Donor Funding Models for Innovation: A Review

Summary

Donors have rhetorically supported the importance of innovation in global development, but the level of resources committed has seldom matched the level of this rhetoric. There are clear barriers to expanding funding for the innovation ecosystem: (1) innovation remains under-resourced, and models that are providing clear results are not properly supported; (2) pathways to scale remain limited because of the total funding available; and (3) the risk appetite of donors remains too conservative to properly support and scale innovation. Recent impact evaluations suggest that innovations supported by the United States Agency for International Development’s (USAID) Development Innovation Ventures (DIV) and the Global Innovation Fund (GIF) have yielded impressive returns. But more importantly, innovation also leverages scarce funding resources and engages with locally based partners.

Background

Supporting innovation in global development to identify new approaches for old, seemingly intractable problems has been an uneven priority for donors, philanthropists, and impact investors. While rhetoric has frequently elevated the importance of innovation, actual allocations of funding and personnel have not quite matched this enthusiasm. Resources for innovation remain scant when compared to overall development assistance. USAID, for example, spends just $30 million per year on its DIV program, compared to the $18 billion in other assistance that USAID obligates each year.

Innovations can be tech enabled but often are simply a new model (e.g., a farmer cooperative) or process to encourage change in behavior (e.g., using behavioral nudges to encourage tax compliance). The International Development Innovation Alliance defines innovation as “a new solution with the transformative ability to accelerate impact. Innovation can be fueled by science and technology, can entail improved ways of working with new and diverse partners, or can involve new social and business models or policy, creative financing mechanisms, or path-breaking improvements in delivering essential services and products.” At the core of support for innovation is an increased reliance on efficacy in making funding decisions. In addition to using evidence, donors have sought to better measure the impact of these new innovations and understand the advantages or disadvantages of one model over another. Grants and investments supported by these models have yielded measurable impact and changes to the way donors program their development assistance.

Supporting innovation in global development to identify new approaches for old, seemingly intractable problems has been an uneven priority for donors, philanthropists, and impact investors.

Through this support for innovation, there is an expansive ecosystem that enables development innovation. However, most of the support remains focused on piloting new ideas and therefore drops off precipitously after launch, creating the so-called pioneer gap. Some approaches have sought to address this gap by adopting a tiered financing model (e.g., pilot, transition, and initial scale) that seeks to promote innovation during the early concept stage. Past this, innovation support begins to peter out as innovators and pioneers face a lack of financial resources tailored to meet their needs. Donors—who invested the initial resources needed to prove a concept—face the prospect that new innovative models will fail to launch.

Currently, there are four ways to support innovation in development:

1. Grand challenges model: Often framed around a “grand challenge,” this is a model where donors provide small grants to seed initial pilot projects that tackle identified challenges. Two examples of this are USAID’s Grand Challenges for Development and the Canadian government’s Grand Challenges Canada. Both are examples of where a donor has provided grant funding that is then awarded to individuals or organizations with a unique idea or approach to solving a vexing development challenge.


2. Venture grant model: Some donors have tried to create an internal initiative that seeks to replicate a venture capital approach, using a “venture grant” model that targets innovation. USAID pioneered this model through its DIV program, which uses a tiered funding model where funding decisions are tied directly to evidence of impact.


3. Hybrid venture model: Seeking to replicate the success of the DIV model, USAID and the United Kingdom’s Department for International Development (DFID) launched a multilateral version—the Global Innovation Fund (GIF). Like DIV, GIF uses a tiered funding model tied to evidence of impact, but it has a broader range of flexible financial instruments, including grants, equity, and debt.


4. Venture capital model: Development finance institutions (DFIs) have also sought ways to support innovation and create greater impact by using a venture capital model to finance early-stage investments. An example of this is the Portfolio for Innovation and Impact (PI²) initiative of the U.S. International Development Finance Corporation (DFC), which seeks to engage in early-stage investments that can spur innovation.

