The Crowdfunding Ecosystem
Roles of Main Actors
It is important to understand their roles based upon the reward-based Crowdfunding model to gain insight in how they interact. The difficulty of this is embedded in the relationships among funders and fundraisers which vary by context and the nature of the funding project.
In the reward-based model, funders take the role of early adopters that means they are granted access to the product before the mass, usually at a better price and with some special rewards such as being part of a movie, exclusive merchandise or the actual product. Concerning rewards, participants in the Crowdfunding project exhibit either intrinsic or extrinsic motivations to pledge. While intrinsic motivation is sparked by the wish to experience satisfaction or fun when doing a particular task, extrinsic motivation arises from the wish for an external reward, e.g. goods, money, career benefits or recognition (Kleemann et al. 2008). One of the fundamental features is that early adopters evaluate the idea and accept the uncertainty involved in product development, and thus are key to make the project work. These characteristics can be related to von Hippel’s (1986) lead user theory that focuses on customer involvement in the innovation process. Lead users (or innovators) sense needs a considerable time before the mainstream experiences these needs at the marketplace. Here, firms can benefit from the use of such lead users in terms of capitalization of their proposed ideas and expertise. Consequently, lead users contribute to identifying commercially attractive innovations by their ahead-of-trend sensing as well as they help predicting the likelihood for high-potential innovations. Despite the obvious lead user characteristics of participants in the Crowdfunding process, they are not ubiquitous. Rather, they represent a minority of risk-takers that lead to the question if the valuable resource ‚Crowd‘ could become scarce with an increasing amount of Crowdfunding campaigns.
In the light of entrepreneurs, it is to ask why they crowdfund. Besides the access to financing at low cost, the pre-ordering mechanism of the product provides seed-capital that facilitates R&D efforts in the development phase and easier market launch. The idea’s concept is validated through the Crowd’s evaluation to pledge which gives new ventures the chance to ‚fail quickly‘ without huge capital investments if there is little interest. Nocke et al. connect product pre-ordering to price discrimination between consumers with different expected valuations for the product in a context of information asymmetry. This particularly applies to Crowdfunding as the quality of the product is still unknown at the point of pledge decision. Therefore, some fundraisers set the price slightly lower with respect to the information acquisition costs that the backer has to incur. Others offer the product at a regular price based on the value of being the first user.
Similar to eBay functions, a Crowdfunding platform is an online marketplace taking the role as a mediator of the relationship between entrepreneurs and Crowd. Despite their variations in size and scope, they typically host specific types of projects and cover a specific market. For instance, Kickstarter is home to any creative and technology project – even potato salad (Gizmodo, 2014), the US platform Fundageek supports research projects and Indiegogo anything from comic books to funerals. Depending on the establishment age and popularity of the platform, it allows reaching out to people from various geographical locations through marketing and communication channels of the platform and social network ties. Agrawal et al. observe that spatial proximity plays a reduced role in Crowdfunding than in traditional financing. Other empirical research using Kickstarter data reveals that geography still plays an important determinant in the nature of projects that reflect the underlying cultural products in their spatial area.
The Emergence from Crowdsourcing to Crowdfunding
By taking a closer look, the Crowdfunding process embodies several important elements of Crowdsourcing which has considerable impact on the development of future innovations and product commercialization strategies.
In the original idea of Crowdsourcing members of a community create and share ideas to solve a problem or pool their actions to create a favorable community for exchange. Kleemann et al. specifies the concept for profit-oriented firms in which they outsource particular tasks to the general internet public with the intention to attract individuals to make voluntary contributions which create value for the firm. The key idea is the same in Crowdfunding, but instead of idea generation of the collective, the Crowd provides financial funds for another one’s proposed project. Consequently, Crowdfunding sparks the redistribution of the inputs of capital and labour to the classical production process that determine the level of the output.
