Does crowdfunding result in good product development decisions?
Just as our hourly mood statuses (www.twitter.com), tedious errands (www.taskrabbit.com), and restaurant conundrums (www.yelp.com) have been progressively fulfilled and/or publicized by various social technology platforms, the want of capital has also turned to social networks sprawled across the internet as an alternative to the traditional financing entities. Crowdfunding, most popularly embodied by Kickstarter, leverages small contributions from the masses to finance various projects. While it generates the most traffic in the creative arts with film & video, music, and publishing categories having the highest volume of launched projects, Kickstarter has cultivated several noteworthy technology products. E-paper watches synced to smartphones, high-resolution desktop 3D printers, 3D pens, and temperature-regulating dress shirts are some of the success stories, with money pouring in through contributions from thousands or even tens of thousands of people accumulating funds that surpass the initial goal by up to a hundred-fold. Kickstarter is said to be the ultimate democratization of product development, but is product development an activity for the masses? Are good decisions being made?
Creators have information on the costs of their innovation, and this information is conveyed to some degree through the crowdfunding campaign webpage and any other communication between the creator and the funders. Creators, with projected costs and value in mind, will set a funding goal. If the creator fails to reach the funding goal, the creator receives nothing, so creators should set an attainable goal. A ludicrously high funding goal would also signal to potential funders that the creator is dishonest, delusional, or otherwise incompetent, and such reputation-based quality signals are very powerful determinants of campaign success.
Potential funders then use whatever information they have to decide what this project is worth to them. If the collective value that funders find in this project matches or exceeds the creator’s funding goal, the innovation will be further developed and commercialized. On one hand, we can view the crowd as pure consumers speaking on behalf of the market. In this scenario, the crowd compares the set funding goal against how it would price the product on the market. A presale rewards model of crowdfunding in particular may mimic the private consumer markets, whose consumptive behavior determines reward amounts and recipients in the patent system. That being said, crowdfunders represent a relatively small slice of active Internet users and thus are not necessarily good representations of the consumer population.
Alternatively, we can view the aggregate crowd as a central planner that decides which innovations are worth bringing to market. Crowdfunders often contribute without expectation of a direct reward or have a higher willingness to pay for the product than regular consumers, and this behavior suggests that crowdfunders find value in backing projects beyond mere consumption. Perhaps this crowdfunding mechanism is able to capture some of the social value that the standard market may miss. In this scenario, the crowd compares the set funding goal against a value that includes intrinsic value.
Realistically, the crowd probably acts as some combination of a market consumer and a central decision-maker. And if we are relying on crowds to direct the course of our innovation and consumer products markets through funding decisions, we need to determine if crowds are dependable. We are already concerned that crowdfunders represent a small segment of the public at large; active social network and Internet users are a subset of the general population and crowdfunders are an even limited subset of active Internet users. While free-riding and collective action problems exist, the sheer number of crowdfunders could make up for the fact that each crowdfunder is not individually performing adequate due diligence. With more eyes looking over projects, there is a higher chance that at least one pair will notice something wrong or something ingenious about the project.
This potential advantage to having a crowd decide whether or not to bring an innovation to market speaks to the “wisdom of crowds,” coined by James Surowiecki in The Wisdom of Crowds—the notion that aggregating the knowledge and information of a large number of people could make the aggregate answer more robust. The idea is that an individual’s opinion or guess, no matter how amateur, has two components: an informational piece and an error piece. Upon aggregation, the errors cancel out and something closer to pure information is left behind. It is important to note that this concept is a statistical phenomenon rather than a social or psychological one, and social influence is more likely to undermine the wisdom of crowds than enhance it.
There are four requirements that need to be met for a crowd to be wise. First, a crowd must be diverse. Diversity brings a large range of perspectives and considerations and also helps the group focus on facts in the decision-making process by diffusing herding effects that might arise from the imbalance of power and influence within the group. Homogenous groups of people are more likely to converge on an conclusion, less likely to entertain outside input, and more confident in their collective judgment. There is a higher pressure, even if unintentional, for individuals within the group to conform. Diversity also helps foster independence within the group which in turn feeds back and contributes in maintaining diversity.
Independence is the second condition for a wise crowd. It refers to the freedom and distance individuals within the group maintain from other members of the group. The more independent individuals are, the less likely it is that the same errors and biases are perpetuated throughout the group.
Decentralization is also very important in maintaining the independence and specialization in a crowd. Power and influence must not be concentrated in one location but rather spread out among “local” subgroups of the crowd. Decentralization is more relevant in some circumstances more than others, such as coordination activities.
Finally, the fourth condition of wise crowd decision-making is that there be some mechanism by which to aggregate information while maintaining the diversity and independence of it.
In addition to being wary of the quality of the collective conclusion, it is important to note confidence the group has in that answer. As opinions converge, individuals in the group, and hence the group as a whole, becomes more confident in the aggregate answer regardless of a whether or not there was an improvement in accuracy.
The crowdfunding mechanism, in its most common setup, is not conducive to gathering wise crowds. Most problematic is the lack of independence among funders. People considering whether to fund a project or not can see how much others have funded the project over what period of time and can calculate what the average contribution per funder was. Sequential group decision-making creates an information cascade in which latter funders mimic early funders assuming that the early funders have the correct information. As the cascade continues, it is building upon previous, uninformed decisions, and collectively the group decision is really the decision of a few of the earliest funders. Information cascades can be socially useful in spreading good ideas if imitation is done intelligently. If sequential decision-making occurs among a diverse group of people and at least some people are willing to made decisions against the cascade, information cascades can be halted. However, this depends on particularly confident or particularly risk-averse people to resist imitating the mass opinion, and sequential decision-making as a whole is not reliable. One additional wrinkle is that because funding is not anonymous, people’s consumption changes when others are watching.
In sum, while crowds may be able to provide accurate information about market demand from consumers, crowds are likely not well-suited to make decisions about innovation and whether a product should be brought to market.
Christine Shim is a J.D. candidate, ’15, at the NYU School of Law.