Beginning in 2010, USAID sought to increase its support for innovation through the launch of the Global Development Lab. Under the lab, USAID launched DIV in 2010 and Grand Challenges for Development in 2011. The success of these initiatives led to GIF’s launch in 2014, which created a nonprofit fund that multiple donors and funders could support. Initially launched by USAID and DFID, it attracted additional commitments from Australia, Canada, South Africa, and Sweden. DFC’s PI² originally launched in 2014 and expanded its operations in early 2020. Such activity is evidence of the U.S. government’s significant role in creating and funding the innovation ecosystem, where it is playing an outsized role.

As the innovation ecosystem has matured, several barriers to greater growth have been identified:

1. Innovation remains under-resourced, and models that are providing clear results are not properly supported.


2. Pathways to scale remain limited because of the total funding available.


3. The risk appetite of donors remains too conservative to properly support and scale innovation.

Tackling these barriers is critical to mainstreaming innovation within global development. Recent impact reviews suggest that innovations supported by DIV and GIF yield outsized social returns on investment. DIV estimates that five of their investments will generate a return of 17:1, and GIF makes a similar calculation. While these yields are impressive, the need to support innovation goes beyond simple impact in two important ways. First, support for innovators and social entrepreneurs furthers the need to increase support for locally based organizations. Many innovators, if not most, are locally based, offering a ready pool of organizations that meet the goals and objectives of the broader localization agenda. Second, funding for innovation provides a powerful source of leverage for global donors, especially in middle-income countries where pockets of extreme poverty are increasingly concentrated, even as they reduce overall development assistance. This leverage enables greater pooled financing by bilateral donors to target development challenges, even as donors themselves are reducing their overall presence in middle-income countries.

Funding Models for Innovation

This paper examines four prominent examples of donor-backed innovation funding models: the grand challenges model (Grand Challenges for Development), the venture grant model (DIV), the hybrid venture model (GIF), and the venture capital model (PI²). Except for GIF, these models all exist within a government entity. GIF is unique in that it is backed by a group of bilateral donors and foundations. There are clear similarities and distinctions among these models based on their annual commitments, investment portfolio sizes, financial instruments, funding approaches, funding amounts, and impact measures. Table 1 summaries key characteristics of these models.

Grand Challenges

The grand challenges concept has existed for some time in global development, but its most recent incarnation came in 2010 when USAID launched Grand Challenges for Development. These are a series of time-limited (five years) challenge funding programs tailored to address a specific development challenge. USAID will frequently partner with donors—official or nongovernmental—to provide small grants for a large range of innovations that hold the potential of solving or addressing identified problems. Since 2011, USAID has launched 12 grand challenges, including scaling off-grid energy, fighting Ebola, powering agriculture, saving lives at birth, and supporting early education. Through partnerships with other funders, these grand challenges have provided $534 million in grants to 786 innovations. Separate from USAID, the Canadian government launched Grand Challenges Canada, which provides a complement to USAID’s work and other donors in this space.

Award sizes under the grand challenges are smaller, focusing more on seed funding (up to $250,000) or initial transition to scale (up to $1 million). These figures vary depending upon the specific grand challenge. USAID conducted an evaluation of nine grand challenges launched between 2011 and 2016, noting:

The GCs [grand challenges] have achieved good results. Some innovations have scaled, but the focus has been largely on early- to mid-stage innovations which evidence indicates GCs are better placed to support. GCs have provided innovators with support for acceleration (moving along the pathway to scale) and for engaging with the innovation ecosystem which has to be tailored to context to be effective. GCs have leveraged substantial funding.

Development Innovation Ventures

Established in 2010, DIV is USAID’s open innovation program that funds breakthrough solutions to the world’s most intractable development challenges. By funding innovation and focusing on rigorous evidence, DIV impacts millions of lives at a fraction of the usual cost. DIV provides grant funding based on a tiered-evidence approach that maximizes impact per dollar spent. This allows for risk at early stages and mitigates risk at later stages, ensuring that funding is targeted to the most impactful and cost-effective innovations. DIV looks for solutions that demonstrate rigorous evidence of impact, cost-effectiveness, and a viable pathway to scale up and achieve sustainability. Since 2010, DIV has funded 252 innovations in 47 countries, totaling $172 million.

