at reducing recidivism in the Petersborough prison, show that the reconviction rates for short-sentence offenders have decreased by 12% in comparison to an 11% increase nationally. Social Finance UK, the non-profit organisation behind the SIB is more hesitant in drawing conclusions, since the figures used in the government are different from the figures that will be used to determine the payout to investors. Those figures will be identified by an independent assessor using a specific methodology set out in the SIB contract in April 2014.

More generally for SIBs to work well the following conditions should be met:

  • Target group definition: The target group has to be well defined;
  • Measurable outcomes: Outcomes have to be clear and measurable, it must be possible to link them to the proposed intervention and they have to translate in government savings that are big enough to pay for the work of the organization and intermediary as well as the investors return;
  • Capacity: Social organizations have to have the capacity to be able to attract investors and deliver the promised outcomes;
  • Public support: there is a desire in government to catalyze the market for innovative financing, to partner with social organiztions for implementation of government programs and to increase evidence of effective programs
  • Risk-taking: Investors need to be available that are ready to face uncertainty and assume a high level of risk most of which is mostly outside of their control after their social partner organizations started work.

In fact, critics have warned that investors may unduly interfere into the work of social organizations or push for well-trusted approaches rather than innovation to reduce implementation risk.

What is next?

Currently, a lot of experimenting in this area is going on. Countries as diverse as Germany (State of Bavaria), Israel, Pakistan or Mozambique are exploring the feasibility of SIB approach within their country specific context.

The Impact Bond Working Group recently released a report which shows the applicability of SIB in a developing and emerging market context using six case studies ranging from low cost private schools in Pakistan to financing businesss development services to develop a (social) SME deal pipeline. They show how Development Impact Bonds (DIB) could add value to traditional aid or result based approaches in development. Besides government and donors, foundations and trusts could potentially play a significant role in piloting the first DIBs.

Want to find out more? Check out a TED talk on Social Impact Bonds by Tony Eccles of Social Finance, the ‘brain’ behind this instrument and a briefing on Development Impact Bond by Centre for Global Development, who worked with Social Finance to develop an instrument suitable for developing and emerging market context.