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SOCIAL Making Waves Vol

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									                                                                                                                   Making Waves, Vol. 11, No. 2




SOCIAL
Return On
Investment
by Jed Emerson, with Mark Cabaj




M
            any people in the nonprofit sector feel that their work is not adequately documented and
            therefore under-valued. Practitioners, in particular, are frustrated because they lack objec-
            tive, timely data on their programs and services, making it difficult to apply their scarce
resources wisely.
    The position of the Roberts Enterprise Development Fund (REDF) is that much of this frustration
is due in part to an absence of appropriate measures by which the value created by nonprofit organiza-
tions may be tracked, calculated, and attributed to the philanthropic and public “investments” financ-
ing those impacts.
    This article describes REDF’s efforts to create a new method of measuring one specific type of
impact generated by nonprofit enterprises: socio-economic value.
REDF is a philanthropic foundation in         vested in the social mission of a nonprofit      lives of individuals and the community.
San Francisco, California that seeks to ex-   today generates future economic and so-          Social value happens in a variety of ways:
pand the economic opportunities for           cial returns in excess of the initial value of   improved race relations, the creation of
homeless and very low-income individu-        that dollar. The second idea is that many of     folk art, greater access to services, pros-
als through the creation of social purpose    the returns created by social purpose en-        perity for a marginalized residents, great
enterprises. To pursue this mission,          terprises (and many tax-exempt nonprofit         public monuments, etc. Social value is
REDF offers an array of resources to as-      organizations) go undocumented. They are         difficult to agree upon and quantify or to
sist nonprofits that launch and manage        therefore largely under-appreciated by prac-     assess in terms of dollars. It nonetheless
such enterprises: core funding, access to     titioners, funders, and policy makers.           has intrinsic value, and its pursuit is per-
business technical assistance, information        It is REDF’s desire to directly tie the      haps the primary motivation for many
management, computer and internet ser-        impact of an organization and program to         working in the nonprofit sector.
vices, and marketplace access.                the investments required to make that im-            Nonprofits generate economic value by
    REDF’s current investment portfolio       pact. This results-orientation has led REDF      creating products or services that have
consists of seven nonprofit organizations.    to continually search for and refine ways to     greater market value at the next level of
They operate nearly two dozen business        document and analyze the results achieved        the value chain. The services provided by
ventures and employ approximately 600         by its investee firms.                           a landscaping business staffed by hard-
very low-income individuals in the greater                                                     to-employ youth, for example, represent
San Francisco Bay area. These ventures        UNDERSTANDING “VALUE CREATION”                   added value to the local economy - quite
generated US$20 million in sales in 1999      IN SOCIAL PURPOSE ENTERPRISE                     apart from whatever social value the busi-
and are set to exceed that mark in 2000.                                                       ness may also generate. Traditional busi-
    In keeping with the venture philan-       Practitioners and investors in the nonprofit     nesses also create economic value through
thropy perspective of REDF’s founders,        sector are very familiar with two types of       employment and by engaging in main-
two strong ideas shape the organization’s     value created through their efforts.             stream commerce. Economic value is eas-
approach to its work.                             One is social value. This occurs when        ily measured in terms of a range of
    One is that a philanthropic dollar in-    an activity leads to improvements in the         metrics, including return on investment,
                                                                   10
Making Waves, Vol. 11, No. 2




