FIVE

Public-Value Exchanges

New platforms that match capital to social need

Which of the following best assesses a student’s critical-thinking skills and command of knowledge of a given subject?

a. A multiple-choice test

b. An essay

Everybody knows that option B is the correct answer. So why are high school students often asked to write just three essays per semester? Because of the high cost of grading them. When professional graders score essay portions of standardized tests, the price tag runs from $2 to $3 per essay.¹ Multiplied by millions of students, that’s a hefty tab. Thus teachers make do with the less meaningful yardstick of multiple-choice tests because they’re easier to grade.

Multiple-choice tests are a scalable form of assessment. Fill in the ovals with your number two pencil, and a computer can grade your test. But what if a computer could grade your essay just as well as your teacher could?

In spring 2012, the William and Flora Hewlett Foundation sponsored a $100,000 competition to find algorithms to replicate the scoring of human graders. It partnered with Kaggle to tap a global community of data scientists. Kaggle is a web-based exchange—a statistical/analytics platform that runs predictive-modeling competitions.

This competition began with scoring data. Kaggle provided the entrants with thousands of hand-scored essays from schools across the country. Competitors had three months to build a software engine to “read” and grade the essays, and the program best able to match the scores given by human experts would win the purse—and the bragging rights.

Ten years ago, nothing like Kaggle existed. The idea of a permanent virtual gathering of geeks pitting algorithms against one another to solve real-world problems was the stuff of cyberpunk. Today, it’s a reality and a key part of the solution economy.

Kaggle is the brainchild of Anthony Goldbloom, who was a young Australian civil servant in 2007 when he entered an essay competition and won a three-month internship at The Economist. While working there, he became fascinated with big data and data mining. He had dealt with data analytics while working for the treasury in Australia, but thought little of it; at the time data analytics was just a way to predict abstract factors such as unemployment. At The Economist, however, he began to see its game-changing potential.

To Goldbloom, the potential of data analytics seemed nearly unlimited. But he noticed two things limiting its growth. First, even sophisticated companies found it difficult to assess the actual capabilities of data scientists, because their capabilities often had little to do with their grades or courses completed. Second, data scientists often lacked the data they needed to refine their techniques and test them against real-world outcomes.

After returning to Australia, Goldbloom taught himself to write code and launched Kaggle, kick-starting a global exchange of algorithms. Kaggle organizes competitions according to specific data problems, with the most accurate predictive model winning.

By the time Kaggle hosted its essay-scoring competition in 2012, the platform had grown to a user base of more than seventeen thousand data scientists from fields such as computer science, statistics, econometrics, math, and physics.² Competitions had already yielded improvements to various tasks, including the forecasting of travel times on Sydney highways and the creation of a genetic blueprint that predicted the progression of the HIV virus. One of Kaggle’s most fascinating innovations was the competition itself, an enticement for thousands of data specialists worldwide to work on a single problem.

“If you’re a lone traffic forecaster, you might try a few things and then stop,” explains Goldbloom. “But the cut and thrust of a competition pushes data scientists to do better than they otherwise would.”³ Goldbloom also notes that entrants, hailing from unrelated disciplines, benefit from a lack of preconceptions. You don’t have to figure out whether the geeky guy or gal trying something new is a little nutty or a genius; the results of the competition will tell you that.

One Kaggle competition sponsored by US, UK, and EU space agencies involved new algorithms to measure the way dark matter causes distortions in images of galaxies. Within a week of the competition’s launch, a glaciologist from Cambridge University, Martin O’Leary, outstripped ten years of astronomical research by applying techniques used to map glaciers from satellite images to construct an algorithm that could map dark matter in space. Other competitors, including a pair of UC–Irvine astronomers who edged out O’Leary in the final stretch, eventually improved on his algorithm. Nevertheless, in deference to O’Leary’s breakthrough, the White House announced that “the study of glaciers on Earth has now deepened our understanding of the cosmos.”⁴ The price tag for this truly astronomical breakthrough: $3,000.⁵

“One great thing about competitions is that [you] don’t need to justify any experience in a specific field to enter,” says Xavier Conort, an actuary based in Singapore. Conort improved credit scoring by accurately predicting individuals most at risk of financial distress two years before they file for bankruptcy. “Only my final result matters, so it’s a great platform to learn new things.”⁶

Kaggle’s model attracts solvers with simple but effective game mechanics such as its global ranking system and real-time leaderboard. “It’s hard to resist entering a competition when I see people I know at the top of a leaderboard,” says Conort.

The key to Kaggle’s success is the real-world factor. “I liked the problem because it’s an interesting dataset, and a problem which comes down to a lot more than just number-crunching,” says O’Leary, explaining why a glaciologist would enter a contest to score essays.⁷

Competition prompts collaboration. Wildly disparate groups are spurred to cross disciplinary boundaries, generating new insights. In any given competition, you might have quant gurus working with business experts, Russian physicists solving problems for the National Aeronautics and Space Administration (NASA), or a glaciologist like O’Leary studying syntax. Kaggle’s exchange accelerates this sort of cross-fertilization, giving contest hosts inexpensive access to thousands of professionals and potentially saving months or years of R&D.

Sometimes the stakes can be relatively high. In the Heritage Health Prize, for instance, an HMO is offering a $3 million prize for an algorithm to help health-care providers reach patients before emergencies occur. Contestants use historical insurance claims data to identify patients destined for the hospital; the prize money will compensate for the intellectual property rights of the winning model. In this case, a $3 million investment could help capture some of the $30 billion wasted annually on unnecessary hospital admissions—and save thousands of lives.⁸

In the Hewlett Foundation’s essay scoring battle, the $100,000 investment brought in many times that amount in resources applied to the problem, producing an astonishingly accurate algorithm that can closely predict the scores of a skilled human grader. Martin O’Leary placed sixth working solo—again, very close but just short. The prize instead went to a team including a data analyst for the National Weather Service, a British particle physicist, and a graduate student from Germany, none of whom had a background in education.

This exchange didn’t involve a buyer and seller. It represents a new recipe: an algorithm exchange and virtual community that draw on new currencies such as data and reputation, with results that are a testament to the power of crowdsourcing.

