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What Problems Does Crowdfunding Solve?

EXECUTIVE SUMMARY

 

Introduction

Since its inception, crowdfunding has been met with optimism. In 2014, musician and entrepreneur Jack Conte published a blog post describing the financials of his band Pomplamoose’s 28-day U.S. tour. Conte explained that despite selling out shows at many historic venues, the band actually lost over $11,000 on the tour, providing evidence of the decline in the music industry. To combat this trend, Conte had founded a new crowdfunding platform, Patreon, that would allow supporters to send a defined amount of money to artists each time they released new material. Conte hoped that this would allow fellow creators to make a living in the new digital economy. The optimism that “the crowd” can provide solutions is not unique to musicians -- in industries ranging from journalism to real estate, many stakeholders hold high expectations based on a few outsized success stories. Can crowdfunding really live up to these expectations? It’s necessary to determine whether the success of a few projects and a few sites is indicative of the untapped potential of the technology or if it is merely evidence that, due to volume, there are bound to be a few outliers.

Classifying by Problems

Many approaches to classifying crowdfunding relies on an analysis of the differences between individual platforms and their types of incentives. An alternative approach seeks to understand the types of problems to which crowdfunding provides unique solutions. Taking this approach helps would-be entrepreneurs discover the best platforms to target for their particular projects.

There are four core problems -- gatekeeping, coordination, patronage, and inexperience.

Gatekeeping
The problem most frequently solved by crowdfunding is granting access to those previously denied. For example, a common complaint about modern venture capital is the underrepresentation of women and minorities on both the financing and entrepreneur side of the table. Crowdfunding platforms help creators circumvent these obstacles by appealing directly to a general audience, providing access to new networks. Sites like Kickstarter seek to solve the gatekeeping problem.

Coordination
Crowdfunding platforms that solve the problem of coordination allow founders to gather money from within their own network of family and friends. This has always been an option for founders, but the right platform can offset some of the difficulties: founders’ reluctance to make “the ask,” for example. Crowdfunding sites offer a frictionless means of processing and tracking contributions, and the smaller networks targeted can make appeals seem more personal. Sites like Tilt seek to solve the coordination problem.

Patronage
The first two solutions address one-time contributions that are often transactional in nature. However, for some founders a lump sum payment is less useful than a lower-volume, but continual, income stream. Scientific research, for instance, requires constant financial support but cannot promise a set schedule of discoveries. And in cultural industries (like film, music, and literature), creators benefit greatly from financial models that mirror those that supported artists of past generations, from Mozart to Michaelangelo. Sites like Patreon seek to provide answers to the problem of patronage.

Problems
Crowdfunding platforms can also address problems of inexperience among founders.

Inexperience
A new class of sites is emerging with a focus not on the amount of money they can help raise, but instead on their ability to help entrepreneurs decide how to use their money. Lead-users can provide resource-strapped founders with valuable improvements, insight into desired features, and evidence of potential market size. Treating supporters as beta-customers, these sites attempt to gauge demand and can help founders decide on marketing, product, and pricing strategies. Some examples are OneVest and Fundable, which were created to help founders after they’ve raised money -- assisting with the development of business plans, pitches, and benchmarks.

Implications

Crowdfunding is a not a catch-all solution for a single industry, but instead is a way of solving four types of problems that transcend industries. Examining the crowdfunding landscape from the perspective of problems addressed, it becomes clear that coordination and gatekeeping represent the two areas where crowdfunding platforms have enabled major changes. In solving problems of inexperience and patronage, crowdfunding platforms have replaced certain actors, but the underlying models themselves remain unchanged.

Most existing crowdfunding sites attempt to solve multiple problems at the same time, some with greater success than others. Sites that try to address gatekeeping and coordination problems are most effective. Generalization was not detrimental to site performance, and in fact offered important advantages to founders. Specialized sites, by contrast, appeared most advantageous in situations where founders were solely interested in funding. For potential entrepreneurs, the answer to whether or not crowdfunding offers hope may depend not upon the industry in which they operate but instead on the specific problem they face.