Private Firms, Development Outcomes, and the Pitfalls of Picking Winners

October 02, 2015

Bridge International Academies is an innovative education start-up working to provide schooling in some of Kenya's poorest urban areas (and, more recently, Uganda and Nigeria). The company is intensely focused on keeping overheads low, standardising everything from school buildings through lesson plans. This means it can charge $6 a month for primary and kindergarten classes in areas where household incomes are about $100 a month.

Like any business model built on razor-thin margins, Bridge's ability to earn a return for its owners and repay its creditors depends on scaling up fast–Bridge's expansion plan in Kenya calls for building 237 new schools to enroll an extra 300,000 pupils (it opened 47 new schools this year alone). Kenya's Ministry of Education dealt that business model a blow in late September when it stopped Bridge from opening new schools until regulations on 'non-formal schools' are finalised. Regulatory risk is nothing new, but Bridge’s case is special: its scale-up was backed by some of the world’s largest development finance institutions, including a $16 million equity stake from the IFC and the CDC Group and a $10 million subsidised loan from OPIC.

Bridge’s performance is hardly going to make or break these DFIs’ balance sheets, of course, and there’s a strong likelihood that the company will overcome this hurdle. But its current challenges are an interesting example of the potential problems with an important new trend. Support from rich countries for development-focused private investment overseas is here to stay, and will be a crucial ingredient in meeting the ambitious Sustainable Development Goals. The outcome document for the Financing for Development conference in Addis this July mentions 'private sector' as many times as it mentions 'international cooperation'. Donors are increasingly on board. In July, the UK announced a £735 ($1.11bn) million injection of capital for CDC, the first such increase in two decades.

Though there’s a great deal to like about Bridge's model, financing start-ups through our development budgets depends on a small group of experts picking winners overseas, offering subsidies to some firms but not others. The motivation for these interventions that is frequently cited is that firms that are poised to deliver dramatic social impact (like Bridge) struggle to attract the funding they need from risk-shy banks or private investors. An alternative interpretation is that local banks or investors aren't willing to offer cheap credit or take a risk on firms because they understand the risks they face. It may well be that local investors were reluctant to work with Bridge because they recognized that its business model faced precisely the regulatory risk that’s stymied its plans to scale up.

How could we support private firms but avoid these pitfalls? As my colleague Owen Barder and I argue in a working paper, donors could identify and pay for transparently-measured and mutually-agreed outcomes. In education, this could be a simple indicator, like median or average test scores. (There's a healthy debate about the role of testing in education, but scores are already used as a metric in Kenya and many other emerging markets – indeed, whether or not its students do well on basic literacy and maths tests is one of Bridge's measures for its own performance.)

Looking at Bridge’s expansion plans, we calculated a plausible figure for the implicit subsidy to the company from OPIC’s loan at below market rates. We proposed that instead of directly supporting a specific firm to deliver educational outcomes, donors could use that money to pay for success–subsidising private firms based on the educational outcomes they demonstrate, rather than investing in them up front or lending them money for outcomes that they might deliver. Though the two approaches have the same cost on paper, paying for educational outcomes keeps the risks of failure on firms rather than on the public sector’s balance sheet–a point that seems salient in light of Bridge's current challenges. And because any firm could compete for these payments, we would be supporting a sector rather than any specific incumbent.

CGD is working on how innovative financing contracts might supplement or substitute for some of the tools we rely on to work with private firms: paying for everything (grants), making soft loans (debt), or betting on specific firms to deliver social outcomes (equity). We all want Bridge to overcome the hurdle it’s facing and succeed; it’s impossible not to be impressed by the people working there and by the work that they do. But much more than that, we should want to support the development of financial instruments that don't implicitly substitute our judgment for that of local markets. We shouldn’t erode support for international development by asking taxpayers to subsidise business plans that don't pan out. And we should invest more in innovative new contracts that might keep us from footing that bill with money that could be hard at work delivering social outcomes elsewhere–in this case, through another private or public school. 


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.