New Models of Exchange

Kaggle’s ability to engage data scientists across the globe demonstrates the powerful pull of two currencies discussed in chapter 4: data and reputation. Many companies and governments are awash in a sea of data. Contestants, by contrast, are hungry for data, and Kaggle offers them the real-world data sets they need to hone their edge. Through Kaggle, for-profit companies, nonprofits, and governments can outsource their data analysis, while contestants enjoy a free forum in which to build skills, exchange ideas, and test their products. In combination, they present an ideal example of an innovative twenty-first-century exchange.

As with Code for America (discussed previously), which persuades midcareer developers to accept lower salaries in return for creative license and citizen stripes, motivations extend beyond money. The thrill of the challenge, the ability to make a real difference in the world, and the bragging rights—not to mention job prospects—that come with success can be a bigger payoff than the prize money.

Unsurprisingly, new models of exchange are critical to the solution economy. They hold the secret to attracting capital of all types and from all sources and applying it effectively to societal problems at whatever scale is needed.

Advancements in web technologies allow people to connect with unprecedented ease. Today, a fifth of American relationships and 17 percent of marriages can be attributed to matchmaking sites such as eHarmony and Match.com.⁹ A history buff in Montreal can bid on eBay for a piece of the Berlin Wall that’s collecting dust in a garage in Munich. An investment banker in New York can use Catchafire, an eHarmony of sorts, matching skilled professionals with nonprofits, to find a volunteer opportunity with a nonprofit that needs help with market research.

Wikipedia, eBay, Facebook, and other platforms create communities of users and deep pools of shared information. Positive reactions from other users motivate further interaction, a key ingredient both for scaling virtual communities and for building the critical mass that keeps an exchange interesting. Savvy organizations recognize how people’s social and transactional needs converge through online exchanges, and seek to cultivate both. As John Hagel and John Seely Brown explain, when participants in virtual communities connect and develop relationships, they can also create value for their hosts, a practice called “co-creation.”¹⁰ The LEGO Group, for instance, increasingly relies on its online fan base not only for ideas for new products but also for help with their design. Kaggle does the same through Kaggle Prospect, which lets organizations solicit ideas for producing value from their data from a community of experts. By encouraging people to share knowledge, networks such as Facebook and Twitter build trust among strangers, further nurturing a propensity for sharing.

“We’re moving from passive consumers, to creators, to highly enabled collaborators,” says author Rachel Botsman, who coined the term collaborative consumption.¹¹ Botsman points to the rapid evolution of the car market. As we noted earlier, in just ten years exchange models have altered the necessity for car ownership, yielding car-sharing platforms such as Zipcar, ridesharing platforms, and the newest exchange model, peer-to-peer car rental.

Exchanges provide mechanisms for the use of new, nonmonetary currencies. Catchafire trades intangibles such as expertise, while carbon exchanges trade specific environmental impacts and peer-to-peer systems trade reputation. Services such as Couchsurfing—which allows people to open their homes to travelers for free, through a platform based on their profile and reviews—are becoming as natural to many as booking a bed and breakfast. It turns out a lot of folks are happy to have strangers crash at their house, provided the visitors are the nice and hip and interesting sorts of people who have garnered good reviews on Couchsurfing. As one surfer told us, “Couchsurfing is the perfect marriage between technology and trust.” The platform is self-sustaining—the more people who join the network and provide peer-to-peer feedback, the greater the site’s impact and international reach.

In general, exchanges connect people with a need (for a ride, a place to crash, a problem solved, etc.) with someone who can meet that need and is willing to do so, for fun, profit, or sheer altruism. New models of exchange are finding innovative ways to move money and resources to the projects and individuals who need it most—and can generate the best outcomes (figure 5-1).

Many exchanges connect borrowers with nontraditional lenders. Crowdfunding a business may soon become as common as a loan from the bank. Supporters of crowdfunding exchanges such as Kickstarter invest to get early rewards and to show their appreciation of the project’s intrinsic value. As of January 2013, more than eighty-three thousand projects had been launched on Kickstarter, with a success rate of nearly 44 percent. These projects raised more than $464 million.¹² And the donations pass through another exchange, Amazon Payments.

FIGURE 5-1

In simple cases such as ridesharing and volunteerism, public-value exchanges can open vast new markets of citizen capital (time, talent, and tangible assets) that can be shared and traded to meet public needs while avoiding demands on the state. These new social exchanges have found their way into the commercial sector as well. The Johannesburg Stock Exchange, for example, runs the first socially responsible investment index in an emerging market, recognizing companies that meet environmental and social criteria.

From fixing neighborhood parks to addressing global infant mortality, new methods of pooling resources and directing investments to social issues are rapidly expanding.

Two-Sided Markets

For centuries, most businesses operated under some variation of the old manufacturing model: they built a product and sold it to a wholesaler, which sold it to a retailer, which in turn sold it to a consumer. Each transaction was a negotiation between a buyer and seller.

Recently, however, economists have begun noticing the emergence of two-sided markets and networks.¹³ In these markets, an exchange connects two parties—as an Xbox connects avid gamers with game designers, Craigslist connects landlords with renters, and Airbnb connects beds with travelers.

Unlike a traditional sales transaction, the two-sided market links the creator and consumer directly and protects both. It attracts participants by providing protections and standardizing transactions, reducing the cost of structuring a deal each time.¹⁴

eBay, for instance, unites sellers and buyers. To ensure a minimum standard of service, eBay lets buyers rate users. To ease shopping, it offers an internal search function. Both of these attributes, quality and search, improve with a large user base: the more participants, the more valuable they are to each side of the market. A high volume of sellers increases your likelihood of finding that 1992 Eric Lindros rookie card, and more user ratings let you know which seller to trust. And if you realize it’s a fake after it arrives? You have recourse through eBay customer support.

Successful two-sided markets tend to subsidize one side, giving the market a money side and a subsidy side. Search engines, for example, charge advertisers but not searchers.

With faster internet service and the ubiquity of mobile devices, two-sided networks are thriving. Ridesharing services, described earlier, epitomize these networks. Lyft, for example, offers a phone-based platform that enables users to geolocate nearby registered drivers and ask for, well, a lift. The company provides the platform; drivers and passengers share the cost of commuting. Drivers receive funds to offset their fuel cost and often gain access to high-speed high-occupancy-vehicle lanes. Passengers get safe, reliable transportation without the hassles of full car ownership. And the company that connects them gets a cut of the revenue.

