An Open Response to “Development Impact Bonds: There’s Still No Free Lunch”

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On December 13th, the Stanford Social Innovation Review published "Development Impact Bonds: There's Still No Free Lunch" by Kevin Starr. Please read our response below.

Dear Kevin,
Thank you for starting a conversation on development impact bonds (DIBs), as well as Pay for Success (PFS) more generally. As a practitioner of PFS, I wanted to share a perspective on the topic formed by witnessing the field change over the last four years. Although I echo your skepticism that DIBs are a panacea, it is important to note that these efforts have not all been in vain and there are key components of PFS that should be lauded and scaled.

First, there is an important definitional point to make. I want to highlight the distinction between DIBs and PFS. Pay for Success (PFS) is a contract where an entity (often a government) agrees to pay for outcomes achieved rather than the cost of inputs or the achievement of outputs. Third-party financing is a way to bridge the timing gap between government payments and the upfront capital needed to run the PFS project. This financing is often referred to as social impact bonds (SIBs) or DIBs. Much attention has been placed on the role of private funders and this innovative financing model despite many examples of PFS where third-party financing is not utilized. Contrary to being a “side show”, prior DIBs/SIBs/PFS projects illustrate that alignment around impact and consistent tracking of measures create benefits that outlast the individual project or its financing. While “unrestricted funding on the basis of impact” is the direction that the field is and should be heading, it is the rigor of a PFS framework that truly sustains these efforts.

The rigorous process needed to build a PFS project necessitates the transaction costs that you highlighted, but also makes the change more enduring. By starting the conversation with an explicit focus on outcomes, rather than resources and activities, DIBs emphasize something so basic, so fundamental, yet often overlooked in program design and management. Frequently, our clients do not have well-articulated goals for their programs’ outcomes when we start. Transitioning from cost-reimbursement to outcomes-based models is not only resource-intensive in terms of time and human capital but also requires shifts in culture that can be difficult to create without tangible proof points. DIBs provide an initial blueprint that brings together a diverse set of stakeholders around an actionable problem and leverages data to measure the achievement of outcomes, as well as inform real-time program adaptations.

Another positive attribute is that because much of the transaction costs are associated with culture change, PFS has the potential to scale across multiple projects financed by a single funder with much lower marginal cost than the first project. Our recent engagements with LA County Department of Mental Health and King County Outpatient Treatment on Demand have shown that transaction costs do not grow linearly with the size of the contracts (i.e., the cost associated with moving n providers to outcomes-based contracts is not n times the transaction cost of a single DIB). While I agree with you that doing a single project in one place and then moving to another place is not a scalable approach to DIBs, field experience has shown the opposite is true when going deep within a single agency.

Finally, the processes and structures created in designing a DIB last beyond the project and embed sustained change. For example, the evaluation plan and governance process tied to DIBs introduce continuous improvement strategies that generate new knowledge and improve practices over time – something that traditional funding has long struggled to do.  When there are multiple contracts in a community these structures develop into innate expectations for active outcomes management rather than historical artifacts of long-passed projects.

If the problem DIBs are trying to solve is articulated as “[how can we] unlock vast sums of private capital for other projects”, then I agree that they are not the best vehicle. If DIBs are seen as mechanisms to transform agencies’ cultures to focus on outcomes, create evaluation and governance structures around outcomes, and reward creating a positive impact in the community, then they are a fantastic approach. By depicting DIBs only as a funding mechanism and ignoring the other systemic changes they create, you overlook the positive aspects that can catalyze lasting change.

Kind Regards,

Brian Beachkofski
Managing Director, Third Sector Capital Partners, Inc.

Christine Kang
Manager, Third Sector Capital Partners, Inc.