Extract of screenshot from Kickstarter project “CST-01: The World’s Thinnest Watch” by Central Standard Timing [screenshot taken on January 10, 2013]
‘Crowdfunding‘ (or crowdsourced funding) isn’t new, but it took a leap forward in 2012 as people became more familiar with websites like Kickstarter (possibly the most well known crowdfunding site), Indiegogo, Pozible, Rockethub, Sponsume, and others.
The pure concept of crowdfunding is very interesting. In some ways it goes right to the the very core of capitalism, using the internet to apply specific marketing concepts. In other ways it raises ethical questions about financing of projects. On the face of it, it’s a huge opportunity for entrepreneurs, artists, individuals, and dreamers.
I’ve recently ‘invested’ in a number of crowdfunding projects, and have for a while wanted to note down some of my thoughts about the emotions that it evokes.
Briefly, for those not familiar with crowdfunding websites, most sites follow a common approach:
“Backers” to a given project can pledge to contribute money to finance the project; if the funding goal is not met, then pledge funds are usually not collected (or returned, if already collected) – that might mean that project does not happen (or at least would need to be financed via an alternative route).
If the funding goal is met, the project continues, albeit with the usual performance risks (project creators are encouraged to be open with these risks, and their approach to managing them, in their funding ‘requests’.
When you contribute to the ‘funding’ of a project, you are in effect ‘donating’ money to the project creator, to help them make the project ‘happen’ – the Kickstarter therefore appeals to the emotional desire that some people have to see something new happen, or become available, that previously is not, and without funding might not come to be in future either (at least, not from this person/team – and maybe they demonstrate themselves as being the best people to launch the project).
While we talk about ‘donating’, most crowdfunding sites are clear to distance themselves from being charities – this is clearly meant to be about funding entrepreneurial initiatives; Kickstarter, for example, has a long list of ‘projects’ that cannot be funded (including charities, and general living costs) – it has to be about supporting the ‘creation’ of something new.
Though some describe the contributions as making an ‘investment’ (as I did in the introductory comments above), the return in that sense is purely emotional; you do not receive an equity stake in the project, and it is not a loan (no money is returned once the funding is made).
So what do you get for your money? Firstly, the satisfaction that the project will happen. Beyond that, it depends – most crowdfunding sites offer ‘tiers’ with different ‘rewards’ (sometimes tangible, maybe only nominal, sometimes intangible).
Implications of behavioural economics
Important concepts of behavioural economics come into play here, including the ‘rationality of investors’, and ‘price psychology’. Dan Ariely raises the concept of ‘price anchoring’ in his book ‘Predictably Irrational‘, whereby people might expect to pay (or pledge) only a certain amount in return for a certain reward/return. In ‘Free to Choose‘. Milton and Rose Friedman identified emotional and rational thought processes that people might make in when determining whether to ‘invest ‘ in goods that they consider ‘nice-to-have’ or that they ‘must-have’. These factors can both help and hinder crowdfunding, requiring the project creator to think carefully how the project is described (and ‘marketed’) and how pledge ‘tiers’ and rewards are defined.
In particular, pledge ‘rewards’ are typically defined in a way to try to distance the contribution amounts from any benefits – you are not expected to consider your contribution as a ‘purchase price’ (if you did, you might often come to the conclusion that the price is not good ‘value’ or ‘too high’, because you would likely then be forgetting the ‘emotional’ good-feeling of helping the project happen). So, how much is that ‘good-feeling’ worth?
That question leads us to one of the most brilliant aspects of crowdfunding – it is a tool that allows the concept of price discrimination (a well-known marketing concept) to be applied extremely effectively. When you sell books, for example, it is often difficult to sell the book at different prices to different people who might ‘value’ it differently or might simply have differences in price (though not impossible, if you factor in time, and form-factor: hardback, paperback, eBook, etc.).
By having different tiers, different people can contribute to their own level of:
- willingness (how strongly they want the project to happen), and
- wealth (how much they can afford to contribute).