and debt/equity and price/earnings ratios.            No measure of socio-economic value can hope to be
     A third type of value that is often dis-
cussed, though rarely understood, is the              comprehensive in its quantification of benefits. Nevertheless, a
socio-economic value. Socio-economic value            nonprofit should be at least partially credited, & in some cases
builds on economic value and incorporates
certain elements of social value. Socio-eco-
                                                      financially compensated, for the benefits it generates.
nomic value refers to decreased public ex-
penditures and/or increased public sector
revenues (i.e., taxes) that result from a             of an enterprise (business revenue minus          (SRR). This is determined by adding up
nonprofit’s work and its impact on the lives          expenses).                                        the net social benefits and business cash
of its clients.                                           The second cash flow is comprised of          flow and dividing them by the total amount
     Initiatives that generate socio-eco-             the total net savings to society and specifi-     of philanthropic dollars invested during the
nomic value commonly provide employ-                  cally, to sources of public funds such as local   investment time frame.
ment for recipients of public support and             or federal government - funds usually spent           Another performance measure is SROI
divert people away from public systems                to support individuals in need. Net sav-          Rate. This is calculated by performing In-
and towards the market. Job training pro-             ings include:                                     ternal Rate of Return (IRR) calculations
grams and supported employment pro-                   ¾ the additional tax dollars generated by         based on the total socio-economic value and
grams for the disabled or homeless are                    individuals who are employed and be-          total “costs.”
some examples.                                            come tax payers.                                  These measurements are for the orga-
     No measure of socio-economic value can           ¾ the reduction of the costs associated           nization and total grant dollars. With some
hope to be comprehensive in its quantifi-                 with unemployment (e.g., welfare as-          minor modifications, individual investors
cation of benefits. Nevertheless, a non-                  sistance).                                    can measure the SROI of a specific invest-
profit should be at least partially credited,         ¾ the new wages of employees.                     ment as well.
and in some cases financially compensated,                Grant and philanthropic dollars used
for the benefits it generates.                        to subsidize the organization are sub-            USING SROI TO ASSESS
                                                      tracted from the total to give the net total      INVESTMENT OPPORTUNITIES
SOCIAL RETURN ON INVESTMENT                           social benefits.
                                                          Both cash flows are tracked, or fore-         With an SROI framework in place, REDF
Social Return on Investment is a simple               casted, over a given time period (say ten         and its investee organizations are now in a
financial assessment of socio-economic                years). They are expressed in terms of            better position to consider the large num-
value. SROI compares a project’s net ben-             present dollar values using a range of dis-       ber of investment options before them.
efits to the investment required to gen-              count rates. The social benefits and busi-            In addition to using a variety of other
erate those benefits over a certain period            ness cash flows are then added up to pro-         social and economic investment criteria,
of time.                                              vide a socio-economic value.                      the SROI analysis can help answer two
    The net benefits are comprised of two                 REDF currently uses two performance           simple questions about an investment
cash flows. The first of these is generated           measures to compare the socio-economic            opportunity:
by the business operation of the social pur-          value to the original philanthropic invest-       ¾ How will it impact the bottom line of
pose enterprise, and tracks the net income            ment. One is the Social Return Ratio                  the business?
                                                                                                        ¾ What type of public costs will be avoided
                                                                                                            and additional tax dollars generated?
                                                           The REDF Portfolio creates three types
                                                                                                        With a little extra work, the SROI analysis
                                                           of value (economic, socio-economic,
                                                                                                        can also estimate the potential negative im-
                                                           and social) over a specific investment
                                                                                                        pact of not making the investment.
                  SOCIO-ECONOMIC




                                                           time frame, ten years in this case.
                                                                                                            Take the hypothetical example of a non-
                                                           Fundamental to all three types of value
                                                                                                        profit organization that requests an invest-
                                                           is a fourth - transformative value -
                                                                                                        ment of $100,000 to purchase a building to
      ECONOMIC




                                                           because the purpose of the nonprofit
                                                                                                        house its social purpose enterprise.
                                                           sector is to transform society for the
                                   SOCIAL




                                                                                                            A SROI analysis projects that the in-
                                                           better.
                                                                                                        vestment would enable the enterprise to
                                                     T10                                                improve sales and net income by approxi-
                                                                                                        mately 22% and 55% respectively over a 5-
  Transformative Value                                                                                  year period. Without the investment, the
                                                 Investment Over Time                                   enterprise business performance is pro-
                                            T0
                                                                           11
                                                                                                                       Making Waves, Vol. 11, No. 2