“This shift in power to the consumer and citizens is not temporary or the product of faddish technology,” writes Simon Mainwaring in his recent book We First. “It is clearly one of the most fundamental and enduring characteristics of the modern digital world, and it will influence how capitalism moves forward.”¹⁵

Transportation is just one area in which two-sided markets can address a broader societal issue. Another is retraining people in an era of exponential technology change, in which skills quickly become obsolete. To address one of society’s biggest challenges, governments spend huge amounts of money on retraining, but the results are unclear at best. In the United States, the General Accounting Office evaluated forty-seven job training programs, whose combined cost was $18 billion annually. The office noted that “only five programs have had an impact study completed since 2004 to assess whether outcomes resulted from the program and not some other cause.”¹⁶

Job training schemes in Great Britain face similar criticism. According to the National Audit Office, the British government’s new training programs are “underpinned by assumptions about likely performance, but there is a significant risk that they are over-optimistic.”¹⁷

Two-sided networks pose a different solution: perhaps citizens could retrain each other. In the same way that ridesharing platforms connect drivers to passengers who need a ride, two-sided markets could connect those who can teach a skill to those who need it. Indeed, numerous start-ups are building exchanges for citizens who want to trade on their expertise.

Several peer-to-peer learning companies, including Skillshare, School of Everything, and TeachersPayTeachers, understand that the best person to teach a lesson is often someone who has just mastered it. SkillKindle, a Delhi-based start-up, marries the virtual world with in-person instruction.¹⁸ SkillKindle classes, both in-person and via the internet, range from traditional academic subjects such as English as a second language to more contemporary pursuits such as writing code.

Avi Flombaum, a former chief technology officer of a small tech start-up in New York City, quit his day job to become a full-time Skillshare teacher, making $100,000 teaching in 2012.¹⁹ His success illustrates the rising demand for tech talent and a new mechanism for delivering it. A programmer by trade, Flombaum notes that Skillshare offers a lot of tech-inspired classes precisely because the market demands them.²⁰

Flombaum is proof that services such as Skillshare can fill a critical knowledge gap. “You cannot learn ‘How To Start A Blog’ in college,” he says. “Anything that’s tech, the education industry has really fallen behind on providing to people, so it just makes sense that Skillshare offers that.”²¹

Of course, there are limits to these two-sided exchanges. Peer-to-peer training may train citizens but may fail to link unemployed workers with future careers. And today, it lacks the networking capabilities of traditional welfare-to-work training or apprenticeship programs.

These exchanges, however, are quickly growing in sophistication. Udacity, the online, open-source university cited in chapter 3, offers pupils the sort of career services once exclusive to physical institutions. It even offers an option to pass enrolled students’ résumés to one of its twenty partner companies. While Udacity is not exactly a peer-to-peer platform, many of its features resemble those of Skillshare and SkillKindle, and it’s not hard to imagine similar career services being offered to peer-to-peer participants in the near future. Platforms that specialize in high-demand skills are understandably ahead of the game, with recruiters pushing for early access to top talent. Students who take one of General Assembly’s online and in-person tech courses can get reimbursed for the tuition costs if they join one of the partner companies.²²

The public sector must think carefully about how it regulates this space, or risk citizen backlash. Already, regulators have been struggling to define how to manage new participants in two-sided economies such as Airbnb and Uber. The learning space, and job retraining in particular, is certain to face significant government scrutiny. Minnesota briefly prohibited colleges from offering unaccredited programs such as Coursera without first registering with a regulatory body. This prohibition lasted a day, before widespread citizen complaints about the outlawing of free online education forced the state to rescind the ruling.²³ While the regulatory instinct often is to provide safety nets for citizens in an informal economy, such reactions can hinder the success of potent two-sided marketplaces.

Crowdfunding

Let’s say you read about a sustainable aquaculture farm that is bringing much-needed revenue and nutrition to a poor rural region. Previously, you’ve had little opportunity to invest, and you probably wouldn’t feel comfortable sending money to someone five thousand miles away. But the microlending platform Kiva allows anyone with internet access and a little capital to fund ventures around the world. To date, more than 1.3 million Kiva users have shared nearly $400 million in loans for efforts in sixty-nine countries.²⁴

Kiva does not itself manage or even prioritize among projects. It leaves those matters to the market it has created and then provides quality assurance. Field partners on the ground screen borrowers, whose loan history and records of repayment appear on the platform, providing transparency to lenders.

A diversified base of borrowers and small loan amounts make Kiva more comfortable serving regions that would unnerve more traditional establishments. Kiva president, Premal Shah, has noted that in postconflict zones such as Sierra Leone, high repayment rates on Kiva loans offer a “demonstration effect” to other organizations, showing that the region is more stable than previously thought.

Entrepreneurs without a prayer of finding nearby funders outside the local loan shark gravitate to platforms such as Kiva to raise capital directly from networks of supporters. This practice of crowdfunding connects social entrepreneurs to the potentially enormous impact of socially conscious citizens.

Crowdfunders have a more personal stake than do traditional investors, usually being motivated as much by social impacts as by economic returns—a clear demonstration of a new type of currency in action. As a consequence, these lenders often double as customers, beta-testers, focus groups, and informal marketers. Most crowdfunding begins with a “friend phase,” drawing funding from people the entrepreneurs know and then strengthening these relationships.²⁵

More Than Me, for example, began as an enterprise to employ and educate Liberian women after fourteen years of civil war.²⁶ The organization needed start-up capital. Founder Katie Meyler decided to pass on grant writing, in favor of making a direct appeal to her social network.

“I don’t have the first clue how to raise money from big-time investors, but I know hundreds of people who believe in us,” she explains.²⁷ Volunteers donated experience and time. One even drafted the organization’s business plan. Instead of a single powerful benefactor, Meyler used a network of engaged benefactors and one powerful idea. Its network of supporters is More Than Me’s strongest currency and the foundation of this model’s success.²⁸

A third party in crowdfunding is government, which sets the regulatory constraints. The 2012 Jumpstart Our Business Startups (JOBS) Act, for example, simplifies the US requirements for crowdfunding and standardizes rules nationwide. Under JOBS, cash-hungry ventures can solicit the public for early-stage equity financing, a previously illegal activity. The law also increases the number of shareholders that can invest in a company before triggering SEC reporting requirements. Under this provision, start-ups enjoy greater flexibility and more time to perfect their operations before entering public markets.

