Response to "The Payoff of Pay-for-Success" (SSIR)

By Tracy Palandjian & Jeff Shumway Fall 2015

As V. Kasturi Rangan and Lisa Chase point out in their article “The Payoff of Pay-for-Success,” pay-for-success is an innovative financial tool “generating more than a moderate amount of attention.” In part, this is because pay-for-success (PFS) sits at the intersection of three powerful movements that are reshaping the social sector: “moneyball for government” (driving public resources to evidence-based programs), “transformative scale” (achieving impact at scale to solve social challenges), and “impact investing” (using capital productively to create both social and financial returns).1

Enthusiasm, as is often the case in new markets, belies the pace of progress. Today, there are only seven PFS deals that have reached the market in the United States.2 Rangan and Chase, in their article, review these and offer predictions for the sector’s future.

Their research into these seven transactions is thoughtful and detailed. Their predictions for the future, however—from our perspective as practitioners—are based on three flawed assertions: first, that governments care about PFS solely to drive monetary savings; second, that linking nonprofit funding to measured outcomes will negatively affect the social sector; and third, that private investors in PFS are seeking either profit or impact—but not both. These assumptions lead Rangan and Chase to conclusions with which we disagree.

Playing Moneyball

Rangan and Chase begin their analysis with the assertion that governments care about PFS solely to save money. Investor payments are defined by a limited set of primary metrics, most of which link directly to expected government savings.3

It is misleading, however, to conflate the metrics in the PFS contract with the model’s primary objective. Governments pay—and, indeed, exist—to achieve policy objectives. Most of those objectives are not about saving money; they are about improving lives. The governments we work with care most about seeing fewer young men return to prison, creating better outcomes for mothers and their babies, and improving educational outcomes. These are persistent challenges that have defied decades of efforts. When a PFS program promises to reduce recidivism, the value of safer communities and successful re-entry for these individuals goes beyond the monetary savings of reduced prison bed-days. That may be the metric in the contract, but the value generated for society goes far beyond it.

PFS is indeed a financing mechanism built on rigorous metrics. Success in PFS, however, runs deeper than finance. Success is about changing the way governments think about contracting for services. Today, governments typically buy services or outputs. PFS allows government to instead buy outcomes—and to know through rigorous measurement exactly what they are getting. The book Moneyball for Government famously noted that less than 1 percent of government spending is backed by evidence of its effectiveness. PFS helps governments to make decisions based on evidence and to pay only for results.

If a PFS project fails to deliver results, that provides meaningful information and the program would naturally sunset (unlike most government programs). This is a success in itself, and a win for taxpayers and society. On the other hand, if a PFS project succeeds, government would gain the necessary information to further improve and double down on the program.

We envision a future in which cities, counties, and states routinely perform detailed cost-effectiveness analyses, rigorously review service provider evidence, fund programs based on their evaluated outcomes, and support those programs with ongoing measurement and performance management—with or without PFS. Until then, we see PFS as a useful tool to ensure that programs that work get the resources to have a positive impact on as many lives as possible.

Building the Bridge to Scale

Rangan and Chase rightly ask hard questions about unintended consequences of PFS. These are questions we wrestle with daily. In their analysis, interestingly, they view the model’s emphasis on outcomes and accountability as both a positive and a negative. They worry that PFS programs will bring in only “high-performing nonprofit organizations” to the detriment of weaker ones. They assert that less-capable organizations will not be able to “lift their game.” This could, the authors fear, handicap their ability to obtain funding for their operations, “resulting in even poorer social service delivery to populations that need them most.”

Yet our real-world experience suggests the opposite. High-quality nonprofits are deeply focused on improvement. They use data to sharpen their measurement skills and enhance their services. With PFS as a funding option, we have seen more nonprofits inspired to lift their games. We have multiple advisory projects under way with service providers that, although not yet ready for PFS, are investing more deeply in performance measurement and evaluation.

Moreover, it is unclear why steering resources to the most effective groups is not in the best interest of society. Addressing complex social challenges at scale will require organizations that can absorb significant new capital and grow with fidelity. In 2008, research by the Bridgespan Group found that only 144 out of the more than 200,000 nonprofits created since 1970 had reached $50 million in annual revenue. Despite tremendous social challenges, nonprofits including those with the strongest evidence—have not achieved the scale to meet the demands of society in a meaningful way.

Funding for social challenges is limited; there will be winners and losers. In the past, these have been decided by any number of factors—relationships, charismatic leaders, cost to serve—but rarely by nonprofits’ ability to measurably improve their clients’ lives with concrete outcomes. For those that can do so, PFS offers a new path to access growth capital.

