Challenge Funds: Policy Case Study on Inclusive Business

Monday, 5 September, 2016

“Enterprise challenge funds (ECFs) provide grants or subsidies with an explicit public purpose between independent agencies with grant recipients selected competitively on the basis of advertised rules and processes who retain significant discretion over formulation and execution of their proposals and share risks with the grant provider." ECFs invite companies working in a targeted field to submit project proposals for inclusive business models that aim to solve a specific development problem and generate high pro-poor impact. The proposals are then assessed against transparent and pre-determined criteria. Successful applicants must match a certain percentage of the grant with their own financing or in-kind contributions. ECFs can trigger new ideas and innovative solutions to pressing social issues.

In contrast to social and civil society challenge funds, ECFs promote innovation oriented to serving people living at the bottom of the economic period (BoP) and fund activities that are projected to be commercially viable without repeated subsidies. They should be applied when trying to solicit new solutions to clear and well-researched challenges. To assess whether or not an ECF is the right solution for allocating public funds, it is essential to understand the target market and existing actors. Markets that are underdeveloped over overdeveloped are not ideal for ECFs since they run the risk of either not having enough business solutions or creating market distortion by externally influencing competition in local markets.

Early ECFs aimed to be light-touch solutions to catalyze risky ventures that otherwise would not materialize or would be delayed due to lack of financial capacity. Recently however, ECFs have been diversifying their objectives and level of engagement. Robin Davies and Kerri Elgar distinguish two emerging perspectives of challenge funds: the “purist” approach and the “pragmatic” approach. Proponents of the purist approach adhere to the logic that managers need not actively engage in implementing projects, but should invest in prior research to understand the market and design eligibility and selection criteria strict enough to only elicit business ideas with a high potential for success and sustainability after the funding period. Purists maintain the perspective that the role of ECFs is to provide risk-reducing subsidies for projects without other forms of support such as technical assistance. Pragmatists, on the other hand, argue that ‘pure’ ECFs achieve very little on their own in terms of impact. They believe that in order to bring about systemic change, as this instrument is intended to do, ECFs should be embedded in larger private-sector development mechanisms or include other forms of assistance for selected businesses.

ECFs can be included in national policies as part of an activation strategy or an Active Labor Market Policy (ALMP) to encourage unemployed citizens to find jobs. The Jobs Fund programme in South Africa is a prime example of this strategy in practice. As detailed later in this paper, ALMP strategies must not substitute or displace natural labour market mechanisms or become deadweight (i.e. achieve outcomes that would likely occur in even the absence of the policy).

Challenge funds engage actors in development by creating a unique partnership between public and private actors, who both have a vested interest in the success of the programme. ECFs leverage donor funds by attracting private capital through matching financing and engage the private sector in achieving development goals. Public partners can strengthen links with domestic and partner-country businesses, and find local solutions to local problems without significant external influence. The competitive aspect of the programme helps public partners to elicit desired solutions by prescribing the means to achieve them and by supporting multiple winners.

This research note introduces common elements and success factors of challenge funds, provides case examples and information about the implementation, identifies ideas for further research and knowledge gaps.

Read the full policy case study (pdf).