Crowdfunding sites cater to lenders’ individual interests. Sellaband lets supporters buy a stake in a new music album, motivating them to promote it. Emphas.is crowdfunds photojournalistic investigations, freeing journalists from editorial restraints. Crowdrise, a philanthropic platform, makes it easy to tap social networks to sponsor a charity run or, in times of crisis, to channel money toward a community in need. ResearchGate lets scientists crowdfund research projects.

Michael Norman, cofounder of WeFunder, sees crowdfunding as an ideal way to fill the lag between fast-evolving citizen demands and steady government resources, noting that crowdfunding is perfect for “social enterprise models that have a very good chance of reaching sustainability and being a good business, but are never going to create that kind of home run that a VC needs to justify an investment.” Because they focus on important social problems, “those companies also really access the excitement of the crowd.”²⁹

What’s more, support networks are transferable. A blogger can transfer his or her network to a crowdfunded project simply by posting a link. Stephen Colbert calls the transfer of his educated fan base to a cause “the Colbert Bump.” The Yellow Ribbon Fund received $350,000 after a few Colbert-led efforts to focus his network’s attention on the charity, which helps wounded American soldiers. How is this different from traditional celebrity endorsements? The key is speed and scale. The Chicago Tribune estimates that Colbert’s viewers raised $3.5 million for various causes between 2005 and 2011.³⁰

At least fifty-six countries have crowdfunding exchanges.³¹ Brazil’s Catarse.me is crowdfunding an employment project for a slum in Rio de Janeiro. The Idea.me platform, which functions much like Kickstarter in Latin America, has just expanded from Argentina and Chile to Mexico.

The number of crowdfunding exchanges worldwide by 2013 was 536. That’s a fivefold increase from 2007, representing significant volume: the industry raised $1.5 billion in 2011, funding more than a million initiatives. This total is likely to hit $3 billion in 2013.³² And these numbers don’t include NGO campaigns that also tap the philanthropic power of the crowd. Governments have also begun to get in the game with Philadelphia and other cities launching crowdfunding platforms to fund local projects like tree planting and park restoration.

But some of the early investors have witnessed enough to be wary, pointing to Kickstarter projects that in concept sound cool but take longer than expected to yield a final product, or perhaps never get off the ground. One study found that fully 75 percent of technology and design projects on the platform didn’t finish on time.³³ Kickstarter doesn’t take this criticism lightly. To prevent investors from defecting, Kickstarter requires project creators to refund investors in the event of a nonperforming project.

The next innovations may combine crowdfunding with other forms of crowdsourcing such as crowd voting and crowd labor. In Washington, DC, Popularise invites locals to vote on new uses for dilapidated buildings, allowing developers and site planners to learn what nearby residents prefer. “Popularise is the 21st-century version of a community meeting,” explains founder Ben Miller.³⁴

The ideas behind Popularise may herald a paradigm shift in the intersection between crowdsourcing and crowdfunding. Popularise paved the way for Fundrise, a start-up that allows individuals not only to vote on, but also to take an equity stake in, real estate developments.³⁵ “By tying together the crowdsourcing of public spaces with the crowdfunding of ideas, we become owners in new ways,” says Peter Corbett of iStrategy Labs.³⁶

Impact Exchanges: Connecting Investor to Enterprise

We’ve seen how crowdfunding exchanges help regular people invest in good causes. But the $1.5 billion raised through crowdfunding in 2011 is only a blip next to global equity markets, which even in a weak economic year stood at $45.7 trillion.³⁷ Social investment, however, represents a growing portion of those equities.

Social investment opportunities are flourishing. Investors find it increasingly easy to use their funds to earn returns and reward socially conscious, publicly traded businesses, which account for 10 percent of all managed assets. The number of funds that exclude industries or companies because of social concerns has risen from only fifty-five globally, worth $12 billion in 1995, to more than seven hundred mutual funds spanning $1 trillion in investments in 2012.³⁸

Greater corporate transparency is one reason that investors can easily choose socially conscious businesses. The rise of stock exchanges that require social and environmental standards for listed companies is another. For instance, both the Johannesburg Stock Exchange in South Africa and BM&FBOVESPA in Brazil have pressured listed companies to improve their standards of responsible governance and sustainability. Those scoring highly on the Brazilian exchange even secure a spot on the Novo Mercado, an elite listing board.³⁹ The public sector is also influencing the investment landscape through social-impact bonds (SIBs), a new form of funding social outcomes that we discuss later in the chapter.

While these are positive developments, even funds labeled “socially responsible” vary in the scale of the social impacts they deliver. There is a significant difference, after all, between simply avoiding companies that do harm and funding enterprises that spark positive transformation.

Fortunately, several socially and financially blended investment products have emerged. At one end of the spectrum, a crowdfunding exchange offers the grassroots intimacy of investing directly, although with less certainty that the entrepreneur will actually meet the social objective and repay the loan. At the other end of the spectrum are socially responsible investment funds. These provide more financial certainty but exclude smaller entities and offer limited visibility for the investor into any social benefits an investment produces.⁴⁰ In between these extremes are impact investments that fund social enterprises; these deliver more-direct social improvements, but may offer more modest financial returns.

Gauging social returns is no easy feat. For the most part, financial ratios and credit ratings traditionally employed to select investments lack equivalents in the social-impact arena. Social metrics often vary; a microfinance enterprise may cite microfinance operating efficiency and communities served, while an NGO distributing water filters measures potable water produced and a solar company estimates reductions in greenhouse gas emissions.⁴¹ Evaluating social returns is still largely a human rather than an algorithmic exercise.

Singapore-based Impact Investment Exchange Asia (IIX) raised $70 million in its first year by individually matching investors to social enterprises. The UK think tank Nesta considers informed financial planners “gatekeepers, influencing the deployment [into impact investment] of a significant proportion of the UK’s wealthy retail investors’ funds under management.”⁴² Planners can help investors navigate the challenging, personal questions an exchange alone cannot solve: does this investment fit my asset allocation model? Is it philanthropic? What is my risk exposure with this combination of investments? These questions can be uniquely difficult to answer in the context of impact investment, where the lines between social and financial returns are deliberately blurred.

Impact investing also differs in time horizon. Resolving societal problems requires patience, but a couple saving for a child’s college tuition needs liquidity. For such investors, IIX plans to develop a liquid market for social-impact securities with an online exchange for debt and equity in social enterprises.

