Presentation to SAEF meeting on ‘Inclusive Innovation’ 9th February 2013

byProfessor Gavin C Reid

Director, CRIEFF University of St Andrews

http://www.st-andrews.ac.uk/crieff/CRIEFF.html

Attitudes to risk, and the potential role of informal investors in inclusive

innovation

Gavin C ReidProfessor of Economics

School of Economics & Finance

Format of talk

• Inclusive innovation• Risk, innovation and investment• Investors and investees• Contractual possibilities for informal investors

Economics of Innovation

The economics of innovation (cf. Swann, 2009) uses a much narrower interpretation of ‘innovation’ (e.g. focussing on price signals, factor productivity, and downplaying institutions) than we find in a variety of inter-disciplinary studies (cf. Hamel, 2011). More recently, even economists have broadened the conception, especially in their emphasis on end-user innovation (e.g. focussing on innovation communities, self development etc. ) (cf. von Hippel, 2005)

Extent of Innovation

The extent of innovation is usually examined by economists under two headings:Cost reduction e.g. Dasgupta and Stiglitz (1980), Telser (1982), Spence (1984)Product diversity e.g. Spence (1976), Dixit and Stiglitz (1977) and Judd (1985)

Inclusive Innovation• In its broadest sense, this refers to embodying core concepts of social

responsibility into the strategy and management of organizations.

• Then organizational innovation is ‘inclusive’ in that it intrinsically links responsibility, strategy and operations.

• This inclusion should embrace principal stakeholders like employees, customers, suppliers, financiers, NGOs and the local community.

Ref: Nijhof, A., O. Fisscher, and J. Kees Looise (2002), Inclusive innovation: a research project on the inclusion of social responsibility, Corporate Social Responsibility and Environmental Management, Vol. 9, 83-90

Innovation and Inclusiveness

More narrowly, ‘inclusive innovation’ is seen as a way of the poorest members of a community (e.g. the informal sector) being involved in innovation that is ideas-intensive, and highly economical.

See next slide!

The Dabbawala (i.e. lunch-box carrier)

• A system of meal distribution in Mumbai.• It meets criteria of economic innovation (cost

reduction, product diversity) and of inclusion.• 5k workers, mostly illiterate, deliver 200k

lunches per day, with errors at 1 in 6m.• Efficiency is high, and workers are included

who might otherwise be inactive. Ref: M Dutz (2007) Unleashing India’s Innovation

The Inclusive Business Model

• Targets low income communities, especially in developing countries

• Seeks engagement in both goods (e.g. as final consumers, as BTB customers, as clients) and factor markets (e.g. as employees, entrepreneurs, producers)

• Aims to foster innovation in terms of products, processes or business models

Ref: Creating Value for All: strategies for doing business with the poor (2008), United Nations

Informal Investors Worldwide: GEM

• The data collected over 6 years (1998-2003) from over 40 countries, using 138 separate surveys.

• Find self-funding and informal investment are the lifeblood of entrepreneurship.

• 99.9 % of entrepreneurs launch new ventures without formal outside equity.

• Entrepreneurs provide 65.8% of the start-up capital; informal investors provide the rest.

Young Entrepreneurs (GEM)

Half of the world’s entrepreneurs are aged between 25 and 44 years.

The highest rates of entrepreneurial activity are amongst 25-34 year olds, for all regions.

Ref: S. R. Xavier, D. Kelley, J. Kew, M. Herrington, A. Vorderwülbecke (2013) GEM 2012 Global Report, launched on 17th January 2013, Kuala Lumpur, Malaysia.

Entrepreneurship and Inclusiveness

‘While entrepreneurship may not be a panacea, it can surely be part of the solution. Yet, growth for growth’s sake alone is not enough. Economic growth through entrepreneurship needs to address issues of inclusiveness and ensure these efforts advance societal well-being.’

Ref: GEM 2012 Global Report, Executive Summary, p. 6

Risk

Risk is of two types: insurable (i.e. actuarial) risk, and uninsurable (i.e. uncertainty). Both can be relevant to innovation, and inclusive innovation is no exception.In principle, insurable risk can take care of a wide variety of risk types, especially if they are founded on settings in which individual risks are small, independent and frequently occurring (e.g. the risk of damage done in a car crash)

Insurance markets

Failure in insurance markets is common, especially in economic development settings. Difficulties arise from:

• Enforcement (a loan is not a grant!)• Adverse Selection• Moral Hazard• Bank Runs• Monopoly power of lenders

Ref: Timothy Besley (1994)How Do Market Failures Justify Interventions in Rural Credit Markets?, The World Bank Research Observer, Vol. 9, No. 1, pp. 27-47

Uninsurable Risk: UncertaintySince the work of Frank Knight (1921), economists have tended to reserve uncertainty for uninsurable risk.

This type of risk represents one-off situations that have not occurred before, and may not occur again.

By its nature innovation involves something new, and if its novelty is indeed genuine, it will not have been seen before.

A problem therefore arises: how you evaluate the riskiness of the innovation? See next slide, which is based on Reid and Smith (2007)!Refs: F. Knight (1921), Risk, Uncertainty and Profit; Reid, G.C. and J.A. Smith (2007) Risk Appraisal and Venture Capital

Importance of Factors in Appraising Risk

0 1 2 3 4 5

local environment

commitment to bring in others

comparable investments

scale of the business

global environment

information system capabilities

funding structure

type of exit

sales model

compelling nature of proposition

business model

employee capabilities

extent of motivation & empowerment

market opportunities

management team

Degree of Importance (0=irrelevant, 5 = high)

Most important factors in risk appraisal: venture capitalists

0 1 2 3 4 5

Commitment to bring in others

Funding structure

Employee capabilities

Information system capabilities

Extent of motivation, empowerment &alignment

Global environment

Management team

Scale of the business

Comparable investments

Local environment

Compelling nature of the proposition

Business model

Sales model

Market opportunities

Type of exit

Degree of importance (0 = irrelevant, 5 = high)

Most important factors in risk appraisal: entrepreneurs

Illustration: Some Indian Start-Up Data

Average number of owners per firm 1.2% Selling products to new customers 25%Average investment needed per firm 72k rupeesAverage investment by owners 39k rupees Opportunity based/ necessity based = 1.43

Source: Global Entrepreneurship Monitor (GEM)

Conclusions

• Inclusive innovation can involve entrepreneurship.

• Investors will typically be informal.• Sums required, and funded, are small.• Investor – investee relations cannot evade

agency effects.• Having an age distribution leaning to the

youthful favours entrepreneurship

Thank you!

Your questions are invited

Selected ReferencesBesley, T. (1994) How Do Market Failures Justify Interventions in Rural Credit Markets?, The World Bank Research Observer, Vol. 9, No. 1, pp. 27-47.Hamel, G. (2011) What Happens Now, HUP.Knight, F. (1920) Risk, Uncertainty and Profit, Chicago UP.Nijhof, A., O. Fisscher, and J. Kees Looise (2002), Inclusive innovation: a research project on the inclusion of social responsibility, Corporate Social Responsibility and Environmental Management, Vol. 9, 83-90Reid, G.C. and J.A. Smith (2007) Risk Appraisal and Venture Capital, T&F.Swann, P. (2009)The Economics of Innovation, EE. United Nations (2008) Creating Value for All: strategies for doing business with the poorvon Hippel, E. (2005) Democratising Innovation (Creative Common Licence)Xavier, S.R., D. Kelley, J. Kew, M. Herrington, A. Vorderwülbecke (2013) GEM 2012 Global Report, launched on 17th January 2013, Kuala Lumpur, Malaysia.