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Wednesday, June 16, 2021

When Do Consumers Prefer Crowdfunded Products?

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Research suggests that companies financed through crowdfunding are often seem by consumers as higher quality and less elitist than products financed through VCs or other more traditional forms of start-up finance. This may explain why Amazon markets a line of Kickstarter financed products.  The effect is not universal, however: where safety is an issue, the judgment of ordinary consumers is less valued than the expertise of professional investors.

Crowdfunding platforms are a boon to entrepreneurial startups, providing not only finance but also links to potential customers. Kickstarter alone has successfully funded over 200,000 projects.

But it looks as if there’s more than just dollars and a few customers in crowdfunding – start-ups seem to get an additional boost from the simple fact that they’ve been crowdfunded.  That’s perhaps why Amazon opened a Kickstarter product category, grouping and explicitly marketing all relevant products as crowdfunded (“Made on Kickstarter: Shop a wide range of Kickstarter projects backed by a passionate community”).

At first glance, this might seem perverse. Crowdfunding is often portrayed as a last resort for start-ups to convince “real” investors to finance their ventures. Take one of the most iconic and successful crowdfunding projects, Pebble Smartwatch, for example. Its founder, Eric Migicovsky, described their crowdfunding campaign as an attempt to “try their luck” after being unsuccessful in securing external funding via traditional means.

For Crowdfunding platforms to offer more value to start-ups than VC firms, their involvement needs to make potential consumers who are not participating in the financing take a closer look at the products on offer than they would otherwise. So do they? Our research suggests that crowdfunding does indeed have this effect on consumers.

In an experiment with 1,512 consumers, we randomly assigned participants to one of the two conditions where a digital notebook with identical product information and consumer rating was presented. The only difference between the conditions was our crowdfunding cue (a text box above the product noting that the product is an outcome of a crowdfunding campaign).  We asked participants to indicate their willingness to pay (WTP) in the course of an incentive-compatible auction. The results were striking; participants were willing to pay about 21% more for the same product when it was described as crowdfunded, compared to when no funding source information was present.

In two follow-up experiments, we compared crowdfunding with alternative funding sources such as venture capital, bank loan, and self-funding. The results were the same: consumers preferred the same product significantly more when its funding source was presented as “crowdfunded.”

What drives such a strong preference? The follow up experiments suggest that crowdfunding leads consumers to make two inferences. First, they perceive crowdfunded products to be of higher quality because information regarding other consumers’ investments in a crowdfunded project serves as social proof. In other words, consumers think if many people invest in a product it “must be good.” In an experiment with 200 consumers, for example, consumers rated quality of the identical camera 13% higher when it was described as crowdfunded compared to when it was described as venture capital funded.

The second inference concerns inequality. Consumers believe that supporting crowdfunding reduces inequality in the marketplace  and see purchasing crowdfunded products as a way to remedy this. In the camera study above, participants felt significantly more strongly (68 percent higher) that purchasing the product would reduce inequality when it was described as crowdfunded as opposed to venture capital funded. This motivation to reduce inequality in the marketplace could also explain why novice investors united against Wall Street pros to support GameStop, despite the substantial economic risks.

Our findings point to a hitherto unrealized marketing opportunity. Start-ups relying on crowdfunding could make a meaningful impact on their bottom lines simply by marketing their products as crowdfunded. They could, for example, label their product packages, websites, and promotional materials to clearly and prominently convey the crowdfunding aspect. Likewise, retailers that sell crowdfunded products could leverage the crowdfunding effect to improve sales.

The findings also inform entrepreneurs’ decision-making when it comes to funding their ventures. While entrepreneurs may have reason to seek alternative sources (for example, obtaining guidance from or utilizing the social networks of the funders), crowdfunding has an edge over alternatives thanks to its signaling value. Therefore, if an alternative funding source’s input is limited to financial contribution only, entrepreneurs should consider choosing crowdfunding to finance their ventures.

There is one caveat: the underlying product should not be characterized by high risk. Our studies show that the preference for crowdfunded products is fully reversed when consumers associate the purchase decision with high product risk. With high risk products such as medical or safety equipment, where the role of expertise is oftentimes paramount, consumers no longer see crowdfunding as a signal of high quality but rather of low quality — because the perception is that a crowd of amateur investors lacks the required abilities to adequately assess the product’s quality. For these categories, therefore, it would be  preferable to downplay the role of crowdfunding.

That caveat aside, our findings do confirm the definite presence of a positive crowdfunding effect for many product categories. Entrepreneurs and retailers should take notice.

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