Fortunately, many drawn to impact investment realize the complexity of the underlying challenges and are comfortable with a longer time horizon as long as they receive routine updates. When exchanges require such information, investors can compare social impacts across enterprises more easily.

Regular investor updates, similar to quarterly earnings reports required for a listing on the New York Stock Exchange, are another key advantage of centralized exchanges. Valuing the independent evaluation and consistent reporting these exchanges provide, investors use these features to compare options.⁴³

Mission Markets, a new stock-exchange system offering shares worth more than $336 million in double- and triple-bottom-line companies, requires businesses to carry one of a few approved third-party assessments, ratings, or certifications.⁴⁴ Standards such as the Global Impact Investment Rating System and B corp certification have emerged to meet this need.

As global impact investment grows, emerging options are helping eliminate the old trade-off between effective social involvement and competitive financial returns. The RSF Social Investment Fund (offered by RSF Social Finance), for example, allows a middle-income mother to invest in the small manufacturer of her child’s biodegradable diapers—and earn healthy returns while doing so. While some impact investors are ready to accept below-market returns, the RSF Social Investment Fund has actually outpaced the S&P 500 for the past decade. It is just one of two hundred impact investment funds worth a combined $50 billion operating today.⁴⁵

Even with these advances, the current market vastly underfunds early-stage social investment. Our Monitor Deloitte colleagues call this the “pioneer gap.”⁴⁶ Monitor’s research in Africa found that only six of eighty-four funds investing in the continent offered early-stage capital.⁴⁷ New ideas serving marginalized populations strike many investors as too uncertain.

On the other hand, for brave investors like Gloria Nelund, a former executive at Deutsche Bank, this pioneer gap is a call to action. “I interviewed probably 30 funds that at least peripherally called themselves social-impact funds or social-focused funds,” she told us. “In those interviews, every single one of them said their biggest challenge was attracting capital. That is when I knew how my background and experience could help scale the impact investing industry.”⁴⁸ Nelund left investment banking to create TriLinc Global and its $1.5 billion Global Impact Fund.⁴⁹

Trilinc’s Global Impact Fund serves the “main street,” a surprisingly novel move in an industry that offers few investment options for middle-class impact investors seeking competitive returns. Nelund is struck by the irony: “As we [in the industry] talk about issues impacting ‘the missing middle’ we are actually creating a missing middle, by only letting the elite participate in this new asset class.”⁵⁰ By contrast, the minimum investment in Trilinc’s fund is $2,000, allowing a much broader swathe of investors to contribute toward social enterprises in developing countries—enterprises carefully chosen to support the fund’s targeted 7 percent annual returns. In a weak financial market, that’s enough to make even those unacquainted with impact investing take notice.

“Changing behavior begins with creating products that look, act, feel, and are even distributed like traditional investment products,” Nelund explains. “We want to be a catalyst to help the industry grow.”

With social-impact exchanges rapidly maturing and new funds such as TriLinc gaining momentum, participation in the solution economy is growing dramatically. J.P. Morgan anticipates the social-impact investment market to reach between $400 billion and $1 trillion by 2020.⁵¹

Another way anyone from regular citizens to world-class scientists can participate in the solution economy is by entering the growing number of competitions geared to solving big problems.

Prizes for Public Value

On April 20, 2010, a blast rocked the Deepwater Horizon drilling rig in the Gulf of Mexico. Flames engulfed the collapsing platform as rescuers evacuated more than one hundred oil workers. A plume of oil billowed into the ocean.

The Deepwater Horizon oil spill pumped 2.5 million gallons of oil per day into the Gulf of Mexico, ultimately costing the region’s fishing industry billions of dollars. Such accidents are an increasing concern given the rise of deepwater drilling; at least thirty-five platforms in the gulf produce oil from a thousand feet below the ocean’s surface. Clearly, improved oil recovery technology is an urgent need.

The Wendy Schmidt Oil Cleanup X Challenge was intended to inspire R&D into oil spill cleanup.⁵² The challenge specifically aimed to double the industry’s best oil recovery rate to 2,500 gallons per minute and to improve the efficiency of oil collection by 70 percent—exceedingly ambitious goals.

The challenge lured three hundred and fifty teams, of which two actually met the demanding criteria. The winner, Elastec/American Marine of Carmi, Illinois, designed a system that dipped rows of grooved, rotating disks into the water perpendicularly, lifting goopy oil at the start of the rotation and scraping it off before it returned to the water. The invention, resembling a floating combine harvester, collected 4,670 gallons per minute, almost quadrupling the industry’s former best effort.

Outsized results such as these highlight the utility of contests. Prizes and challenges convene the brightest minds from multiple fields and can elicit collaboration in unique ways.

Incentives for public-value-producing innovations range from the Ensign Group’s $150,000 Eprize, for innovations in nursing-home care, to awards of $10 million or more from the X PRIZE Foundation.⁵³ The organizers set a challenge, offer a prize, and then stand back as a horde of smart, ambitious people vie to produce the best solution.

Challenges are important for the solution economy; they unite problems with problem solvers, filling holes in business models that cater mostly to traditional buyer-seller relationships. As journalist Tina Rosenberg observes, prize programs engage problem solvers often neglected by traditional initiatives such as university research programs. And unlike patents, prizes can spur and reward innovations that don’t promise an immediate payback in the marketplace.⁵⁴

Prize programs also offer a cost-effective alternative to traditional government procurements. They eliminate trade-offs in a way that typifies the solution economy: traditional procurement funds approaches, whereas prizes reward results. And while the procurement system favors players with traditional credentials and proven track records, competitions accept anyone, thereby multiplying the number and diversity of brains tackling the problem.⁵⁵

Furthermore, contests promote the comingling of ideas in a way that isolated, closed-door R&D efforts can’t. In open contests, ideas can build on one another, as with the astronomers who perfected a glaciologist’s model of dark-matter detection for Kaggle. It’s a competition, but it often nurtures collaboration.

