Henry Chesbrough's "Open Innovation" was based on the idea that "not all the smart people work for you." Simple but brilliant. 

I recently wrote two SocialEarth posts - one on short-termism in the private sector and another on starvation in the nonprofit sector - that randomly and beautifully came together the other day in the form of Hernando de Soto's book "The Other Path."

"The Other Path," Perverse Incentives, and Social Devolution

Hernando de Soto is a highly regarded and sometimes controversial Peruvian economist who is given significant credit for the downfall of the Shining Path, Peru's Maoist guerrilla group known for its brutal tactics.  

Written in 1986, De Soto's work highlighted the entrepreneurial qualities and aspirations of Peru's poorer urban classes, as well as the mercantilist policies and laws that were preventing these classes, and Peruvian society overall, from prospering.  He brought to light, for example, the amount of time and money required to legally secure land, build a house, and start a business (often years and amounts of money that equated to many times an average salary).

As indicated by its title, "The Other Path" re-framed the struggle of Peru's poor from one of proletarian suffering and revolution (espoused by the Shining Path) to a fight for markets and policies that were inclusive and universally enabling rather than at the service of the politically-connected.  His message resonated and, importantly, gave Peruvians an alternative war to wage in the battle against poverty and inequality.

The other critical lesson to be gleaned from De Soto's work, and the one pertinent to this post, is the following:

When official laws and policies exclude large groups of people or otherwise fail to be relevant to large sectors of society, these excluded groups are given incentives to create their own norms and institutions, in line with their own needs and values, in competition with the formal framework.

We see this all the time in the world around us - both in developing and developed nations.  In the U.S., people who believe in small government find "creative" ways to avoid taxes. Underage individuals nonetheless consume alcohol. Gays and lesbians find churches who will marry them, despite laws that prohibit or do not recognize same-sex marriage. Across Latin America, poor urban families "invade" public and private lands in efforts to acquire property and housing where these are otherwise very difficult to attain. In Peru, according to De Soto's research, street vendors developed complex associations with other vendors to procure high-traffic locations and then protect their presumptive right to these locales, even when laws did not permit such action.

The common thread tying these examples together is the idea that when laws, institutions, and norms fail to stay relevant, people begin to systematically act in illegal ways, their actions justified by moral philosophies that are different and/or more progressive. In instances where the law and institutions eventually adapt, these episodes of illegality are temporary. Society accepts the moral basis for the formerly illegal action, we adapt our laws, and we go back to behaving legally. This was the case with the civil rights movement in the U.S. and is likely to be the eventual outcome of the battle for same-sex marriage. When laws and institutions fail to adapt effectively, however, and when government does not have the means to control illicit behavior, laws lose their legitimacy, illegality in general becomes increasingly acceptable, and whole generations can start to adopt the notion that ends justify means. In other words, if you believe you have just reason for breaking the law, go ahead and do it.

Illegal actions are, indeed, justified by higher-order rights and moral philosophies in certain cases (the U.S. Declaration of Independence, for example, openly promotes revolution in the face of despotism).  However, the "moral drift" that results when laws and institutions fail to adapt and people are left to behave illegally can have disastrous long-term societal consequences and be incredibly hard to recover from.

Creating Another Path for Our Organizations

Okay, so where does that leave us?  

Well, to bring this down to a very immediate and practical (and perhaps more mundane) level, I believe that, as a result of the unrealistic expectations we place on our organizations, both for- and nonprofit, we create incentives for them to behave badly.

In the case of for-profit organizations, our expectation that companies produce greater returns quarter after quarter drives "short-termism" and creates:

• Disincentives to act in environmentally and socially sustainable ways
• Incentives to engage in unethical, "creative" accounting
• Incentives to make questionable business decisions, such as acquisitions that more-often-than-not destroy value

In the case of nonprofit organizations, our unrealistic expectations regarding overhead create:

• Incentives to engage in unethical, "creative" accounting
• Incentives to not give employees adequate  job training and competitive wages
• Disincentives and an often an inability to invest in the sustainable growth of the organization

In these cases, we are the short-sighted lawmakers and government bureaucrats who have failed to adapt. We have created norms and institutions that have failed to keep up with the needs and best interests of our organizations and our societies. And our failure is both inhibiting the creation of a better world and encouraging our leaders to make unethical, undesirable, or simply questionable decisions that become more and more "normal" every day. Time to stop pointing the finger.

We got ourselves into this mess.  What are we going to do to get ourselves out?  How are we going to create new norms and institutions that recognize reality and pull our societies and organizations away from the ledge?