Moreover, nonprofits have long been “squeezed” in the challenge to raise funds. PFS lets nonprofits steer away from unhelpful overhead rules, allowing them to fund whatever activities are necessary to achieve outcomes—including technology, data systems, staff training, and strong management. It provides flexible, multiyear, stable funding, tied directly to their mission, allowing organizations to spend less time securing funds and more time letting results speak for themselves.

The authors also worry about a future in which governments—who can use PFS to more accurately put a price on outcomes—drive to lower cost, inadvertently pushing nonprofits away from serving those most at risk. It is worth noting that this is true in the sector today: nonprofits constantly struggle to maintain mission against ever-shrinking budgets. Well-designed PFS contracts, in contrast, help to counter this challenge, not reinforce it. In PFS, evidence-based programs typically perform best when beneficiaries are most at-risk, not least, since the highest-risk individuals drive the most cost and have the poorest outcomes under the status quo. In PFS contract development, we have found that government, investors, and nonprofits benefit most by serving the most vulnerable.

Investing for Impact

Rangan and Chase see a future in which “PFS’s ability to attract pure return-seeking capital to social programs will be muted.” They believe growth in the sector will come from “impact-seeking” rather than “return-seeking” capital. This trend, in their view, limits the field’s potential.

If the ultimate goal of PFS is to change how government allocates resources, then its success is not predicated on an ability to draw in one kind of investor or another. Nevertheless, adequate investment capital—and the returns necessary to access that capital—is an important means to achieving that goal.

We agree with the authors that philanthropic capital has and will continue to play a catalytic role in advancing the field. Philanthropy has acted as guarantor, though this has been less common as the field evolves; it has taken junior investment positions in “blended” capital structures; and in some cases philanthropy has funded deals in their entirety. Philanthropy has also spurred the field in less visible ways, providing grants to support nonprofits, evaluators, and intermediaries. Indeed, the very interventions and evidence on which PFS is built have been funded by philanthropy.

But philanthropy is not alone. Impact investors have played a strong role in PFS. Impact investing has, like PFS, drawn significant attention lately.4 The bifurcation of investment into “impactseeking” and “return-seeking” is, in the face of a growing impact investment movement, overly simplistic. All seven deals to date have blended different kinds of impact capital. Through program-related investments, foundations can and do make investments to further their missions, and expect the ability to recycle their money; high-net-worth individuals, such as those who made up the majority of our project in New York State, invest and want tangible social impact along with the possibility of financial returns.

This is particularly true for the next generation of investors. According to a survey conducted in 2014 by US Trust, interest in social investing strategies is growing: 40 percent of high-net-worth investors—including nearly half of women, and two-thirds of millennials—agree that investing is a way to express their values, as well as to produce returns.5 Investors are further attracted to the uncorrelated investment returns that PFS generates. To ignore this complexity is to misunderstand PFS investors.

Looking to the Future

Rangan and Chase provide a valuable overview of the seven PFS transactions launched to date in the United States but prematurely make predictions about the model’s future based on assertions that we, as practitioners, do not experience as the reality of the field.

Pay-for-success is a cross-sector collaboration that weaves together three important social-sector movements: government accountability, scaling effective nonprofits, and impact investing. We are still in the early stages of PFS development. The potential for pay-for-success is exciting, yet its potential remains that of a tool. It is no panacea; it serves as a means to an end. The end is about achieving measurable and meaningful progress against our greatest societal challenges.

Read the rest of the responses.




1 Jim Nussle and Peter Orszag, eds., Moneyball for Government, Disruption Books,2014; Jeffrey Bradach and Abe Grindle, “Transformative Scale: The Future of Growing What Works,” Stanford Social Innovation Review, February 19, 2014; Paula Goldman and Lauren Booker, “Parsing Impact Investing’s Big Tent,” Stanford SocialInnovation Review, June 10, 2015.

2 There are now more than 45 active PFS/social impact bond projects globally. We
work closely with our sister organization in the United Kingdom, where there are 31
active projects, to apply the lessons of a more developed market to our own work.

3 A notable exception to this rule is the PFS contract in Chicago, in which two metrics—kindergarten readiness and third-grade literacy—are less directly linked to monetary savings, though they clearly fulfill important social objectives.

4 See, for example, Goldman and Booker, “Parsing Impact Investing’s Big Tent.”

5 2014 US Trust Insights on Wealth and Worth, US Trust.

Tracy Palandjian is cofounder and CEO of Social Finance, where she helps nonprofits, government, and funders put together effective pay-for-success programs. She was previously managing director at The Parthenon Group, and before that worked at Wellington Management Co. and McKinsey & Co.

Jeff Shumway is vice president at Social Finance. He worked previously at the Bridgespan Group.