In 2021, DIV made 26 new awards that provided $23.6 million in funding. Figure 1 breaks this new funding down by region. DIV continues to provide a significant amount of its funding to organizations and innovations that focus on sub-Saharan Africa (60 percent of new commitments in 2021) and South Asia (16 percent of new commitments in 2021).

Recent work by economist Michael Kremer suggests that DIV had delivered significant impact at the portfolio level. In a 2019 paper that reviewed DIV’s early portfolio investments, Kremer and his coauthors found that 10 out of 41 initial innovations reached 1 million or more direct beneficiaries. These 10 innovations likely accounted for 95 percent of the 55 million people that the 41 innovations reached, accounting for the vast majority of DIV’s social return. Sufficient data was available for Kremer and his coauthors to estimate a social rate of return on four of DIV’s innovations that reach 1 million or more direct beneficiaries. They estimate that these four innovations will generate $86 million in discounted social benefits, or $5 per $1 invested by DIV. Looking ahead, Kremer and his colleagues suggest that the net benefit of DIV’s portfolio could be as much $17 per $1 invested.

Because DIV is part of USAID, it is subject to the same political environment—with positive and negative impacts. During the Trump administration, DIV shut down for a period as political leadership at USAID considered what to do with DIV and the Global Development Lab more broadly. This created disruption by ending new funding commitments during the shutdown period. That shutdown yielded congressional action, which created a spending directive in the Fiscal Year 2018 State and Foreign Operations bill for DIV in the amount of $21 million (later increased to $30 million). DIV weathered this storm, and it appears that the Biden administration likely has a greater commitment to innovation and the use of evidence in driving funding decisions in this space.

Global Innovation Fund

Founded in 2014, GIF is a nonprofit, impact-first investment fund headquartered in London, with offices in Washington, D.C., and Nairobi. GIF was originally backed by USAID, the United Kingdom, Australia, Canada, South Africa, and Sweden. Taking an agnostic approach to innovation, GIF invests in the development, rigorous testing, and scaling up of new products, services, business processes, and policy reforms that are more cost-effective than current practice and are targeted at improving the lives of the world’s poorest people. Through grants and risk capital, GIF supports breakthrough solutions from for-profit firms, nonprofit organizations, researchers, and government agencies to maximize their impact and catalyze meaningful change. GIF’s portfolio currently includes 24 for-profit investments and 27 investments in other types of organizations. Through 2020, GIF had invested just over $100 million in these innovations.

GIF takes a venture capital approach, using a tiered financing model and offering graduated funding. The goal of GIF’s staged funding approach is not to fund small and medium-sized organizations that intend to stay that way; rather, its goal is to support organizations that intend to scale up to reach millions of people. An important comparative advantage for GIF is that it can use a variety of flexible financial instruments, including grants, loans, and equity. This approach enables GIF to meet the innovator where they are in terms of stage and financial need. Moreover, GIF can de-risk investments for other investors who may have a lower risk appetite. This has enabled the fund to create significant co-financing opportunities, investing alongside a wide range of funders, including:

• DFIs: International Finance Corporation, Proparco, British International Investment (BII), Netherlands Development Finance Company (FMO), Belgian Investment Company, and the DFC;


• Foundations: Shell Foundation, Skoll, Omidyar Network, Mulago Foundation, and Draper Richards Family Foundation;


• Impact Investors: Village Capital, Good Ventures, Patamar Capital, Novastar, and Ycombinator;


• Governments: DIV, Grand Challenges Canada, Nigerian Sovereign Investment Authority, and Norwegian Agency for Development Cooperation; and


• Venture Capital: Aspada Investment, Kickstart Ventures, 500 Startups, and IMJ Investment Partners.

GIF backs innovations with the potential for social impact at a large scale, whether they are new technologies, business models, policy practices, technologies, or behavioral insights. GIF supports innovators at all stages of their life cycle, from start-up and pilot testing through to larger scale implementation. The innovations that GIF funds can be in any developing country and can focus on any sector relevant to international development, provided they improve the lives of those living on less than $5 a day.