On the basis of this knowledge Kleemann et al. discuss the changing relations between firms and their customers and identify the emergence of a new consumer type – the ‚working consumer‘. They argue that consumers are acting more like co-workers and are involved in various firm tasks such as product design, advertising, quality monitoring and finding solutions for technical problems. Clearly, Crowdfunding also has great potential to incorporate the Crowd in the innovation process for product design, technical solutions and marketing. This does not only expand the firms‘ capacities and adds significant value, but allows to observe the Crowds‘ actions. However, this seems more feasible on a limited scale for new ventures as their capacities to cope with the ideas of large Crowds are bounded.
Adding to the mentioned Crowdsourcing features, Open Innovation and Open Source are related concepts that focus on customer involvement. Contrary to Open Source where the (knowledge) resource belongs to the community, in Crowdfunding the resource is owned by the firm. Since crowdfunded capital cannot be shared, the innovation process remains under the control of the entrepreneurs while resources can be sourced externally.
In a nutshell, Crowdfunding projects mainly benefit from the Crowd in terms of idea validation and acquired capital that can lead to cost-reduction as specific tasks are outsourced. The firm can gain additional value by incorporating customers in product development to launch a better market-fit product that could accelerate time-to-market and improve customer acceptance.
Pros and Cons of Crowdfunding
Consolidating the actor’s roles and Crowdsourcing features in Crowdfunding in the light of the entrepreneurial innovation process, general advantages and disadvantages can be inferred from the entrepreneur’s perspective (mostly over traditional financing).
- Enables to gauge public interest before launching new products that allows projecting the scope of general consumer interest.
- Finance at very low cost in line with full ownership of the project.
- Idea testing and validation through early financial supporters (Crowd) at almost zero costs and with few resources, using as little as a video pitch or prototype.
- Investors become ’network evangelists‘ helping to promote the project via their diverse networks in their role of a built-in marketing community.
- In the case of unsuccessful campaigns (all-or-nothing-rule), entrepreneurs fail quickly without losing much other than time and some public image.
- Funds from pre-selling a new product can be directly applied towards R&D, production and marketing expenses.
- Campaigns are stressful and filled with unexpected ups or downs – in the case of success or failure. Entrepreneurs may spend much time and effort to raise money, but there is no recipe for success. Different communication and interaction strategies are required to engage with the Crowd such as more creative and story-telling pitches using Web 2.0 features.
- Constant effort in ongoing social marketing campaigns requires self-confident entrepreneurs that are able to put themselves out there.
- Many other projects are competing for the same audience on online community platforms, share of voice and the backer’s hard-earned cash.
- Publishing the idea means that competitors can potentially capitalize on this public knowledge.
Summary: The Economic Relevance of the Crowdfunding Ecosystem
A look at the Crowdfunding ecosystem discovers that the roles of the main actors are determined by the relationships and interactions of the funders and fundraisers, while the platform facilities the exchange. Crowdfunding projects must have some fascination and must be exciting to a certain audience to increase success chances. It enables to raise initial seed capital to get the project off the ground in terms of raising public interest and financing product development and production. Tapping into a greater pool of public capital allows ’normal‘ entrepreneurs and less wealthy individuals to realize their idea they are enthusiastic about. Formerly, these people were excluded from most traditional financing as VC-investors and Angel-investors rather focus on ‚high net worth individuals‘. Possibly, the most important function of Crowdfunding can be seen in signaling. Here, the role of lead users helps predicting the likeliness for an innovation’s success.
the embedded value indicates that signaling effects classify strategically higher than the financing function. Because of that, ideas seem more attractive to investors given the proven market interest by the campaign. Subsequently, Crowdfunding represents a viable financing tool for initial implementation activities covering product development, doing market analysis, filing a patent or professional advice, etc. Especially the pre-ordering function seems to shorten the length of the innovation process which is important in regard to the reward-promise made to the backers. Hence, this mechanism has great potential to prepare more viable projects for formal investments in subsequent stages. For instance, Cunningham argues that the disruptive nature of Crowdfunding provides more cumulative capital to all categorized firms over time. His hypothetical illustration is based on the work of Bower/Christensen (1995)2, but is not backed up by statistical evidence that could perhaps spark future research efforts.
Literature; The Relevance of Crowdfunding, The Impact on the Innovation Process of Small Entrepreneurial Firms, Nadine Scholz, Manchester, UK, 2015