The interaction of these two categories is also very interesting – you might end up with people who are very keen to see a project happen, but with low wealth, contributing highly; or more wealthy people contributing at lower tiers due to only a passing interest in the project (but can afford to contribute something with minimal consequence to their wealth) – both variants maximize the project’s funding.
Funding versus “profits”?
Such ‘donating’ could become ‘complicated’ when you consider that many projects are intended to give the project creator a chance to eventually make profits – by taking this route the project creator is choosing crowdfunding over other sources of funding (debt or equity, for example), which would have a corresponding cost (and return to the provider of funding), that crowdfunding backers forego.
In the event that they project creator might be able to afford to fund the project themselves, the funding would then, in a sense, be entirely “profit” to the project creator, and in any case, maybe not have an influence on the project being funded (ie, the project may happen anyway, and backers funding is just a clever way of extracting more money for the project creator). A specific case to consider this might be when corporations choose crowdfunding for their projects – on the one hand they collect crowdfunding, and on the other hand, they pay dividends (but presumably, at least, a later point in time).
It’s not all about the money?
This brings us to another interesting aspect of crowdfunding – the projects can be a great way to appraise interest in a potential project, where there might be some uncertainty prior to investing in a new idea (ie, something that can be a very useful tool for a company with potentially constrained access to capital). When people “vote with their pockets” it can be a great way to gain comfort that the idea will be successful post-launch.
In this sense, where there might be a fear by a project creator, that they are seen by potential backers to simply be “money grabbing”, they can offer some pledge tiers with real rewards (ie, where the backer does actually get something in return for their contribution) – this is often done via an ‘advance sale’ of whatever ‘product’ the project creator might be looking to produce.
To capitalize from all of the above (ie, price discrimination, together with an ‘advance sales’ concept) project creators typically offer various pledge tiers with differing levels of reward.
So who does crowdfunding benefit the most?
Because of the above aspects, crowdfunding tends to be of most help to new, aspiring artists (including authors, musicians, film creators, painters, independent computer game creators, etc.) who find it difficult to stand out in a crowded field dominated by major ‘publishers’ (or similar), or start-ups, with an idea, but difficulty in forming sufficient evidence for their idea.
Sites like Kicktraq (a ‘free’ site that provides analytics of the funding of Kickstarter projects) help graphically portray ‘interesting’ trends in the funding during a project, potentially also helping project creators monitor the need to further ‘market’ the existence of their funding projects.
Risks of crowdfunding
The most obvious risk is that project creators might collect funds and then fail to deliver their idea (or less worryingly, be late to be bring their idea to life). They often don’t have a track record (otherwise they might have found it easier to gain funding from investors who expect a financial return – again, debt or equity). As mentioned above, potential underlying risks of performance are usually acknowledged and addressed by project creators when requesting funding.
Matters involving cash changing hands are also subject to abuse – project creators might even ‘run with the money’, or not be entirely transparent of their need for funding (maybe a project has been largely funded already, and maybe even completed, before the crowdfunding project even begins, with funding request designed to appeal to people’s emotions, and extract ‘extra’ cash from them in the interests of ‘profit taking’). Such actions would be unethical and damage the overall image of crowdfunding, and thankfully there seem to be few such scare stories so far.
I’m a big fan of crowdfunding – it is a great way to encourage, and give a chance for the delivery of innovation from creative individuals who, in a market that favors those with capital, might not otherwise have the necessary funding to bring their ideas to life. As with all activities involving money, it does have associated risks, and all parties need to be aware of this in their dealings.
In a time when many corporations, often despite their marketing statements to the contrary, are becoming less creative (something that is more risky, and requires acceptance of some failure), crowdfunding is a fresh approach to supporting true innovation.
Filed under: Global economic environment Tagged: | Behavioral economics, creativity, Crowd funding, crowdfunding, Crowdsourcing, Indiegogo, Innovation, Kickstarter, Pozible, price discrimination, price psychology, Rockethub, Sponsume