5 reasons why impact investments and market-creating innovations go hand-in-hand

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Feb 13, 2020

It has never been easier for investors to support causes that matter to them. Hunger to do good has resulted in the growth of impact investments, conscious capitalism, and social entrepreneurship movements. In fact, socially-concerned investments now account for one out of every four dollars of professionally managed assets.

There’s no doubt that more socially minded investments would do the world some good, and opportunities for positive impact abound. But most investments remain stubbornly focused on Europe and North America, which not only received the bulk of global foreign direct investment in 2018, but also received more than 75% of private equity investments. What if more investors targeted companies in frontier and emerging markets, in order to bolster these economies? In regions such as major parts of Sub Saharan Africa and South Asia, most people still lack basic necessities. By simply investing in companies that provide these basic needs, investors can have significant social impact, and reap financial returns. 

Of course not all companies, or innovations for that matter, are equal in terms of impact. Investors play a pivotal role in shaping how societies evolve, and to that end, it is important they understand which types of companies do the most to raise the quality of life for people in a society. 

Investing to create inclusive prosperity

In our research at the Christensen Institute, we’ve sought to understand how different types of innovation impact the economic trajectory of a region. Our research is conclusive: companies that prioritize market-creating innovations have a profound impact on the development of a region—while still generating returns.

Market-creating innovations transform complex and expensive products into simple and affordable ones, enabling more people to benefit from them. What makes them so special? The markets they create unleash a domino effect of sustainable economic development, lifting thousands, if not millions, out of poverty in the process. Market-creating innovations pack a serious punch for five reasons:

1. They create jobs. Market-creating innovations target nonconsumers who have previously been unable to afford or access existing products on the market, and they’re typically the majority in poorer societies. To reach this enormous segment of the population, innovators must hire many people to make, distribute, sell, and service their products.

2. They lead to sustainable investments infrastructure. Infrastructure is vital to the operation of any society, but as Danish economist Bent Flyvbjerg notes, many projects under-deliver on their promise of economic development. The reality is that infrastructure is incredibly expensive to develop and maintain. That’s where market-creating innovations come in.

Because infrastructure is often lacking in low- and middle-income countries, market-creating innovators have no choice but to fill in the gaps by investing in it themselves. Unlike government-sponsored projects, these investments are far more sustainable because they are tied to a market that addresses an unmet need.

Consider the impact Tolaram Industries, which created a market for instant noodles in Nigeria, has had on the development of the country. Though Tolaram is in the noodle business, the lack of adequate logistics in Nigeria required it to build networks of trucks, vans, and staff in order to fill this void. The company also provides its own power in all 13 plants it runs across the country so it does not have to depend on unpredictable power supply from the grid. Tolaram made these investments to support its own business, but in so doing, it also lifted and developed the regions where it operated.

3. They strengthen institutions. Successful market-creation has the result of “pulling in” the necessary institutions such as legal systems, more contextual regulations, and even more relevant schools when they become essential to sustaining and growing that market.

For instance, before IguanaFix created a new market for home improvement services in Argentina, most contractors worked in the informal economy where they did not register their businesses or pay taxes. All of this changed when IguanaFix made it simple and affordable for them to do so. By joining the formal market, service providers are able to access corporate customers, access health and work insurance, and open their first bank account. In turn they’ve become tax-paying, law-abiding citizens.

It’s important to note that before IguanaFix, there were laws, systems, and institutions that contractors were supposed to abide by. But it was when IguanaFix created the new market that the incentives for the people were altered—and the institutions were able to function the way they were meant to.

4. They bring consumers into the formal market, generating more tax revenue for the government. Not unlike other types of innovation, market-creating innovations create significant revenue for governments. But what makes these innovations unique is that they bring nonconsumers, who’ve previously engaged in workarounds, into the formal market, transforming them into tax-paying citizens. With more tax revenue at their disposal, governments are able to reinvest these funds into communities, strengthen their institutions, and provide better social services.

5. They’re a powerful antidote to crime and corruption. In our research we have found that corruption is often a workaround—a way to make progress when few better options exist. A police officer extorts citizens because she struggles to pay for her children’s private education. A hospital worker demands bribes because he’s not paid enough to fend for himself. 

Market-creating innovations change this incentive structure by creating wealth and strengthening the legal and law enforcement institutions that fight corruption. Corruption becomes far less attractive when there are better ways to make progress, and the chances of being punished are higher.

Today’s socially-conscious investors must consider many important environmental and social factors in their investment decisions. They would do well to also keep an eye out for market-creating innovations in frontier and emerging markets, which offer another powerful avenue toward making a positive impact.

Efosa Ojomo is a senior research fellow at the Christensen Institute, and co-author of The Prosperity Paradox: How Innovation Can Lift Nations Out of Poverty. Efosa researches, writes, and speaks about ways in which innovation can transform organizations and create inclusive prosperity for many in emerging markets.