Not all problems lend themselves to challenges, but those that do can reap impressive results. Even the losing proposals can advance an industry. The $10 million Ansari X Prize spurred twenty-six teams from seven nations to invest more than $100 million in space flight, investments that may accelerate development in technologies ranging from rocket fuel to seat belts. Such a tenfold return on investment is not uncommon for prize challenges.⁵⁶

The US government now uses prizes extensively. Challenge.gov, launched in September 2010, provides an online platform that federal agencies can use to create competitions. Within its first two years, Challenge.gov posted 212 challenges from forty-eight federal agencies and awarded more than $34 million in prize money.⁵⁷

The principles of good competition design are fairly universal. Luciano Kay of the Georgia Institute of Technology’s School of Public Policy says a successful prize program will involve a challenge that is exciting and ambitious, yet achievable. Not every problem lends itself to a challenge. The sponsor should define the problem simply enough to declare a winner without controversy, yet leave room for numerous creative approaches.⁵⁸ As NASA’s Jenn Gustetic puts it, many challenges seek unspecified solutions to specific problems.⁵⁹

Joe Parrish and Jason Cruzar from NASA have overseen dozens of challenges. Like Kay, they say that the objectives of the contest should be “simple enough to explain in one breath.” In their experience, if a goal is broadly applicable, where participants stand to gain additional value out of their competing concept, commercial enterprises want in since the enterprises will retain the intellectual property.⁶⁰ Contests structured like NASA’s offer opportunities beyond the prize itself—a chance for the winners to take their innovations and run with them.

As the Wall Street Journal reports, critics “dismiss the newest trend in prize-giving as a form of advertising that masquerades as public service—and a clever ploy to attract top research talent at a discount.”⁶¹ But sometimes, publicity is exactly what a public service needs, as when the US Veterans Administration increased access to its Blue Button health-care service with a contest specifically designed to raise awareness about it.

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QUALITIES OF A GOOD PRIZE CHALLENGE

• Is open to anyone

• Is amenable to cross-disciplinary approaches

• Is challenging

• Has simple objectives, multiple potential solutions

• Has broad market potential

• Enables losers to emerge with valuable developments

• Oft en encourages open-source iterations

• Has potential to attract angel investors

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NASA’S OPEN INNOVATION CHALLENGE MODEL

NASA’s Open Innovation initiative releases challenge statements, via Inno-Centive and other platforms, to solicit solutions from as many disciplines as possible.^a

NASA developed Open Innovation in response to budget cutbacks. When 45 percent of the Constellation program’s budget was cut in 2005, Jeffrey Davis, director of the Space Life Sciences Directorate at Johnson Space Center (JSC), recognized that JSC’s goals couldn’t be reached “just doing 45 percent less. We need to approach this whole program in a new way.”^b

NASA’s first three challenges, issued in late 2009, drew 1,217 initial responses from sixty-five countries. The administration ultimately selected and evaluated 128 entries. The challenges asked contestants to learn how to keep food fresh for as long as three years; to design a zero-gravity resistance mechanism for exercise in space; and to devise a way to forecast solar activity so that NASA could schedule launches to minimize exposure to harmful radiation. NASA’s challenges have generated a variety of breakthroughs. The Green Flag Challenge, for instance, sought to attain superior aircraft fuel efficiency by beating the industry standard of 20 passenger-miles per gallon. The winner attained a remarkable 406 passenger-miles per gallon. The top four entrants spent $5 million collectively designing their super-fuel-efficient aircraft.

Joe Parrish, a deputy manager in NASA’s Jet Propulsion Laboratory, estimates that NASA received more than $3 in research and development benefits for each dollar it spent on the prize. “The Green Flag Challenge was one of our smallest expenditures yet one of our biggest achievements,” Parrish says.

a. Sander Olson, “X-Prize Director Describes Incentive Prizes in an Interview with Sander Olson,” Next Big Future, June 3, 2011, http://nextbigfuture.com/2011/06/x-prize-director-describes-incentive.html.

b. Andrea Meyer, “Frugal Innovation at NASA,” Working Knowledge, August 1, 2011, http://workingknowledge.com/blog/?p=1522.

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Clearly, prizes for a few superlative inventors cannot sustain an entire scientific community. X Prize’s Erika Wagner says, “Prizes aren’t good for stimulating basic science, and we need to have a strong science infrastructure in this country.”⁶² But by creating a forum that links problems with potential problem solvers, challenges provide a powerful vehicle to unite talent worldwide in fruitful collaborations.

Pay for Success

From the outside, Doncaster Prison, about an hour’s train ride from London, looks like any other—it’s big, imposing, and drab. Step inside, however, and it resembles a mixture of job training facility and community center. Bright signs cover the walls with warm and fuzzy proclamations such as “People are our business.” A “Night at the Musicals” poster and sign-up sheets to watch the play Oliver adorn multiple walls painted in bright shades of blue and yellow. For those aspiring to the stage, there’s a chance to work at Second Shot Productions, a social enterprise housed within the prison walls and specializing in theater, television, filmmaking, and graphic design.

The production company, along with several other organizations, is housed within the prison’s resettlement wing, where prisoners spend their final three months before being released back into the free world. The wing is designed to replicate the outside community within the prison walls. Case managers coordinate intensive job training, job readiness, and reintegration services, all directed toward preventing inmates from returning to prison. This is a huge departure from most prison systems, which leave released inmates largely on their own to deal with the shock of reintegration into society.

Operated by privately owned Serco Group, Doncaster Prison is part of a pathbreaking experiment to reduce recidivism by aligning provider payments with outcomes, with the ultimate goal of reducing the prison population without spurring an increase in crime. Ten percent of Serco’s payments from the government are contingent on reducing recidivism by at least 5 percent. If Serco fails to achieve the target, the company is out a cool £2.5 million. It’s a bold experiment, to say the least.

“Delivering public services is not cheap,” explains Sean Mason, assistant prison director at Doncaster. “Getting it wrong is now quite expensive.”⁶³

The Doncaster Prison project is part of a much larger initiative. The UK government is engaged in an ambitious experiment to shift funding across a range of public programs—everything from welfare to work to youth services to offender rehabilitation—to focus on real-world results.

Naturally, exchanges are springing up around this concept. Pay-for-success (alternately called payment for results) exchanges connect buyers of social outcomes—typically governments, foundations, international development institutions, and corporate philanthropists—to solution providers, allowing buyers to shift from traditional contracts and grants to rewarding specific outcomes. As with prizes and challenges, this approach attracts new providers, new approaches, and radically new business models.

