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Social impact bonds - lessons for social innovation

Updated: Jun 25

Social Impact Bonds have limitations, but are important tools for innovation

Over the past few years I have done a fair bit of work in Australia on Social Impact Bonds (SIBs, aka Social Benefit Bonds, a type of Pay for Success contract or Payment by Results contract). There’s lots to learn about these tools and their related impact finance innovations, first invented in the UK, and spreading in a range of flavours around the world.

SIBs are important

SIBs are important because they are a rare innovation in social service financing that has allowed organisations and funders to get more precise about what should be funded. The underlying principle that we should be funding outcomes not services (inputs or outputs) is robust and represents the direction that I think most social service funding should move in. A society should ideally fund recidivism programs that actually keep people out of prison, rather than fund a number of hours of service delivered.

SIBs try to achieve this goal by turning a funding contract from a purchase of services into a purchase of outcomes. You get paid the full price if you achieve a target of outcomes, a bonus if you overperform, and lower than full price if you go below target.

This creates a challenge — not-for-profit organisations don’t have the investment cash to risk on losing money on a service contract. Ethically and optically this also doesn’t work, as the government funder is the one that controls the cash. They also have to wait until the outcomes are proven in order to get paid their full cost, which could be years in the future. So there is an upfront gap in the funding that is essentially risk-based. The SIB idea is to fill this gap with a third-party’s investment dollars. That third party could be a private investor, a social impact investor, a philanthropist (who might be willing to take the risk of the investment and consider a loss to be a donation to the organisation), or the organisation themselves.

So most of the work involved in negotiating a SIB is about how to measure the outcomes, how to set the performance targets based on historical data, and who takes what risk and pays what to whom when. This makes it complicated to negotiate — you have to develop a sophisticated financial model so everyone knows what’s paid on what rule when and what the risk and net present value of the investment is. This is in order both for the government funder to agree to fund the SIB, and to attract investors who have to satisfy themselves about the level of risk (the chance that the provider will under-perform the target and therefore leave the investor with a loss).

Structural limits on growth

This all means they are fiendishly complicated, and therefore have higher transaction costs than a plain old contract for outputs. There are new variants of pay-for-success contracts that are less complicated, like setting rate cards for what price the government will pay for an outcome up front, so there is still plenty of experimenting to be done on social finance for outcomes.

This transaction cost does put a limit on the growth of SIBs though. They also have some philosophical opponents who find the idea of a third party investor profiting from a social outcome as distasteful. They will likely remain an important niche social finance tool, but they won’t replace the majority of funding any time soon. They do, however, provide incredibly valuable lessons for how we drive social impact forward.

Five lessons for social innovation

Just like the that ‘life is what happens when you are making other plans’, I feel that social innovation is what happens when you are trying new, even flawed, experiments. The long term impact of a new idea or method might be the spin-offs, the learnings that flow from it rather than the thing itself. In my time working with social organisations on designing and developing SIBs, I’ve come to see them as important but flawed instruments that nevertheless point the way to the future.

Here are the five lessons I’ve learned from this social financing journey -

  1. Incentives, both explicit and implicit, within funding and contracting matter

  2. Social mission is limited without aligned financial incentives

  3. Measurement and data is the foundation for achieving outcomes

  4. Focus on outcomes matters — it electrifies and motivates staff

  5. People from outside the sector should be involved in social innovation

  6. Incentives both explicit and implicit within funding and contracting matter

You can also find the the original article on the Medium Blog -

1. Incentives, both explicit and implicit, within funding and contracting matter

To misquote Bill Clinton, it’s the people stupid. In social impact, it all boils down to what people on the frontline actually do when they work with the beneficiaries of the service. It’s the behaviours and actions of the millions who work in this sector that has the biggest impact. So the systems-thinking question becomes — How does the system produce the right incentives for behaviour that best delivers outcomes? What is funded but also the specifics of the KPIs in the funding contract can hugely influence those frontline behaviours. Built-in incentives to achieve outcomes at low cost will, over time, change how things are done for the better as people learn how to do outcomes better. SIBs have shown that incentivising for outcomes does work in principle — we should ensure, even if it’s not a financial incentive, that incentives for outcomes-focused behaviour are embedded in most social service contracts.

2. Social mission is limited without aligned financial incentives

Despite our best efforts and intentions, if a behaviour is not funded, it’s unlikely to get done. Social mission to ‘eradicate poverty’ or ‘make the world a better place’ is an important north star (or Southern Cross if you live down under), but the doing of it requires funding to be aligned with the mission. I’ve seen how just negotiating on what outcomes to fund can focus the mind on what really matters and generate productive debates about the interim outcomes vs long term outcomes, and ensuring contracted goals align with participants’ goals. Contracting for outcomes matters and we should keep experimenting with ways to do it.

3. Measurement and data is the foundation for achieving outcomes

A good deal of the time negotiating SIBs is spent on finding, analysing and agreeing the right data to prove outcomes and prove whether your program is responsible for the outcomes (causation not just correlation). Without robust data on what’s delivered, for whom, and what works where and when for what outcomes, we can’t hope to have an impact let alone contract on it. This realisation led me personally down the path of focusing my organisation’s work on data-empowerment and analytics for social impact as my main day job. Without better ways to do this, everything else is moot.

4. Focus on outcomes matters — it electrifies and motivates staff

Outcomes matter to Government and taxpayers in a general way — we want our taxes to pay for things that work, at a reasonable price. That goes for building roads, hospitals or social services. But outcomes matter in a specific and personal way to the people working in social services (social workers, counsellors, case managers, support workers, etc..). The feeling of doing something worthwhile (an outcome) for a person (in relationship), and getting that direct feedback that you’ve actually helped — that’s why people work in this sector. Clear measurement of that achievement through tracking outcomes and collective evidence is a supercharger of that feeling — seeing the numbers of achievements gradually crawl up on a dashboard — I’ve seen that transform and motivate people on the frontline. It really works, and we shouldn’t reserve that only for SIBs — it should be universal for social programs.

5. People from outside the sector should be involved in social innovation

From a motivation, cultural and social class point of view, investors and frontline social workers couldn’t be more different. But that’s one of the side benefits of SIBs — it gets social sector people to rub shoulders with financial people. Without trying, they learn from each other. Investors bring a fresh perspective into a project, their focus on how to price risk, use data, and apply commercial acumen can really add value to social service projects. It doesn’t hurt a finance person to learn more about doing good either. More diverse brains around the table on addressing social issues is sorely needed.

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