Affordable Housing Innovations 03: Affordable housing's intangible infrastructure

By David A. Smith

Perhaps the biggest barrier to the growth and sustainability of innovative Mission Entrepreneurial Entities (Mee's) around the world is lack of capital for their intangible infrastructure. Nobody wants to fund it. In fact, few funders understand what it is.

What is intangible infrastructure?

Whether for-profit or non-profit, every social enterprise must eventually achieve sustainability or it goes out of business. For that sustainability, the Mee needs three things:

  1. Theory of impact. A socially valuable consequence of doing the thing that we do.
  2. Business model. A repeatable revenue source connected to our delivery of products or services; as we do more of what we do, our revenue rises to match.
  3. Intangible infrastructure. The piece which represents the difference between motivated individual(s) and the entity which they become. Includes the particulars listed in the inset box.

Intangible infrastructure

All the assemblages to create a Mission Entrepreneurial Entity that acts in its business area.

  • R&D costs of business creation
  • Product/ service suites tailored to the market
  • Established business model
  • Senior management in place
  • Value chains and contractual relationships with counterparties
  • Offices and equipment
  • Trained, reliable staff or volunteers
  • Documented business protocols
  • Peer network for peer-to-peer learning
  • Organizational culture
  • Brand and market visibility
  • "Scaling losses" on product rollouts

Women's savings collective, Mumbai : Intangible infrastructure personified. What is its capitalized value? Cost to create?

The theory of impact, business model, and intangible infrastructure all combine in a self-reinforcing way. Each depends on the other two:

  • Theory of impact is the reason for existence.
  • Business model is the means of sustaining existence.
  • Intangible infrastructure is the way to deliver the business model continually and enduringly.

Why is intangible infrastructure so critical?

In its evolution from gleam in a founder's eye to successful, impactful incumbent, a Mee goes through five stages of growth:

  1. Ideation. A visionary has an idea.
  2. Proof of concept. The visionary accomplishes a first example – a property, a loan product, a savings collaborative, a partnership – which thereafter represents a visible pilot project.
  3. Business startup. The visionary commits to making this into a full-time business – an institution, not just one person's effort.
  4. Intangible infrastructure. The entity creates and registers a legal form; hires people; opens an office; builds systems and procedures; transfers and memorializes knowledge.
  5. Scale-up. The entity grows from one location or volume level to larger and larger activity.

Of these five stages, the fifth – scaling after success – is by far the easiest to fund. Indeed, many a non-profit has labored mightily for years if not decades, only to be discovered, seemingly overnight, and then able to expand multi-fold very quickly.

At the other end, the first three phases – ideation, proof of concept, and business startup – are also straightforward to fund. Founders start things, out of their own personal resources, because they are driven to do so. Foundations love funding proof of concept and even a business's initialization.

Network buildup is the missing piece nobody funds:

  • Donors and foundations get skittish because the scale of capital required is substantially larger, maybe 10x the startup costs, and they worry that they lack an 'exit strategy' for continuing contributions.
  • Impact investors won't downwardly fund the intangible infrastructure because, unlike the scaling, it does not produce a sustainable current return. Intangible infrastructure does not produce profit or cash flow; it's the cost of establishing the platform that can produce profits.

This leaves a large gap, with donors and foundations on one side urging fledgling Mee's to grow and change (and not providing the capital to do so), and impact investors on the other side rooting for the Mee's to cross the divide but not helping them do so.

The trap of pricing 'for growth' instead of 'at scale'

Mee's that hit this funding void try to solve their growth problem out of operating profits. To do that, they price the product or service, not at the lower cost they could achieve if they were already large, but at a higher cost which includes some contribution toward paying for that scaling/ growth intangible infrastructure.

This is a trap.

Markets get formed around initial price expectations; if the price is high, the product is unaffordable to the larger base of the pyramid, and that shrinks the volume expectations … which means the enterprise will never get big enough to achieve the lower prices. It's a self-defeating strategy.

Mee's that want to grow must price their product or service as if they were already at scale. Then the customer expectations will set accordingly, the market will grow rapidly, and the scale can be achieved. But that has a further consequence: every individual transaction in that growth phase has an embedded 'loss leader' (the difference between our marginal cost at small scale and our lower marginal cost at large scale), and that cumulative loss leader has to be funded in the intangible infrastructure. These are the "scaling losses" referenced in the previous page's inset box.

It sounds paradoxical that we're going to enter a business expecting to lose money on the first widgets, and indeed many donors find the idea anathema. But it's the only way to scale.

The difference between venture capital and social venture capital

The for-profit venture capital world understands this inherently. Money-losing cool ideas attract huge sums and high valuations because the capital markets are envisioning scale, and treating the pre-liquidity capital as funding that intangible infrastructure.

That model, however, depends on a liquidity event – an Initial Public Offering or a sale to a major for-profit institution – which represents a cashing out.

Social enterprises don't have that big payday at the liquidity event, so they can't fund and grow.

Fund the intangible infrastructure

Donors have to recognize the entities they incubate will never grow to scale and sustainability unless they fund their intangible infrastructure. So if donors want 'exit strategies' from grant funding, if they want Mee's that grow to sustainable expandable scale, they must help those Mee's fund their intangible infrastructure, including their scaling losses, or they will be perpetually starting new ventures that expire just when they could otherwise break out into widespread success.