“Currently, the boundaries in which public service providers can innovate are quite narrow,” says Tom Gash of the UK Institute for Government. “Payment by results enables new business models to emerge.”⁶⁴ In this way, pay for success represents an important stage in the creation of functioning markets for social outcomes.

A pay-for-success system transcends departmental territoriality and allows providers to scrap experiments swiftly if they prove ineffective. Fast failures along the way can even be advantageous if they lead to improved results before the clock times out. Pay for success is not just an innovation; it’s an innovation multiplier that creates incentives for creative solutions.

Pay for success is not a new concept. Previously, however, it was beset by countless challenges: the need for objective measures, the time needed to achieve results, the correlation of an organization’s specific role to the overall result, and so on. In a dozen ongoing pilots, the United Kingdom is systematically trying to overcome each of these challenges.

Take metrics. Governments traditionally spend money reactively, not preventatively. Crime prevention is much trickier than punishment. Consider Doncaster again. Negative pressures from fellow criminals must be overcome with positive support, from personalized vocational training to the maintenance of constructive relationships beyond prison walls.

To adjust prison programs and conditions by legislative decree can produce knots of red tape, and some experiments may prove ineffective. With pay-for-success schemes, government can allow providers (nonprofits, contractors, and social entrepreneurs) to master the details and shoulder the risks. The United Kingdom is rewarding contractors on specific metrics, such as the requirement that Serco reduce recidivism by 5 percent. Conditional payment offers a compelling stimulus for Serco to align its goals with government.

Creating such metrics presents one of the biggest challenges facing pay-for-success exchanges. The exchanges must avoid creating perverse incentives and must avoid tactics such as cream-skimming, that is, serving the best applicants while neglecting less promising candidates. Contracts must set achievable goals that account for nationwide trends such as economic recession.

“You have to write contracts so that you’re not paying for stuff that would have happened anyway,” says Antonia Romero of the UK Ministry of Justice.⁶⁵ This is why payouts at Peterborough Prison, another UK experiment in pay for success, are measured against recidivism rates at similar prisons.⁶⁶

Public service providers have long hesitated to pursue potentially effective projects such as early intervention in child development because the providers can’t be assured of long-term funding, regardless of results. Nonprofits want to grow, says Sir Ronald Cohen, a British venture capitalist who has long advocated funding for social entrepreneurs, but “the volatility in funding makes it impossible.”⁶⁷

In the current landscape, “the majority of nonprofits [in the United States] bring in less than $500,000 annually,” explains Yao Huang, founder of The Hatchery, a New York City–based organization that cultivates social entrepreneurs.⁶⁸ There are 1.8 million nonprofits out there. Should all of them, judging by performance, exist? No! There’s unnecessary overlap, and the ones that demonstrate strong effectiveness should attract the funding.

Social-impact bonds (SIBs), mentioned earlier, represent an attempt to ameliorate the problems of volatile funding, lack of accountability for results, and an overcrowded field of nonprofits. This new financial instrument allows individual investors to buy shares in a project that has a clear and quantifiable social objective, such as reducing a school district’s dropout rate by a targeted margin. If the target is met, investors recoup their full investment; a missed target means some money is lost, while an exceeded target earns an attractive return.⁶⁹ Thus the SIB guarantees long-term financing while spreading the risk between the three parties: government (which pays for the outcome), investors (which are willing to fund the outcome), and providers (which deliver the outcome).

Those who have witnessed the success of payment by results are among the most enthusiastic about SIBs. In 1996, Minnesota passed a pay-for-success model, one of the earliest of its kind, to help the state’s unemployed return to work. The funded nonprofit, RISE!, produced an estimated 624 percent return in economic value to the state.⁷⁰ Now Minnesota is piloting a $10 million Human Capital Performance Bond in the hope of repeating this success with a larger pool of capital. To accomplish this, the state is enlisting philanthropists, high-net-worth individuals, and foundations to help with up-front investment and risk.⁷¹

Where there is an opportunity to turn a profit, social programs attract new investors. Goldman Sachs, for instance, has committed $9.6 million for a New York City program intended to reduce jail recidivism by 10 percent. If the program reaches the 10 percent target, Goldman Sachs will be repaid in full. If the recidivism rate declines by less than 10 percent, the investor will not be repaid; if the rate declines by more than 10 percent, Goldman Sachs can make a profit of up to $2.1 million, or 22 percent on its investment.⁷²

These are risks and returns that Goldman Sachs, and a growing number of banks, are willing to accept, particularly given the public benefit. In this way, SIBs align incentives around outcomes that benefit both society and investors. Government pays only for programs that work, and it can evaluate effectiveness according to the metrics it prioritizes.

Payment by results also provides entrepreneurs, private companies, nonprofits, and social enterprises with a strong incentive to team up, creating a shared, vested interest in meeting the objective. A diverse cast of contributors can produce new, innovative approaches.

Antonia Romero, of the UK Ministry of Justice, expects pay-for-success schemes to spur more innovations such as Doncaster Prison’s “daddy day care” program, which allows fathers to see their children. “Keeping the family unit together is a key driver in reducing recidivism,” she says. “Things that might be considered to be soft stuff actually work in reducing reoffending. The great thing about alternative providers is they often have more freedom to do things like that.”⁷³

UK-based Ingeus is using results-based funding from the government to spur its employees to find jobs for welfare recipients. “The milestones for which you get paid, and what you actually get paid for, are more challenging than any predecessor program,” says Dean James, Ingeus CEO.⁷⁴ Instead of receiving a fee for processing a client, Ingeus receives its biggest fees when a client retains a job for six months. This approach is sometimes called “black box,” meaning that Ingeus and other providers face little interference and have a tremendous amount of flexibility in how to achieve the prescribed outcomes.

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BIG SOCIETY CAPITAL: THE MARKET MAKER

Traditionally, venture capital firms have provided two assets to the firms in which they invest: capital and savvy advice. Fledgling firms with a good idea would receive an infusion of cash and some great guidance, which helps the young businesses take off. Once they invest in a company, venture capitalists take an active role in helping it to succeed.

But where can a “start-up” social enterprise look for such a boost? Traditional venture capitalists oft en can’t make enough of a return. As a result, a social-mission corporation with a good idea oft en fails to make as much impact as it could.

