The Harvard Business Review published an article today by Endeavor’s CEO Linda Rottenberg and the director of Endeavor Insight, Rhett Morris, entitled “If You Want to Scale Impact, Put Financial Results First”. This piece is the inaugural article for the HBR-Bridgespan Insight Center on Scaling Social Impact — a partnership between the Harvard Business Review and The Bridgespan Group, supported by the Omidyar Network — that will share stories, insights, and lessons from the most innovative voices in the field.
The text of the article is reprinted below. The original article is available on HBR.org here.
If You Want to Scale Impact, Put Financial Results First
Entrepreneurs who lead for-profit, social enterprises face a unique challenge: they must simultaneously create financial value for their investors and social value for those they seek to serve. Having two missions, however, sometimes creates conflicts that can slow companies’ growth.
Endeavor Insight, the research arm of our organization Endeavor, has found that the way that entrepreneurs who lead social enterprises make tradeoffs between social and financial goals is a critical factor in determining the degree to which their companies will grow. Indeed, in our experience, and in a targeted study of close to 20 entrepreneurs, we found that those who prioritized financial goals over social ones were more likely to grow their social enterprises and achieve greater impact. We also discovered ways to build business models that reduced friction between commercial and social goals, thereby smoothing the path to growth.
What is our vantage point? Over the last 15 years, Endeavor has selected, mentored and accelerated more than 750 high-impact entrepreneurs across 14 countries. Their fast-growing companies work in almost every industry, from online retail to manufacturing to professional services, and together they have created more than 200,000 jobs and generated revenues of more than $5B in 2011. While Endeavor does not specifically target social entrepreneurs, more than 50 individuals in the Endeavor network lead companies with direct social impact – education and healthcare improvements, environmental preservation, financial inclusion, assistance to disadvantaged populations, and other areas.
A Tale of Two Entrepreneurs
Let’s look at two examples from our study (some of their names and details have been changed). Roberta leads a business that seeks to improve the healthcare system in her Latin American country by providing better IT infrastructure and processes in order to reduce medical costs and improve the quality of patient care. Most of the population in Roberta’s country has traditionally lacked access to quality healthcare, and government experts have forecasted that chronic diseases will bankrupt the healthcare sector in the next few decades. Roberta wants to make change at both a macro and micro level.
“It is really motivating to walk into a hospital and see that things are better. You hear patients telling you that last year they had to wait for three hours and now they only have to wait 20 minutes or you see hospitals providing access to people in rural areas who have not had it ever before,” she told interviewers.
Roberta’s company has aligned its social and financial goals. As the business reaches more hospitals, revenues grow and the impact on the healthcare system increases. This strategy has led to strong results. Over the last three years, the company has expanded to serve more than 1,000 hospitals and clinics that provide care to over 15 million patients each year. Revenues have also grown by more than 600% during the same period. The firm is looking to raise funding from venture capital firms so that it can further grow.
Thousands of miles away in Asia, another Endeavor Entrepreneur, Adam, also runs a social enterprise. His company seeks to transform the lives of people within a severely disadvantaged population by employing them at a manufacturing firm. The jobs at Adam’s company offer potential employees full-time employment and training that they cannot find elsewhere. Unemployment rates for the general population in Adam’s country consistently run in the double-digits and are even higher among his company’s target group. Adam decided to launch a for-profit enterprise because non-profit solutions took too long to create jobs.
“In a business you have an amazing ability to be flexible,” he said. “It’s far easier to create the change you want because in a day or two you can implement it.”
Adam’s business has not been as successful as Roberta’s. Revenues have stagnated over the last few years, in part because Adam has no ambition to expand into other countries despite the relatively small size of his current market. The social impact of the business has also suffered. The company has never employed more than 100 people and recently reduced its headcount. He is now pursuing grant funding, which he believes will address these issues and will enable his business to expand its product lines.
Why Has Roberta’s Company Scaled While Adam’s Hasn’t?
Roberta and Adam went through the same selection process to join Endeavor. Both of their companies were judged to be among the top 2% of applicants, yet one has significantly outperformed the other in achieving its social and financial goals. This example represents what’s happening across the sector: While some socially-focused firms have achieved rapid success and scale, many others have had promising starts, but never build on that success to expand their impact. Why?
We spoke to Michael Chu, a Senior Lecturer in the Initiative on Social Enterprise at Harvard Business School and the managing director of the investment fund IGNIA, who said that this trend may be due to the unique challenges faced by social enterprises. “In many cases when people are addressing a social issue through commercial platforms, they are looking to be even more disruptive than a purely commercial enterprise. You actually need even more rigor in your thinking. Just because you are trying to do something good doesn’t mean that the world will change the rules for you.”