In assessing its impact, GIF recently undertook a review of its portfolio-level impact using the same method employed by Kremer to assess DIV’s impact. GIF found that 7 of its 38 initial investments reached 1 million people and 14 innovations reached over 100,000 people. Using a social rate of return, GIF estimated that five of its investments generated $53 million in discounted social benefits. GIF notes, “With modest assumptions, we show that, conservatively projecting out five years, the five investments will have generated $134 million in discounted social benefits, more than covering the costs of GIF’s early portfolio and operations. This corresponds to a social rate of return of 35 percent.” Others calculate that foreign aid provides a return of 10 percent and impact investment funds target a return of 11 to 18 percent, meaning GIF is significantly outperforming other forms of development finance.

Program for Innovation and Impact

DFIs have also sought to fund innovation to create new markets and achieve greater development impact. In 2014, the Overseas Private Investment Corporation (OPIC) launched the Portfolio for Impact, an initiative that aimed to target early-stage investments with the potential to generate significant development impact. Originally, this was conceived as a relatively small program that would provide debt financing of up to $5 million to early-stage entrepreneurs who were not yet ready for larger investors. OPIC investment officers saw social investors who were investing in social enterprises, but there was a distinct lack of debt available for these investments. Equity and grants were available, but social enterprises needed debt to grow in a more sustainable manner. OPIC found good success with this program, and when OPIC became the DFC in December 2019, the Portfolio for Impact became PI².

The PI² initiative officially launched in February 2020, aiming to bridge the financing gap for early-stage social enterprises with innovative solutions for challenges facing the developing world. DFC’s PI² initiative is investing up to $10 million in promising early-stage businesses, which otherwise struggle to access financing due to their relative size, short track record, and novel approaches. In 2021, PI² committed 20 investments totaling approximately $145 million, more than doubling the size of the program. The total portfolio is currently just over $300 million in 55 investments. But like DIV, PI² is a relatively small part of the DFC’s overall annual commitments; in 2021, the DFC made new commitments of $5 billion. This portfolio is well aligned with the DFC’s development mandate, with these investments scoring as “highly developmental” on the DFC’s Impact Quotient. PI² has also sought to innovate with the types of financial tools they use. For example, PI² made two of the DFC’s first three direct equity investments and provided the first technical assistance grant.

Expanding Innovation

Given the relative success that DIV, GIF, and others have achieved in investing in evidence-based innovation, there is an ongoing interest in how to expand innovation and “mainstream” it within the broader global development ecosystem. That said, the amount of funding remains relatively limited, with DIV receiving $30 million in annual appropriations and GIF receiving an initial commitment of $200 million. For successful innovations, moving to scale is the goal, but this remains a challenging objective for the field. Donors, philanthropists, and impact investors have been able to generate a fair amount of funding for pilot and early-stage innovations, but there is a significant gap in funding after these stages, creating the so-called pioneer gap. For social entrepreneurs, this means greater access to patient, impact-focused capital. For nonprofits, this will mean continuing to work with philanthropists, donors, and local governments to identify the resources needed to take successful innovations to scale.

Evidence from innovation funders suggests that innovators and entrepreneurs in developing countries need:

1. Patient capital with at least a 10-year time horizon;


2. Financing that provides flexibility and terms that support their early-stage models as they grow;


3. Concessional capital for social entrepreneurs that will allow other investors to take greater risk by backing less proven business models; and


4. Tailored funding amounts tied to stage that can evolve as a business or entity grows.

DIV and GIF are both meant to respond to this challenge, though GIF can engage with a broader range of innovators given its more extensive financial tools. For example, GIF has found that social entrepreneurs—those who have created a for-profit model—often prefer to receive risk capital (even if concessional in nature) because it signals to the broader market that they are a serious investment. While grants are useful to seed an early idea, they become less valuable as a business matures and seeks to raise the capital it needs to grow.

Funding to support innovation has been somewhat lopsided, with significantly more resources provided to the grand challenges model than to the other models discussed. Since 2010, donors have committed $534 million in grants to grand challenges. The largest grants funded under these programs are no more than $1 million, which means the model has funded a tremendous number of pilot ideas. In contrast, DIV provided $172 million in grants over the same period, while GIF has provided $100 million in commitments over a six-year period. Both DIV and GIF have used their funding to leverage additional cofinancing. GIF estimates that they have been able to secure $130 million in cofinancing for the innovations they support to date.

