Social impact investing, a strategy that focuses on achieving a positive social goal while still generating a profit, is a trending topic. As well it should be. However, this laudable investing approach is often misinterpreted by entrepreneurs who don’t understand the concept of revealed preference.
Revealed preference is a theory first described by the economist Paul Samuelson. It’s a method for analyzing choices made by consumers and predicting their future purchasing preferences. I won’t pretend to understand the theory in detail, as its measures of WARP (Weak Axiom of Revealed Preference) or SARP (Strong Axiom of Revealed Preference) are beyond me. Nonetheless, at its more basic level it should be understood by any startup founder.
Take this food industry example:
Customer surveys invariably show that consumers want healthy food choices. Buying pattern analysis reveals a different behavior; after all, people don’t reach for their wallets when answering survey questions. Consumers want food that tastes good. First and foremost. Then, they want value for money, at least to a certain degree. Any other product claim, be it a health benefit, an environmentally friendly attribute, or a charitable donation, tends to have a lesser impact on purchasing decisions.
I learned about revealed preference the hard way while managing Monsoon Kitchens, an Indian food manufacturing firm. Monsoon sold to the foodservice industry, including many university and college food service operations that were mandated (by students and administrators) to provide healthier food choices. Monsoon’s vegetarian and gluten free offerings seemed an ideal fit. We sold to and sampled products on numerous campuses, all with relatively similar results. Student trays would be piled high with burgers and fries long before they slid past our nutritious entrees and side dishes without pausing. The students recognized the importance of eating healthier food . . . they just found the taste of less-healthy items more compelling.
What does this have to do with entrepreneurs? A great deal if your business plan relies heavily on product differentiation achieved primarily through low-environmental-impact packaging and/or by donating a percentage of profits to charity. Great social goals. Yet, if yours is really just a me-too product, then these added social attributes will appear as little more than window dressing to most investors. Suitable, perhaps, for building a nice, lifestyle business but not as a vehicle for delivering traditional angel/venture capital returns.
Even investors with a stated social objective look for truly unique products or services. First.
Mr. Dragone has spent the past twenty years as an acting/consulting CFO for a number of start-ups in a wide range of industries. Peter’s prior experience is that of a serial entrepreneur, managing various start-up and turnaround projects. He was a co-founder of Keurig, Inc.