Eliciting Innovation through Challenge Funds
Challenge Funds (CF) have been implemented in several countries by donors to elicit innovative responses to a variety of chronic challenges, including bottlenecks in financial access, reducing the number of out-of-school children, arresting waste and inefficiencies in agricultural value chains, increasing responsiveness of local governments for improvements in service delivery, to name a few (see Exhibit 1 for a detailed list).
Exhibit 1: Global Challenge Funds
Functioning of a Challenge Fund
The objective of a CF is to provide financial contribution to a project with a social impact. A well-designed CF provides the smallest possible financial contribution to make it less risky and more financially sustainable to the promoter7. A CF identifies a critical problem or market failure and then solicits solutions from a wide variety of potential implementers, ideally focusing on the private sector to provide sustainable solutions. This makes ‘problem identification’ a crucial part of the CF process. The funding is in most cases structured as a matching grant, but can also be provided as debt or equity. Applicant qualifications differ across challenge funds based on the focus area and economic environment. Also, rules and processes are widely advertised to ensure maximum competition and transparency and commercial viability and sustainability constitute a core assessment criteria for proposed projects.
Global Successes of Challenge Funds
An example of a highly successful project funded via the CF mechanism is M-PESA8 in Kenya. Born as a result of the Financial Deepening Challenge Fund (FDCF), M-PESA was initially piloted to help with repayment of microfinance loans. This pilot stage, which ran from 2005-2006 and with a funding of £ 2 million from Safaricom and Vodafone, surfaced various opportunities to develop targeted products and services after experimentation of a test and learn approach. A local remittance product, that was low cost and agent supported, was developed as a result. The success of this product led to the launch of the M-PESA service in 2007. The service on-boarded 2 million customers in one year and after expansion to several other countries9, the service currently has 25 million active users. The past twelve months have seen the service focusing on international payments, partnering with various transfer hubs and mobile operators10.
Similarly, an example of a CF with significant overall impact is the regional Enterprise Challenge Fund (ECF)11, funded by the Department of Foreign Affairs and Trade (DFAT) – Australian Aid, which ran from 2007-2013. ECF provided grant funding to varied businesses in South Asia and the Pacific12, for triggering long term sustainable growth. See exhibit 3 below.
Exhibit 2: ECF Funded Projects: Sectors and Regions
The ECF was managed by a network of country managers and a fund management team. Grantees were selected through a competitive process and were expected to contribute at least 50 percent of project cost. ECF received a total of 532 proposals from 1,200 companies from 2007 to 2009. The total amount disbursed was approximately $13 million to 24 projects across eight countries, directly affecting 78,000 people by increasing income and employment.
Karandaaz Pakistan aims to influence market change and therefore has recently launched its own Innovation Challenge Fund using a rounds-based approach. The rounds will be centered around Karandaaz’s primary themes of financial inclusion, increased participation of women and youth in the economy and SME growth. Some key numbers underscoring the need for this focus are presented in Exhibit 3 below.
Exhibit 3: Focus Area Specific Key Figures
The first challenge round is focused on improving/expanding the outreach of remittance services for overseas Pakistanis18. Karandaaz will partner with public or private sector licensed firms to pilot innovative products, services or approaches. Both Karandaaz, and its sponsors, are looking forward to launching the next M-PESA success story from Pakistan.
 Irwin and Porteous (2005)
 “Enterprise Challenge Fund for the Pacific and South-East Asia: Project Completion Report”, Coffey International Development (2013). http://www.enterprisechallengefund.org/
 Pakistan Remittance Initiative