I recently published a two-part series on SocialEarth called, "If you were the non-profit god, what would you fix?" The series was well-received (woohoo!... Thank you!), so I thought it worth taking the time to point out one apparent inconsistency in my proposal.  At least it's apparent to me; it hasn't seemed to bother anyone else. If you haven't read the SocialEarth posts, go there first - Part I here, Part II here. In Part I, I discuss a couple of the problems associated with the way non-profits have implemented the three-party market model.  In that section, I include the issue of having to cater to multiple customers with sometimes disparate needs (donors vs. target populations).  In doing so,  I suggest that for-profit businesses who rely on the same model (radio stations, Google, Facebook, etc.) don't have this same problem. This is of course not the case.  Any business who serves multiple masters ultimately struggles to balance their interests.  In fact, every business that receives third-party funding struggles with this same challenge, regardless of whether that funding is coming from donors, third-party customers, banks, or private investors. The big difference is that in most of the for-profit world cases, effectively serving your primary customer also directly and positively impacts your secondary customers/funders.  So, Google creating more and more free applications gives advertisers more and more opportunities to get in front of their target audiences.  Likewise, as D.Light expands and becomes increasingly effective at providing affordable and energy efficient lighting solutions to the BOP, investors at the Acumen Fund will be rewarded for it.  It's a win-win-win scenario. In the non-profit world, however, when an organization improves its ability to serve its target population (something that is often hard to measure or prove), donors may receive more or better stories of good deeds and see more compelling impact numbers in the annual report, but they are still not likely to receive anything more tangible.  That is, I think, the essence of what makes the non-profit model so much less sustainable. Put a bit more conceptually (feel free to tune out here if you're not interested in the academic speak), we do not seem hard-wired to use optimal-decision making methods when it comes to altruism.  We seem to be content knowing that our money is going to a "good cause" (or that we're getting a tax write-off), and  few of us will take the time to look hard for better or "optimal" causes when it comes to how we invest our philanthropic dollars.  So when it comes to giving, we're somewhat arbitrary and especially fickle. Another way to think of it... if you're 401(k) or 403(b) was only returning 3% in a good economy, wouldn't you look to put your money somewhere else?  Probably, and your fund managers know that.  So you are, even without knowing it, putting pressure on your fund managers to maximize returns.  On the other hand, if you're seeing regular returns of 20%, you're going to leave your money right where it is, and fund managers know that, too.  Your decision is logical, predictable and, therefore, more sustainable. But the same "you" may very well be sinking money into a non-profit that hasn't substantially improved its operations...well...ever.  Do you care?  Maybe.  Maybe not if you just like the cause (or tax write-off).  Either way, you are probably not putting much pressure on the non-profit's management to improve.  At the same time, if another similar but seemingly more effective non-profit came along, would you move your money over?  Maybe. Maybe not.  Here, your decision is seemingly arbitrary, fickle, and much more difficult for the non-profit to predict and sustain. There is much more to this whole conundrum, and this post is already giving me ideas for another post that might take a deeper look.  But I'll leave it here for now.   If you have any reactions or suggestions, please let me know!

My latest SocialEarth post (HERE) explores the relationship between web 2.0 companies, the book "Free" by Chris Anderson, and the world of social enterprise. Please check it out here: While I advocate for the positive aspects of "free" in the post (mostly because that's where I stand), I also wanted to share the following NPR series that explores both the pros and cons of free. Enjoy! Part 1: Free For All? Profits Can Be Elusive Online Part 2: Web Firms Find Paths To Profits: Free Vs. Fees Part 3: Musicians Look For Pay In An MP3 World

Crutches cast off by those healed at Santurio de Chimayo, Mexico
The idea of "below market returns" has always made me a bit squeamish. For whatever reason, the utterance of the phrase sets off alarms in my brain. Truly, my reaction is quite visceral and 90% negative. For some time, I felt incredibly guilty - like less of a "do-gooder" - for not embracing the philanthropic sentiment that the expressions entails. I felt too hard-nosed, too pragmatic, too business- and market-oriented in my mindset. Recently, I decided to tell the guilt complex in my brain to quiet down so I could think this through a bit more rationally. What I've determined is that I have very good reasons for being suspicious of the idea of "below market returns." Here they are... Flawed Assumptions Underlying "Below Market Returns":

• That a company can't do good by doing good. Or, perhaps, that a company can do OK but should be careful to not do too good, for that would suggest that it's placing financial returns ahead of its social mission.  Also, we seem to assume that making products and services at price points that are affordable to BOP consumers will necessarily lead to smaller profits.  This belies the notion that the BOP is huge and, provided they can reach sufficient scale, BOP businesses are presented with an enormous and very profitable business opportunity.

And, conversely...

• That a company can only do good by doing evil. It seems that the suspicion toward the private sector that has long characterized many non-profits has seeped its way into the social enterprise sector.  For some reason we automatically seem to associate financial gain with greed and unethical business practices.

And also...

• That it's okay to aspire to mediocrity in some aspects of how we manage a business.  This is what really drives me nuts.  Why should any company not strive for excellence in everything that it does?  And, if not in everything, at least those areas that are most critical?  Having a "double bottom line" suggests that both social impact and financial success are crucial to building a strong social business.  So why settle for "below market returns"?!

Assumptions that we must be embracing:

• Financial returns and social good work in tandem. When we believe in and accept this principle, we embrace the idea that employing ethical and sustainable business practices pays off in the long run.  Green practices save money.  Competitive pay and employee benefits attract talent and promote productivity. And being obsessive about customers and their needs - in this case, the needs of BOP consumers - encourages customer loyalty, facilitates customer acquisition, and spurs growth.
• "Profit maximization" will allow us to do more good for more people. Once again, in defense of profit, I want to emphasize that profit maximization plays a massively important role in driving operational efficiencies and overall better business practices, which in turn support scaling and growth. Also, profit as a metric serves as a strong indicator of whether companies are successfully innovating and finding better, more cost-effective ways to  meet customer needs.

Ulitmately, I don't want to suggest that below market returns aren't or won't be the reality for some social businesses. What I'm questioning is the notion that it's OK to have "below market returns" be your point of departure. Social entrepreneurs must aspire to be as, if not more, financially successful as our private sector brethren if we are to thrive. What should be done with the profits that are gained is a discussion we can continue to have. However, we need to put our foot down when it comes not letting the idea of "below market returns" continue to be a crutch that only social entrepreneurs have the privilege of sporting.