by William A. Sahlman and Sir Ronald Cohen | 10:00 AM July 31, 2014
Though governments around the world have mounted massive campaigns to address poverty, expensive (and poor) healthcare, crime, and ineffective education, daunting challenges remain. Fortunately, we are witnessing three fundamental changes that offer hope.
First, private citizens, particularly younger people, are choosing different types of career paths. The old model — get a job, earn money, pay back — is being replaced by an earlier commitment to change. Wendy Kopp, who founded Teach For America, and Linda Rottenberg, who founded Endeavor are just two well-known examples. Second, changes in technology have dramatically lowered the cost of experimentation and create unprecedented transparency into problems, solutions, and results. Finally, innovation in the financial markets are funding novel approaches to address these problems.
Take the story of Salman Khan and the eponymous Khan Academy. Kahn, 38 years old, graduated from MIT in 1998 and Harvard Business School in 2003. Soon after, when Khan began tutoring his niece in mathematics while working at a hedge fund, he hit upon the idea of developing short video tutorials on YouTube. Each video showed Khan writing on a graphics tablet while talking about the subject. His niece, and many others, enjoyed the videos and were able to master content they struggled with in school. In 2006, Khan launched Khan Academy to deliver “a free, world-class education for anyone, anywhere.” By 2014, the academy comprised over 3,000 videos on subjects from mathematics to art history. Approximately 10 million people engage with that content each month.
When Khan started tutoring his niece he did not imagine he would devote his life to education; he was simply trying to be helpful. In the process he discovered a fundamental problem in American K-12 education — that the traditional lock-step approach to mass public education of everyone taking the same courses at the same age in the same sequence, did not work for millions of kids. Khan’s self-paced, master-then-move-on model changed the paradigm. Individuals or even entire schools were able to flip the typical classroom structure — have students watch Khan videos at night and do homework with the support of teachers during the day. He created tools to help teachers, students, and parents track progress. Students who mastered materials quicker could help students who needed more time or could go through more advanced materials.
How did Sal Khan finance his venture? Private donors have invested over $40 million since Khan Academy was officially launched in 2009. Philanthropists have also supported efforts to translate the content for local use. Khan has been able to attract some of the best computer programmers and educational content experts in the country even though he has no profits to share or stock options to grant. His backers believe that investing in Khan Academy represents one of the highest returns in improving education around the world (see this HBS case for more on how funders decided to get involved).
The Khan Academy story well illustrates those three changes we’re witnessing. First, Sal Khan could have continued in finance and made far more money than he does in a nonprofit. The same is true of everyone on his team. But, instead, they want to make the world a better place. Second, technology made Khan Academy possible. The cost of running the initial experiment — attaching a graphics tablet and microphone to a personal computer — was trivial. Distributing content over the Internet is also inexpensive, while reaching a potential audience of billions. Khan has easily created tools to measure mastery and progress for individuals and institutions, comparing the effectiveness of his classroom model to the traditional one. His niece, who might have been assigned to the “slow” math class, zoomed to the top of the class. Khan Academy does not replace public education, though it might in other countries; it supplements or complements what is possible for all citizens.
Finally, venture philanthropists are willing to invest in projects like Khan’s that can reach millions of people with a modest amount of money. In this case, a select group of private philanthropists have funded the organization. That’s great but the sums involved are modest compared to the $200 trillion in global financial assets. What if some of that capital could be deployed to attack social challenges? A relatively new instrument called a social impact bond is a powerful example of how this might be done.
Several years ago, one of us (Sir Ronald Cohen) and a group of like-minded individuals in England hit upon the idea of using private capital to fund efforts to reduce prison recidivism. When prisoners are released without an effective support system they are highly likely to end up back in jail, which is devastating to them and their families and costly to government. However, private social enterprises have been effective at reducing recidivism rates. Cohen and his colleagues created a bond, backed by private investors. If the social enterprise delivers on the promise of reducing the recidivism rate relative to current best practice, the investors receive their capital back and a capped but attractive rate of return. If not, the investors receive a lower return and risk losing their capital. The government benefits by saving money.
One can imagine many similar areas in which there are measurable costs and outcomes that might benefit from this approach. Increasingly governments are publishing data on the costs and consequences of issues like recidivism, dropping out of school, or treating certain diseases. This data provides a benchmark against which a financial instrument can be devised.
For example, there have even been efforts to use securitization techniques to support finding and delivering better therapies or cures in certain disease areas. Professor Andrew Lo and colleagues at MIT have pointed out that individual company efforts to find new therapies for cancer or Alzheimer’s are risky and not able to attract debt financing. If, however, there were a way to invest in a pool of such efforts, the aggregate portfolio risk would be far lower. Some investors with modest risk tolerance could invest in a bond secured by the pooled research and intellectual property. Other investors might buy equity tranches that have a higher likelihood of low returns but the potential for outsized returns.
These are exactly the kinds of new solutions we need to succeed where previous monolithic attempts to tackle society’s woes have failed. But these efforts won’t make a difference if people continue to protect the status quo and block these new ideas. Instead, we need to encourage the trends we’re witnessing — the continued commitment of human and financial capital and the use of technology in new and innovative ways — if we are going to help future generations create an affordable and equitable society.
WILLIAM A. SAHLMAN
William A. Sahlman is the Dimitri V. D'Arbeloff-MBA Class of 1955 Professor of Business Administration at the Harvard Business School.
SIR RONALD COHEN
Sir Ronald Cohen is Chairman of Big Society Capital and The Portland Trust. He co-founded Bridges Ventures and Social Finance UK, and is director of Social Finance USA. In 2012 he received the Rockefeller Innovation Award for innovation in social finance.
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