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

By V. Kasturi Rangan & Lisa A. Chase

We thank George Overholser, Tracy Palandjian, and Jeff Shumway for their insightful and thoughtful commentaries about our article, “The Payoff of Pay-For-Success.” Their observations regarding the roles of investors, service providers, and governments in future pay-for-success (PFS projects) reveals how quickly the model is evolving. A careful reading of the two responses leads us to believe that our perspectives have much in common, despite differences around PFS’ potential unintended consequences.

Even in areas where our opinions diverge, the responses are not entirely unequivocal, underscoring the uncertainty that still exists at this early stage of the field’s evolution. For example, while acknowledging our projection that a few nonprofits may benefit disproportionately, Palandjian and Shumway (of Social Finance) argue that industry consolidation is a good thing (better run organizations will grow through access to PFS funding), while at the same time conceding that they do not yet see this trend developing. Similarly, while Overholser (of Third Sector Capital Partners) argues for pervasive government adoption of performance-based government contracting without investor capital (which we all agree would be an overwhelmingly positive breakthrough), he recognizes the catalytic nature of philanthropic and impact investor capital at this stage. Given the inherently organic nature of PFS, this indicates to us that the landscape could unfold quite differently from any of our projections.

Realizing the optimistic projections provided by the commentators—and avoiding the potential pitfalls we’ve outlined—will require deconstructing existing projects and learning from the early implementations, to improve their ability to serve society’s neediest citizens. In this regard, the excellent additional commentaries provided by Mark Hand and Margo Johnson, Christopher Spera and Jeffrey Lubell, and Mark Fliegauf provide concrete action paths for how and where those developments might arise from.

Spera & Lubell (of Abt Associates) hit the nail on the head when they point to the paucity of nonprofit organizations that have been able to rigorously demonstrate evidence of their effectiveness. They make a call for significantly increasing the role of impact evaluations in order to build the capacity of the industry to be PFS-ready. While we entirely agree with that view, we urge caution in assuming that all impact evaluations should follow the gold standard of randomized control trials. As we state in the article, an important role for evaluations is to help an organization make process improvements in its service delivery model. Unless such a spirit of learning pervades the yearning for impact measurement, we will not be able to raise the capacity of the social sector to be ready for PFS funding. Fortunately, we see already evidence of such a trend. At prison recidivism project at Peterborough, the UK’s central government has eliminated the social impact bond intermediary to directly contract with service providers, using lessons from the project’s first phase. The UK Ministry of Justice’s new intervention program is directing prisoners to rehabilitation services before their release, expanding interventions to previously underserved short sentence offenders, and incentivizing nongovernmental service providers through a PFS structure. By rigorously measuring interventions and understanding the logic model underlying PFS performance, intermediaries, service providers, and state and municipal governments will all learn how to enhance and improve their service delivery model, thus improving the capabilities of the sector. 

Interestingly while almost all the commentaries acknowledged the role of the mission-driven impact investor, it is Hand (of UnLtd) and Johnson (a social work practitioner) who urge us not to dismiss the return seeking investor, because as they rightly argue there is tremendous potential in that monetary stream. But they also flag a critical stumbling block, the lack of mission alignment. We believe the harmonization will come not through the route of providing return seeking investors with venture capital-like returns as Fliegauf suggests, but by providing a safe tranche that would mimic a low-yield/low-risk bond.

The Benevolent Society’s financing construction for its Australian project provides valuable lessons for attracting impact-driven investors. Most notably, the first of three funding tranches promised investors their principal plus a guaranteed interest payment, regardless of the performance outcome. Similarly, Overholser mentions in his commentary the construction of financial instruments where the government would return 80 percent of the promised payout via a traditional reimbursement model. Such innovations are absolutely essential to attracting the vast sums of money available with pension fund managers and nonprofit endowments. We believe such social impact bonds would minimize the investors’ risks and offer them a safe alternative to balance their portfolio, with the satisfaction of having channeled investments to socially beneficial opportunities. As astutely summarized by Hand and Johnson, “PFS… provides a unique space in which actors with wildly different motivations can still come together to achieve success, with success defined different ways to different actors.”

In their commentary, Palandjian and Shumway remind us that the purpose of government, and of PFS contracting, is to construct policy goals and achieve societal benefits that may not be easily reduced to a monetary metric. Like Palandjian and Shumway, Fliegauf (of the think tank stiftung neue verantwortung) reminds us that PFS’ greatest promise lies in expanding and making government social interventions more effective, and not necessarily to save money. In fact, Fliegauf points out that in a social democracy with a strong social welfare system, the objective may be to spend more rather than less money on social programs, provided those initiatives are improving citizens’ health and well-being. We see parallels between Fliegauf’s German context and California, for both the German and the California governments prioritize a robust social welfare system, while seeking more efficient and effective ways of addressing critical social problems.

The Santa Clara County, Calif., PFS to address chronic homelessness may be a forerunner in that regard, by explicitly prioritizing social mission above—or at least equal to—cost savings. Since rigorous impact measurement has been a key dimension of PFS contracting, the construction and execution of the Santa Clara project will provide valuable insights into quantifying both policy goals—monetary savings and human well-being. Balanced evaluation models that quantify the value of broader social welfare goals (achieving social justice) along with more effective service delivery (spending less to keep more young people out of jail) will pave the way for broadening the scope of issues that can be accommodated under the PFS umbrella. We also believe that achieving this type of blended performance may necessitate governments and funders awarding contracts to multiple service providers, possibly separated by operating segments or geography. Doing this would help ensure that social interventions do not exclude unique segments of the population, particularly when the government’s goal is system-wide social improvement. Even if it requires a plurality of performance benchmarks, this approach could ensure that several qualified providers are included and that a broader population is served.

We noted in our article the reluctance of US foundations to engage in program related investing (PRI). We encourage them to learn from the Children’s Investment Fund (CIF) in Rajasthan, India, which will be the ultimate payer of performance for the Educate Girls project. Foundations should be attracted to the prospect of paying conditional on performance, rather than paying upfront and hoping for results. It’s a win-win for foundations, which can either achieve mission goals by achieving impact, or preserve capital for future mission investments. We hope CIF’s example will spark serious discussions about dismantling barriers to US PRI funding and increasing the flow of foundation capital. 

We, the authors, as well as all of the commentators (and this journal) are united in our search for social innovations that achieve significant progress on overcoming society’s most critical challenges. The purpose of our article and the commentaries is to encourage productive discourse to ultimately improve the ability of PFS contracting to serve society’s neediest citizens. We look forward to contributing to that evolution.

Read the rest of the responses.

V. Kasturi Rangan is the Malcolm P. McNair Professor of Marketing at Harvard Business School. Formerly chair of the Marketing Department, he is now cochair of the school’s Social Enterprise Initiative, which he cofounded in 1995. Rangan also founded the school’s executive education program, Strategic Perspectives on Nonprofit Management, in which he continues to teach.

Lisa A. Chase is a head writer and editor at Harvard Graduate School of Design and a research associate at Harvard Business School.