Thoughts on challenge fund investment leverage

A recent discussion on the MaFI Linked in group has thrown up a couple of very important points about leverage that we have been working on with ABIF: 

1. What does leverage actually signify? 
2. How is leverage measured? 

ABIF achieves development results through incentivising investment by private sector partners. So answering both of these questions together is important to the understanding the project's performance. 

The original question posed in the discussion about the relative importance of project and partner's leverage is relevant to any project from a value for money point of view. However, it is important to note that the relationship between financial inputs and development results is far from linear or consistent. For this reason, in answer to the question of what leverage signifies, we do not look at partner leverage as a target in developmental terms. Rather it is used as a measure to ensure that we provide the minimum financial commitment necessary for any given project to go ahead. In other words, we are looking for a rational basis for assessing the tipping point in any investment decision. For any project, talking about leverage is important, but it should not be seen as a developmental indicator, instead it gives insight into the quality of the management process and decision making. 

The second question is surprisingly complex. Somewhat naively, when I first came to the world of challenge funds, I assumed that there would be an agreed methodology for calculating leverage. As Sharad Rai said in his original post, this is regarded as a very important indicator, so you would imagine that there would be a definition of how it is calculated. I was surprised to discover that looking through reports on past and current challenge funds, there was no consistency of approach (in fact some projects do not even disclose how the leverage claim is calculated). We have therefore developed our own methodology, which will be published in our forthcoming project review. When we started to work on this methodology, we realised that there are many variables that need to be defined if a project like ABIF is to present its results in a transparent and consistent way. 


So calculating leverage in the simple cash terms of we put this in, they put that in, does not tell you much, there are context specific issues around risk (political, commercial etc). Such factors make reporting partner investment leveraged potentially misleading and certainly make project to project comparisons unhelpful (I would expect a project in one set of circumstances to be leveraging less partner cash investment than a less risky project in a less risky environment, but this would not show in typical project results presentation). So the question then becomes what is the correct benchmark for any particular project? Donor funded projects have so far come up with two solutions of which I am aware: 

1. Matching grants "one size fits all" benchmark, which by definition, always gives too much grant, but is bureaucratically simple; and 
2. Risk based calculation, which provides a project-specific approach approximating to the "right" amount of grant by seeking to find the tipping point, but is more difficult for donors to understand! 

But this is only part of the story. Should we also be talking about the end-user investment in adoption leveraged? Absolutely in my view. This is an excellent indicator of the behavioural change stimulated by the project and the key to opening the door of the desired development outcome. At ABIF, we place great emphasis on new products or services being accessible, relevant and affordable to end user target beneficiaries. The affordability recognises that these people (particularly producers) typically have to make their own investment and take their own risk in adopting a new technology or technique. In my experience, this is something that scaling up strategies rarely address, and one of the main obstacles to spontaneous copying by end users. 

One of the things that I have seen in the past is that projects tend to make optimistic assumptions about spontaneous copying among target beneficiaries who have been exposed to a new product or service. It seemed to me that these assumptions did not place sufficient emphasis on two points:

1. That end users are themselves required to make an investment and take a risk by changing behaviour; and
2. The closer the end user is to subsistence level, the greater the risk that they are taking.

For example, one of our current investment projects is with an Afghan company that is introducing certified high-yield apple varieties to Afghanistan. With ABIF support they have set up a nursery, and are now selling hundreds of thousands of saplings to farmers. To make the nursery project investment happen, ABIF and the investor both contributed significant amounts of cash, and this is what we used to think about as the investment leveraged. But looking at the project more carefully, we realised that the investment that the end-user is being asked to make is actually much more important and useful to us as an indicator than this traditional view of leverage.

Let's say that to make the original project happen, we put in 100,000 and the investor put in 200,000, we would happily report that we had leveraged 200,000 investment, but what does that actually tell us about the developmental impact of the project? Very little, if anything at all.

But if this nursery goes on to sell 500,000 saplings at a price of 5 each to our target beneficiaries, the scale of collective investment (2,500,000) by the end-users dwarfs the original investment in the nursery project. And more importantly, this leveraged investment does tell us something about behavioural change and gives us a useful indicator of how market systems are changing. Of course, the relationship between the scale of investment and the development result is not linear, but at least we can assume that the end-users buying the saplings perceive a positive risk adjusted return on the individual investments that they are making.

Based on this thinking, with ABIF we have moved from a view of "leverage" focused exclusively on the investment made by the challenge fund grantee, to a wider view that emphasises the investment made by the end-user target beneficiary at the point of service/product adoption. This is where we see a very useful indicator of the way that markets are working for such people is changing.

Having this focus on the end user, starts to fire off other thoughts about the risk and investment involved in changing behaviour, for example:

1. What is the nature of the risk that the end-user is taking;
2. How big is the risk relative to the end-user's economic capacity/diversity of income sources;
3. How can we reduce perceived risk to encourage adoption;
4. How big is the initial investment relative to resources; and
5. How significant is the expected source of increased revenue.

All of these questions helps us to build a picture of the risk adjusted return in the eyes of the end-user.

I don't want to give the impression that we get into hugely detailed calculations or that we have some equation that can show whether copying will or won't happen, rather we try to anticipate the nature and the scale of obstacles to copying, and address them through the investment projects that we are supporting. Clearly, our development interests in copying and the grantee's commercial interests in increasing sales are fully aligned, so frequently it is a matter of finding correct price points, ensuring that marketing is effective etc. But the bigger point is that we do have a differentiated scaling up strategy focusing on demand side copying.

In terms of results measurement, we are now working through these thoughts with our donor, and trying to come up with a results management system that captures this kind of developmental leverage. I think that we are getting there!

Fruits of labours

Delivery of nursery equipment to Trio

The fourth of the seven ABIF first round grantees has just achieved a major project implementation milestone. Trio, a fruit nursery project in Balkh province has taken delivery of and completed the planting of some 150,000 saplings for sale next season in addition to the 150,000 that are already sold (50,000) or ready for sale (100,000) this year.

Trio came to us originally as an orchard and cold-storage project, but spotting the greater market development potential of a nursery supplying certified saplings to small farmers, we encouraged them to re-think the business model accordingly. As the proposal developed, it became clear that there was very promising commercial potential in importing mother stock and selling on semi-dwarf variety saplings in the north of Afghanistan. The saplings are supplied together with a drip irrigation and shading system that maximises yields and reduces water consumption.

The ABIF Investment Panel recommended that the cold-storage component was dropped, and with the new business model, this made perfect sense.

Meanwhile, we put the investor in touch with the Afghan National Nursery Growers Association, a sector association founded with the support of an EC financed project under the Ministry of Agriculture, Irrigation and Livestock.

Working on the new nursery

As soon as the weather became warm enough, the nursery was established on 2.5 hectares of land, adjoining the current orchard owned by the same investor.

The successful implementation of the Trio project means that four of the first round projects are now well on track (the others being Al Hadi 786 pharmacy chain, the Herati Cashmere and Skins de-hairing line and collection centres and Naab Interiors computer assisted furniture production). The fifth (Saniazada Edible Oils) is expected to pass its main implementation milestone in the very near future and the remaining two are on track to make significant progress later this year. It is great to see such tangible results from the financial support provided by ABIF, and a pleasing reflection on the selection and process of the first round that all of the projects appear to be heading very firmly in the right direction.