That is changing in the solution economy, however. “Our mission is to develop the market for social outcomes,” explains Nick O’Donohoe, director of Big Society Capital (BSC), a privately run, £600 million social-investment fund that claims to be “the first ever social investment market builder.”^a O’Donohoe is a former J.P. Morgan investment banker recruited by the UK government to lead this groundbreaking institution.

Privately run and answering to a board, BSC is funded from fifteen-year-old dormant bank accounts that revert to the government if unclaimed. BSC’s charter is to radically enlarge the social investment landscape by making affordable financing and advice available to social enterprises and charities.

The fund makes three major types of investments through financial intermediaries: SIBs, funds that invest in social enterprises, and direct investments in intermediary companies that support the market infrastructure. For instance, one SIB supported by BSC committed £4.5 million to the UK Department of Work and Pensions to tackle youth unemployment in Liverpool. The program, Triodos Bank’s New Horizons, aims to improve the behavior and job prospects of thirty-nine hundred young Liverpudlians over three years through one-on-one coaching and other behavioral interventions.^b

“If they can demonstrate they can address unemployment for 4,000 kids in Liverpool, they can then take that model to three to four other cities,” O’Donohoe says. “That’s how they achieve scale.” If New Horizons succeeds, BSC adds another market-building investment to its portfolio, while society benefits as vulnerable young people receive a better shot at becoming productive citizens.

BSC also acts as a wholesaler for the social investment market. Instead of investing directly in social ventures such as urban renewal programs or shelters, BSC invests in funds and intermediaries that support these frontline social ventures. These intermediary organizations, called social investment finance intermediaries, include social banks, nonbank social investors, and support providers. As a group, they represent a new financial market, connecting social-impact investors with organizations in need of funding.^c Eventually, O’Donohoe hopes BSC can help UK organizations coalesce broadly around agreed-upon social outcomes.

In the United Kingdom and throughout the world, pay for performance is still expanding. “In five years,” O’Donohoe says, “there will be more people involved in delivering outcomes, more investors and more intermediaries. Our goal is nothing less than a sea change in how social outcomes are funded and delivered.”

a. British Prime Minister’s Office, “Prime Minister Unveils Big Society Capital,” April 4, 2012, www.number10.gov.uk/news/prime-minsiter-unveils-big-society-capital/.

b. Andrew Holt, “£4.5m DWP Social Impact Bond for Merseyside,” Charity Times, January 23, 2012, www.charitytimes.com/ct/4.5m_DWP_Social_Impact_Bond_for_Merseyside.php.

c. “Our Vision and Mission,” Big Society Capital, accessed February 6, 2013, www.bigsocietycapital.com/our-vision-and-mission/.

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“It’s forced us to really think about what a fundamental shift in welfare-to-work would look like,” James says. The approach encourages radically different approaches. For example, job counselors could supplement their work by connecting clients to online peer-to-peer groups that could share learning, advice, and references.

Pay-for-success models are spreading globally. President Obama pledged $100 million to pay-for-success schemes in his 2012 budget. Instiglio, based in the Harvard Innovation Lab, is consulting with developing nations on using SIBs to improve school attendance, access to potable water, and financial literacy. The UK organization Social Finance Limited has received funding from the Omidyar Network to develop SIBs in Ireland, Scotland, Australia, Canada, and Israel.⁷⁵

Thus, an entirely new solution economy infrastructure is emerging, involving both monetary and nonmonetary currencies that engender new ways of keeping score. New markets and new exchanges enable intangibles (such as reputation) to trade alongside tangibles, yielding a bottom line that brings profits and social impact.

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PUBLIC-VALUE EXCHANGES: IN A NUTSHELL

THE BIG IDEA

The impact currencies of the solution economy are now being traded across a variety of novel exchanges. Enabled by web technologies, these exchanges drive public value by connecting capital of all types to societal problems and to those who wish to solve them.

TYPES OF EXCHANGES

• Two-sided markets link buyers and sellers directly, with one side of the market typically subsidizing the other.

• Crowdfunding platforms raise capital directly from networks of supporters, connecting social entrepreneurs with socially conscious citizens.

• Impact exchanges invest via both traditional and specialized equity markets to reward socially conscious businesses while they earn returns.

• Prizes and challenges convene the brightest minds from multiple fields, uniting problems with problem solvers.

• Pay-for-success arrangements connect the buyers of social outcomes—governments, foundations, philanthropists, etc.—with solution providers, enabling a shift from traditional contracting and grants to rewarding specific outcomes.

GROWTH TRAJECTORY

• The number of crowdfunding exchanges rose to 537 worldwide by the end of 2012.

• The number of funds that exclude industries or companies because of social concerns has risen from fifty-five funds globally in 1995 to more than seven hundred in 2012.

• Funds labeled socially responsible investments account for 10 percent of all managed assets.

• J.P. Morgan anticipates social-impact investments to be a $1 trillion market by 2020.

EXCHANGE ACCELERATORS

• Peer-to-peer platforms have dramatically reduced the transaction costs of collaboration and encourage people to share knowledge.

• Third-party assessments, ratings, or certifications of social enterprises and funds—such as the Global Impact Investment Rating System and B corp certification—empower impact exchanges by providing investors with independent evaluations.

• The innovative use of metrics enables pay-for-success exchanges, with goals based on historical data and payments based on data-supported outcomes.

• Social-impact bonds spread the risk of investing in social projects.

• Social investment finance intermediaries connect social-impact investors with social sector organizations in need of funding.

EXCHANGE INNOVATORS

• Kaggle: This platform organizes competitions for data problems, in which the hosts post a data set, and the most accurate predictive model wins.

• Kiva: One of the largest microlenders anywhere, the organization enables anyone with internet access to fund ventures around the world.

• Skillshare, School of Everything, and TeachersPayTeachers use peer-to-peer exchanges to teach and train people over the internet.

• Mission Markets: This new stock exchange offers shares worth more than $336 million in double- and triple-bottom-line companies.

• TriLinc Global: The firm’s $1.25 billion Global Impact Fund connects “main street” retail investors to social entrepreneurs.

• Challenge.gov: US federal agencies can use this online platform for prizes and challenges.

• Big Society Capital (BSC): This UK government-sponsored, privately run social investment fund provides affordable financing and advice to social enterprises.

QUESTIONS FOR THOUGHT

Which of these varieties of exchange have you observed in action? What type of organization operated the exchange, and did it meet the desired goal? In light of the examples shared here, is there anything you would change about the exchange?

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