Let me begin with an aphorism of my own:
IF YOU DON’T LEARN FROM FAILURE, YOU DON’T LEARN.
IF YOU DON’T LEARN… YOU END IN FAILURE.
Or, if you like: a market that doesn’t learn from failure is doomed to repeat it.
Because successful market development depends on learning from failure. Markets that work are about discovery. And the richest form of discovery is from what has already been tried. And for individual market participants learning from their own failures and from everyone else’s is the way to build market position and competitive advantage.
The social investment market and every participant in it thus each have privileged access to the best source of learning and competitive advantage that they could hope for – their own records of what has been tried, what succeeded and what failed – and why. If they could but find the time and resources to access and analyse them. (Some are and increasingly are trying to).
Yet failure is an awkward thing to get to grips with. It suffers from a poor image – who wants to be associated with “failure”. No-one wants to be endorsed on LinkedIn for a competence in failure. Failure needs a decent brand consultant.
Failure also comes in different forms. Some failure is good failure, some is bad. How do we tell the difference?
Here’s a suggested typology of social investment “failure”.
Each of course, in social investment, might apply either to social outcomes or to financial outcomes or to both. Whether financial risk and return and social risk and return are correlated is a different topic again. (Already below you will see that I am mixing up social and financial outcomes but conceivably they are not related at all – or they might be closely correlated or negatively correlated).
- NORMATIVE FAILURE – In-line-with-risk failure: I call this normative because it is pretty much what investment is supposed to be like. No return (financial or social) without risk. At an individual investment level, as long as the agreed investment discipline for a firm was followed, it is hard to see the failure here save in the most mundane and merely factual way. Entirely to be expected there is only a problem if at the portfolio level the learning steps aren’t taken cumulatively to understand risk and see if the failure performance cannot be improved over time.
- RISK ASSESSMENT FAILURE – Taking-on-more-risk- than-expected failure: real failure if either at a portfolio level the failure rate turns out higher than expected or at the investment level if an investee which appears to meet the criteria for expected successful investments nevertheless goes off the rails. Either already understood risk factors have been missed (process failure) or there are new risk factors which need to be understood (arguably not real failure but instead a learning opportunity and opportunity for epistemic gain) or risk was mispriced (process failure).
- RISK APPETITE FAILURE – Taking-on-inadequate-risk and thus not achieving the desired returns failure: Conversely not enough risk can be taken, new investee business models not tried out, the challenge of the new or the scaled or the rolled-out not seized. Not enough risk and either social outcomes will be disappointing or an opportunity cost of not investing capital for superior outcomes elsewhere will be realised.
- BUSINESS MODEL SELECTION – in-line with-business model failure: across a spectrum of possible social investment approaches and styles, different investment business models will be available that involve different risk profiles. Social investment is best understood as a pluralism of different investment styles and business models. To compare (to take a crude example) the higher failure rate at a fund intent on supporting start-up stage social enterprises with one backing only scalable social enterprises with a track record and established contracts and to ascribe the presumably higher capital write-off rate at the former to “failure” would be to miss the point.
- PORTFOLIO FAILURE – Failure to learn: Whereas types1-4 are about individual investments (which might then be aggregated and used to classify a portfolio approach), this risk is all at the systemic portfolio level. The money has been got out of the door by the investor but not skillfully. No value has been added over the process; the investor has not learnt and revised its investment judgements over the portfolio life. The portfolio investment might be strategic in the sense that it adhered to the initial chosen area of focus or investment style but over time it has suffered from strategic drift as instead of learning how to achieve its investment aims it has simply ploughed on. This is a failure of rationality – a means-end confusion. (Taking rationality as the most efficient matching of appropriate means to ends.) Rather than understanding the investment making process as a means to achieve and improve on the “end” of a target set of investment outcomes, the investment process (getting the money out there) has become the end in itself.
1-4 are all about expectations and the ability to baseline or benchmark expectations of success and failure – or carry out reliable risk analysis and risk pricing in other words, one of the holy grails of social investment.
Learning from failure – the “learning curve game” necessary to avoid failure type 5, can therefore be seen as a necessary “expectations game” and a “data game” dependent on continually crunching the data and learning the lessons from the cumulative investment process – to understand better and better the driving explanatory factors for success and failure. If we do that we can set benchmarks for social investment and for different sub-sectors and business models of social investment. Then we can tell (and have some warning of) when investment performance is tilting from a normative to-be-expected investment experience to something worse than expected with real failure – failure of analysis or of pricing or of investment readiness preparation.
Until we can understand and set benchmarks, we risk perpetually confusing expected “good” risk with “bad” risk.
And if we can’t set and explain benchmarks for expected risk (and expected returns, social and financial) we shouldn’t expect to attract in too much mainstream capital in a hurry save as de facto charity or blatant experimentation.