jected to drop dramatically within a year.      REDF encourages philanthropists and prac-         is underestimated, the total return will be
When the total business and socio-eco-          titioners to use a variety indicators and tools   overvalued.
nomic cash flows are projected, the total       to assess the outcomes and overall SROI               Determining a discount rate is fairly
socio-economic return is estimated to be        of a nonprofit enterprise.                        straightforward in the private sector - one
between $343,000 (discounted at 9%) and                                                           simply refers to historical market returns.
$520,000 (discounted at 0%). By dividing        FUTURE WORK ON THE SROI                           But the newness of the SROI and lack of
these returns by the investments required                                                         historical “social operating ratios” mean that
to generate those benefits, an SROI per-        While the REDF’s work to date on the              no such standards exist in the nonprofit
formance measure could be derived.              SROI is significant, the analysis requires a      sector.
    The potential application of the SROI       number of refinements. To capture more                REDF is currently compensating for the
analysis goes beyond simple planning and        precisely and accurately the socio-economic       lack of industry benchmarks by using dif-
monitoring. As nonprofits begin to docu-        value of social purpose enterprises, four         ferent discount scenarios for each invest-
ment the true value of their work, the tenor    major improvements are required.                  ment under consideration. The discounts
of their discussions with the public sector          One is to find a better way to estimate      range from 0% to 25%, each with different
and other funding sources can change. The       the true “cost of capital” or “discount rate”     assumptions. Though imperfect, this ap-
agenda can now include the linkage of fund-     of the philanthropic dollars invested in an       proach provides decision-makers with a
ing to demonstrated impact. By so doing,        organization. As with any private sector in-      better sense of the true value of their in-
the SROI cash flows are converted into ac-      vestment, philanthropic investments carry         vestment until a better method is devised.
tual, real-dollar funds that can be used to     an opportunity cost. Each dollar invested             Ultimately, REDF plans to create its
finance the operations of the nonprofit en-     in the social purpose enterprise might have       own standards based on the historical per-
terprise.                                       been invested elsewhere, generating an-           formance of its investees. The experience
    Again, like any measure of socio-eco-       other, perhaps better, return. Investors fac-     of creating this mini-market, and the stan-
nomic value, SROI analysis does not at-         tor this into their calculation as a cost in      dards it generates, will be instrumental later
tempt to quantify and capture all the ben-      order to determine the true value of their        on as the nonprofit sector systematically
efits that accrue from a successful program.    overall return.                                   begins to create its own industry standards.
SROI just estimates the cost savings or rev-         The integrity of the SROI analysis re-           The lack of data on historical SROI per-
enue contributions that result from that in-    quires that the organization and funder use       formance also makes it difficult to assess
tervention. But then, no informed inves-        an accurate discount rate. If the cost of capi-   the degree of risk associated with differ-
tor relies upon a single measure to under-      tal is overestimated, the calculated SROI         ent organizations and programs. A program
stand the worth of an investment. So            will be undervalued. Conversely, if the cost      with a target population requiring complex




                                               TABLE: SROI CALCULATIONS ($000s, USD)
  Time Period
              0          1          2          3          4          5           6          7          8          9         10            Perp

  Business Cash Flow
       $3,182         250        380        420        510        620         750        840        950      1,170      1,290           1,400

  Social Benefits Cash Flow
       $2,373         200        254        328        412        496         589        653        786        816        920           1,000

  Net Present Value

        $5,555
                  Present Value of the Benefits                                (NPV** Business Cash Flow + NPV Social Benefits)
                  Present Value of the “Costs”*                                 with Internal Rate of Return calculation provides:


                       Social Return Ratio                                                           SROI Rate
  * Present Value of the “costs” in this case is the grant equity contributed to the organization by government and foundation sources.
  ** Net Present Value

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Making Waves, Vol. 11, No. 2