Risk appetite for official finance remains a barrier to greater innovation support. Bilateral grant-based official development assistance (ODA) remains reluctant to shift significant resources toward new innovative approaches, largely over concerns related to failure. The U.S. government relies on an extensive network of for-profit and nonprofit implementing partners who execute their work through grants and contracts. This system is largely designed to deliver accountability and transparency to the U.S. government, Congress, and the U.S. taxpayer. The other source of official finance—DFIs—should be more willing to take risk but again defaults to seeking safe, higher returns on investment. The risk-return calculus for DFIs is too skewed in seeking private equity-type returns when they could take smarter risks and provide the type of investment needed to help bring innovations to scale.

By their nature, innovation funders such as GIF and DIV have smaller amounts of funding available. This is why both adopted a model of tiered funding that ties higher financing to greater evidence of impact. Even with greater evidence of impact, a larger investment implies greater risk. Figure 3 compares GIF’s and DIV’s portfolios in terms of funding stage. At present, GIF’s portfolio is more weighted toward Scale and Test & Transition (GIF’s terms for the second and third stage of funding), suggesting a slightly greater risk tolerance than DIV. GIF can take greater risk because it is backed by multiple governments and because it is an “off-balance sheet” fund; its risk is borne by GIF alone. While DIV should be applauded for its pioneering approach, it still reflects the overall risk-averse nature of the U.S. government by concentrating more on early-stage pilot projects or funding for research, such as randomized control trials.

Recommendations

Donor support for innovation has generated significant impact. As noted above, GIF and DIV have both shown that their investments have yielded impressive impact on a portfolio basis. Their innovations, along with those of the other models analyzed in the paper, have improved the lives of millions of people living in poverty. Despite this impressive impact, these models are unlikely to be sustainable in the long term on their own. To expand their reach, it is critical to recognize that these models exist as part of a broader innovation ecosystem. It is incumbent upon donors who provide financing to these various models to put aside parochial differences and increase support for innovation.

To do so, the U.S. government should do the following:

1. Build a more integrated innovation ecosystem incorporating its existing funding models.


2. Increase the amount of funding and other resources available to support existing funding models.


3. Create sustainable paths to scale innovation.

Build a More Integrated Innovation Ecosystem

The U.S. government is a significant funder of innovation, as outlined in this paper. The four models of donor support are all backed by the U.S. government in some form. To date, cooperation between these various entities has largely been done on a personal basis and not through formal mechanisms—outside of direct funding, as in the case of GIF. This means that when collaboration or cooperation does occur, it is often simple happenstance, as opposed to a serious commitment to align efforts. USAID and the DFC should formalize collaboration and cooperation among the three innovation support entities they have had a role in creating: DIV, GIF, and PI². Such an approach would create collaboration along three main axes: (1) pipeline sharing, (2) cofinancing opportunities, and (3) better integration of partners into each other’s investment processes.

Holistic thinking about the innovation ecosystem should seek to take advantage of each entity’s unique comparative advantages. For example, grand challenges and DIV could concentrate their support on early-stage (pilot) projects that, while carrying some risks, are not as risky because of the size of financial commitments (less than $1 million in most instances). Assuming these entities prove their value through evidence, they could then be passed along to GIF to provide larger amounts of money (likely cofinanced with other grant-based funders for nonprofits or private investment for social enterprises) to further test and prove their concepts. At scale, they could then graduate toward DFI investment alongside impact investors or be scaled by local governments working with bilateral or multilateral donors. This is an ideal scenario, but given the U.S. government’s role in supporting various innovation funding models, there is no reason why it could not create a more seamless ecosystem.

There are also obvious cofinancing opportunities between DIV, GIF, and PI². DIV and GIF are similar models and have both provided support to several different innovations over the years. When it has worked best, DIV has frequently provided a small initial pilot amount of funding that helped to generate additional evidence of impact. GIF then used that evidence to justify taking further risk and providing a greater amount of money to scale up a particular innovation. GIF has also coinvested alongside the DFC (or OPIC) and other DFIs, often playing a “de-risking” role by making an investment more palatable.