In Chu’s experience, motivations are also critically important. “We tend to see lots of people who fall in love with the social impact and hide the weaknesses in the business model and the weaknesses in execution,” he said.
Our team set out to further explore this question by looking at the 50+ social enterprise companies in our network. We analyzed more than 100 different characteristics, none of which accounted for the discrepancies we saw in growth. So we conducted in-depth interviews with close to 20 entrepreneurs who lead these companies. We asked the entrepreneurs to rank how frequently they favored one type of goal over the other when making inevitable tradeoffs.
For example, Roberta has to decide whether to discount services to hospitals too poor to buy them at a profitable price. Should she influence the quality of care of more patients? Or keep margins healthy? And what about Adam? Should he plow cash into increasing the pay of the disadvantaged people he employs, or build his working capital?
What We Learned
Our research showed that the entrepreneurs’ approach to tradeoffs plays a critical role in their ability to scale. Those who prioritized financial goals over social goals were much more likely to experience high rates of growth and have greater social impact. Though the sample was relatively small, the trend was quite strong. The more likely entrepreneurs were to favor financial goals, the faster their companies grew.
Here is what one entrepreneur said about this balance: “The first thing I have to do is make sure that I stay in business because social businesses are more challenging than other types of companies. For long-term sustainability, you need to value business first and make sure that all of your actions have business case to support them.”
Unfortunately, this is not always easy. Entrepreneurs with dual missions regularly face tradeoffs. We’ve found with the social entrepreneurs in our network that one of the best ways to avoid sacrificing financial sustainability for social impact is to reduce the total number of tradeoffs that entrepreneurs must make. The design of a company’s business model is among the most important factors that influence its ability to scale.
“Social entrepreneurs need to understand if their social mission is complementary to their financial goals or if there are going to be lots of friction points due to conflict between them,” said Cathy Clark from the Center for the Advancement of Social Entrepreneurship at Duke University. “The ventures that grow fastest are likely to be the ones that have the most frictionless business models. Just because you have a misalignment, it doesn’t mean you won’t scale. It just means you have to be even smarter. You have to manage around more of these sorts of issues.”
Below is a matrix that shows how we believe an entrepreneur’s approach to tradeoffs and business model design affect a social enterprise’s ability to scale. Entrepreneurs can use this tool to evaluate their current position, and can use this information to adjust their business model or approach to tradeoffs. The hope is that by shifting their strategy, it will be easier for their enterprise to increase its social and financial impacts.
Anecdotally, we have seen that entrepreneurs and businesses tend to gravitate to the top right and bottom left sections of this chart. Entrepreneurs who deal with tradeoffs by prioritizing social goals over financial ones tend to design business models that require more tradeoffs to be made. Entrepreneurs who fall in the upper right hand corner tend to report that they did not obsess over the conflicts between the social and financial objectives of their companies. Instead, they focused their attention on growth, believing that any step they took to help their companies scale allowed them to accomplish more.
So What Does This Mean?
Of course, there are limits to this research. For example, the entrepreneurs included were drawn from a single organization with a distinct selection process. And their enterprises ranged from those in which the consumer and beneficiary were one and the same, like Roberta’s, to ones in which one set of customers created benefits for another, as in Adam’s case. However, these findings can inform any entrepreneur leading a social enterprise or investors funding it.
Entrepreneurs leading social enterprises should consider the following:
– Design business models that align financial and social goals as closely as possible to minimize tradeoffs and reduce friction.
– When tradeoffs must be made, prioritize financial goals over social ones to maximize the long-term sustainability of the business.
The organizations that support them also need to:
– Work to identify founders who can develop business models that prioritize financial sustainability and ability to scale. In our experience, entrepreneurs with strong business backgrounds who develop passion for social issues tend to do this very effectively.
– Encourage entrepreneurs at social enterprises to prioritize long-term sustainability when dealing with trade-offs.
Additional background on Endeavor’s methodology
In order to understand the factors that lead to success and failure for social enterprises, Endeavor’s Insight team analyzed more than 100 different characteristics of the social enterprises within Endeavor’s network. Over the last 15 years, Endeavor has supported more than 750 high-impact entrepreneurs leading fast-growing companies in almost every industry. Though Endeavor does not specifically target social enterprises, more than 50 of the entrepreneurs supported by Endeavor lead social enterprises.
These companies have experienced a wide variety of growth rates during the last three years. Approximately one-fifth of these firms have grown their revenues at 40% or more on average each year. Unfortunately, the majority of these firms have experienced negative, low or moderate growth revenue rates, which makes it quite difficult to achieve their financial and social goals.
After using existing data to analyze characteristics that influence the likelihood an enterprise will scale for each of these firms, the Insight team conducted one-hour, in-depth interviews with close to 20 entrepreneurs who lead these companies. These analyses and interviews informed the results published in the article.