and intensive support (e.g., previously in-      organizations attempt to isolate the value
carcerated youth) has a higher likelihood of     added by their program.                             REDF’s work on calculating return
failure than one that serves youth just out                                                          on social investment is a product in
of high school who seek employability skills.    RESPONDING TO POTENTIAL                             development. Its original frame-
    Private sector investors can refer to a      LIMITATIONS OF SROI                                 work was presented in New Social
quantitative measure of an investment’s                                                              Entrepreneurs: The Success, Challenge
volatility or risk compared to the overall       REDF and its investees are confident that           and Lessons of Nonprofit Enterprise
market. Similarly, philanthropic investors       in time they will make these four improve-          Creation (1996). The foundation’s
should have information that allows them         ments and tailor Return on Investment               recent second volume in that
to assess the risk of their investment in a      principles and measurement systems to fit           series, Social Return on Investment,
social purpose enterprise.                       the realities of the nonprofit sector.              describes many improvements to
    As in the issue of discount rates, REDF           Some practitioners and funders feel            the tool. In the fall of 2000, REDF
uses a range of statistical models to ex-        otherwise, however. No matter how con-              will publish an analysis of the
plore ways of determining co-efficients of       ceptually sound the SROI may become,                methodological challenges of
risk and factoring them into SROI calcula-       they see it is an inappropriate, even dan-          applying SROI analysis, as well as
tions. When coupled with the discount rates,     gerous, tool to use in the nonprofit sector.        “portfolio reports” that present its
the result should be an even more accurate       Let’s consider three of their major criti-          analysis of its investee firms. At
SROI analysis.                                   cisms.                                              the same time, REDF intends to
    A third challenge is the difficulty of as-        The first is that the SROI analysis pre-       post SROI templates for practitio-
sessing the relative value of different pro-     sumes that the organizations and programs           ners to use in their own SROI
grams or strategies. For example, one pro-       in question work with people who repre-             calculations. The advanced version
gram that employs at-risk teens may have         sent a cost to the public system – those            of these templates will allow the
an SROI of 34%. This program is not nec-         receiving social assistance, for example.           user to actually tweak ratios and
essarily better than an adult program with       However, some people are so far outside             formulas to reflect local conditions
an SROI of 22% that provides transitional        society’s mainstream that they receive vir-         and costs. Read and download
employment and educational support. Like         tually no public support (the chronically           REDF’s reports and other articles
apples and oranges, the two cannot be com-       homeless, for example). SROI analysis is            and publications at (URL)
pared.                                           technically inapplicable to programs which          www.redf.org. We recommend
    Over time, such comparisons should be        assist such people.                                 bookmarking that website to keep
easier as reporting standards are estab-              Were REDF to present the SROI                  track of the latest developments in
lished and similar programs can be grouped       framework as a definitive and comprehen-            REDF’s work.
into sub-sectors (e.g., microenterprise pro-     sive measure of a nonprofit’s value, this
grams for the homeless and training pro-         would be a critical concern. However, REDF
grams for homeless). Just as the for-profit      proposes the SROI as a way to capture one            This is quite possible. Even the best-
world recognizes different rates of return       dimension of a nonprofit’s work that gen-        intended efforts can easily be subverted
between Small Cap and Bond Funds, the            erally gets overlooked, i.e., socio-economic     by human nature. Some in the private sec-
nonprofit world could have different ex-         value. In the right circumstances, the SROI      tor misrepresent the value and financial
pectations of its sub-sectors.                   represents a powerful addition to the un-        situation of their companies. There is no
    The fourth and final conceptual chal-        derstanding and tracking of a nonprofit’s        reason to believe that it won’t happen in
lenge for REDF, as for every nonprofit, is       work. It is by no means meant for all pro-       the nonprofit sector.
to determine the degree to which social          grams in all circumstances. Nonprofits and           As serious as this concern is, however,
purpose enterprises are responsible for the      funders must therefore use the SROI judi-        we must not let it keep us from trying to
improvements in their target populations’        ciously and in combination with other mea-       improve our current systems of measure-
lives, and the socio-economic return asso-       sures that capture the broader social and        ment. It simply means that the sector
ciated with that improvement.                    economic value that a nonprofit generates.       must also create an environment that en-
    There is no easy way to determine                 A second criticism is that once the tools   courages honest dialogue and communi-
the causality (or “incrementality”) of a         are refined and standards are established,       cation. REDF is creating such an envi-
nonprofit intervention. The nonprofit            people will discover ways to “cook the           ronment by allowing investees to specify
sector has struggled with this meaty is-         books.” They will falsely document perfor-       the measures they feel best reflect the
sue for years. REDF and its investee             mance to make their SROI results mislead-        goals of their program.
firms are tackling it through a combina-         ingly impressive. The motivation to do so            A third criticism raised by skeptics con-
tion of a high-end client data tracking          will be particularly strong if grants and sub-   cerns the relatively sophisticated informa-
system and an auditing process in which          sidies are tied to a fee for performance.        tion systems required to use SROI prop-
                                                                      13
                                                                                                                     Making Waves, Vol. 11, No. 2




erly. While the SROI may ultimately be a        analysis. Rather, the analysis be applied and     objective performance standards for the
valuable tool, few nonprofits have the fi-      supported with good judgment.                     nonprofit sector as a whole, and, ulti-
nancial and human resources required to                                                           mately, to a greater infusion of much-
create and manage those systems.                INTO THE FUTURE                                   needed capital into the field.c
    REDF’s position is that if foundations
and government funders insist that non-         On the whole, the nonprofit sector has not        JED EMERSON is the president of the
profit practitioners provide measurable         aggressively addressed how to measure or          Roberts Enterprise Development Fund,
outcomes on their work, they should be          track the value it creates, social or economic.   located in San Francisco, CA. He is also
ready to underwrite the costs involved in           The SROI analysis is certainly not the        the Bloomberg Senior Research Fellow in
developing and using the necessary in-          only answer, but it does represent a sig-         Philanthropy at the Harvard Business
formation systems. In its efforts to cre-       nificant leap forward. SROI introduces            School, Harvard. From 1989 to 1996, Jed
ate its information system, for instance,       more rigorous measurement of nonprofit            served as director of the Homeless
REDF has invested over $750,000 of its          value creation, and ties that value back to       Economic Development Fund of the
own funds. Another $500,000 came from           the original investment.                          Roberts Foundation, an organization
the Charles and Helen Schwab Founda-                REDF believes that over time, the             assisting agencies with the expansion of
tion and $100,000 from the Surdna Foun-         widespread use of SROI and related                economic opportunity for homeless
dation of New York.                             tools, and the performance standards              people through the creation of small
    Each of the concerns described above        they help create, will lead to better pro-        business and related strategies.
is valid. But they do not justify discontinu-   gram management, improved account-
ing the development and use of SROI             ability and community ownership, more




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