Increase Funding and Other Resources

Funding for innovation remains relatively small compared to the overall amount of bilateral ODA and annual commitments by DFIs. Since 2010, DIV has committed $172 million to fund innovation; since 2014, GIF has committed approximately $100 million; and last year, PI² committed $145 million. More can and should be done. As noted above, the U.S. government should meet its commitments to GIF and should increase those in the coming years. Too much official finance—both grant-based ODA and DFI finance—remains risk averse, preferring to provide investments or grants to relatively safe, tested methods. From an accountability perspective, this is understandable, but it does limit what the government is willing to support, and it may not always deliver the best return for the money provided. Shifting risk appetite among donors is critical to ensuring that financing remains available for bringing innovations to scale.

The U.S. government should continue to fund GIF and other innovation funding models. By funding non-U.S. government entities, the U.S. government could shift some of the risk off its “balance sheet” and onto an outside entity. Nancy Lee of the Center for Global Development has argued that donors should create “special purpose vehicles” or off-balance-sheet investment funds that would shift the risk from the donor onto an outside entity. Such an approach would help preserve the donor’s credit rating (in the case of the multilateral development banks or DFIs) or provide accountability to political overseers. The U.S. government should recognize that it already has such an entity in GIF and build on that success. Given the right amount of funding, GIF and other funding vehicles could take more smart risks and continue to experiment with new approaches. By doing so, GIF and its partners would help create a robust pipeline of opportunities that the DFC, and USAID more broadly, could support through more regular funding.

Funding alone, however, is insufficient. Internally, programs such as DIV and PI² are understaffed relative to their overall impact. USAID and the DFC should increase the number of staff assigned to these two programs to enable greater impact and an increased number of investments. Increasing staffing would enable these two programs to take full advantage of their existing funding and allow them to absorb additional funds should USAID and the DFC make new commitments in the innovation space.

 Create Sustainable Pathways to Scale Innovation

Funding to scale innovations remains elusive, especially as innovators transition from the pilot and early test phase. This is the so-called pioneer gap. GIF and DIV both provide some funding at this critical stage, but they cannot do it alone with their limited resources. Even if they received additional funding, a significant gap would still exist. To truly bring innovations that work to scale, there are two pathways: (1) private sector finance for social entrepreneurs and (2) public sector support for nonprofits. There is likely a third option that sees a hybrid of private sector financing and public sector support done as a public-private partnership.

Funding to scale innovations remains elusive, especially as innovators transition from the pilot and early test phase. This is the so-called pioneer gap.

Donors and official finance can play a critical role in bringing these potential pathways to scale. For social entrepreneurs, DFIs can provide catalytic funding that could help de-risk their innovations to unlock greater private capital from impact investors and other institutional investors with a lower risk tolerance. DFC has sought to take such an approach through its PI² program, but the amount of financing remains relatively small compared with the need. DFC and other DFIs should adjust their risk-return calculus to make more funding available by looking at social enterprises as an opportunity for more DFI finance. This would provide mutual benefits to the DFI and the social enterprise: the DFI would invest in scaling up developmentally impactful projects, helping them achieve greater impact (something they are often criticized for not doing enough), and it would provide the social enterprise with a strong market signal that they are moving toward scale and should be seen as a good investment choice.

For the public sector, donors can play an important role in helping generate additional resources that could scale up innovations focused on improving the delivery of social services. This could include work targeting domestic resource mobilization, which includes efforts to increase the amount of government revenue available for issues such as the delivery of social services. In addition, donors should look to see how they can use their resources to incorporate new innovations into their existing programs within countries. This would help to not only scale innovations but also provide further evidence to the local government that the innovation is proven and worthy of support beyond a time-limited donor project.

Conor M. Savoy is a senior fellow with the Project on Prosperity and Development at the Center for Strategic and International Studies in Washington, D.C.

This report is made possible by support from the Global Innovation Fund.

This report is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s). 

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