Sunday, 10 February 2013

Graph of the week: Crowdfunding

Or How technology improves market efficiency (by linking successful projects to alternative funding sources).

The Economist produced a graph on crowdfunding and what works and what doesn't on the biggest crowdfunding site Kickstarter. For those unaware of this recent technological phenomenon, crowdfunding is a collective funding platform for individuals who use networking to pool money and fund their creative ideas and projects. It is usually done online and is used to support a variety of activities. It is a great way to replace more formal and traditional funding techniques. It is literally funding by crowds of people.

How does it work? People who have innovative, great ideas or projects, but lack the funds to finance them, "upload" them online on a specialized site and that way enter a relatively large market of potential investors. Depending on interest and the idea itself, a variety of individuals fund the project, and naturally bear a certain risk, but also expects a payoff. I don't know how crowdfunding sites get around the problem of intellectual theft, but I'm sure they've come up with something.

And if anyone thinks that crowdfuning is still small and couldn't be used to fund big projects, the numbers claim the opposite: 

Source: The Economist
"LAST year more than 18,000 projects were successfully funded on Kickstarter, the largest crowdfunding website. A total of $320m was pledged by 2.2m people, making possible creative projects including a documentary on fracking, a home aquaponics kit and a community centre for circus arts. Games, a category which includes video, board and card games, received the most support, with $83m pledged to more than 900 projects. Given their high development costs and passionate fans, video games are a good match for crowdfunding, particularly as established publishers churn out ever more sequels, leaving a long tail of unmet demand (see article). In all, 44% of the projects launched last year managed to raise the money they requested, but the success rate ranged from a threadbare 26% in fashion to a sprightly 74% in dance. Seventeen projects raised more than $1m apiece in 2012. Technology projects received the highest average pledge by category, at $107 per backer. The biggest Kickstarter project to date is Pebble, a watch that connects to a smartphone via Bluetooth, which received almost $150 per backer to raise $10.3m in May. (The first finished products are due to be delivered to backers next week.) According to Kickstarter, the total amount raised last year increased by more than 200% compared with 2011. Having opened itself to British-based projects in October, the site expects to see further growth in 2013."
And Kickstarter is only one crowdfunfing site. There's plenty more.

I am always in favour of such innovative ideas that can help fix existing market failures, particularly if the idea is originated within the market itself. As Arnold Kling says: "markets often fail, that's why we need markets". The idea of crowdfunding, as it is with many new technological improvements, is among the best possible proof of this. When there is a downturn in the credit market, and banks are highly restrictive of lending and borrowing due to tight conditions which seems to lead us to a self-perpetuating vicious cycle, a new idea comes along, generated by the market participants allocating information and comes up with an innovative solution. 

It's all about quality as only the best perceived projects get funded, i.e. projects that offer a good value for money, or are simply a great idea (some campaigns and charities get funded as well). Crowdfunding is, in my opinion, the future of financing successful projects. For a technological visionary (which I'm not but many people are) it's not hard to imagine that sites like Kickstarter will soon enough replace banks (or at least take a big portion of their assets). This is excellent for at least two reasons: (1) more projects get funded that probably wouldn't have received funds in a traditional way, and (2) banks get more competition, which forces them to adapt or perish. The final outcome will be mutually beneficial for all market participants - we get more new ideas in more quickly, and more people are able to fulfill their entrepreneurial dream. 

7 comments:

  1. Great post, there was also a nice article in the Economist about a market solution to "illiquidity" problems where smaller startup companies buy liabilities on discount and try to get most of the money back (or something similar).

    But my primary reason for writing the comment was to say, that it was a nice surprise this week when I got my Lider in the post box and saw you in a Lider feature, along some other Croatian economists. Things may be moving in a positive direction "idea wise" in Croatia, especially after seeing the Jutarnji article this morning ;) Congrats!

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    1. Thank you! I'm glad you liked the articles.
      (P.S. I haven't forgotten about our monetary policy debate, but you probably see why I haven't had the time to finish my response yet)

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  2. It is another great example of how the internet has changed everything. I helped fund a game I was interested in on Kickstarter.

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  3. I have not a problem with the notion of finding a funding source for a great idea. The one major problem that one has to contend with when private investors are brought into a company as owners is the possible potential of losing control over the company that one founded. When one becomes a minority owner of a business all bets are off because once you lose control over your company to a outside group of investors its pretty much like your just another employee of the company. And than you can quickly be cast aside for many reasons. In some ways it can be worse than borrowing money to fund a business. Remember most major investors a very likely numbers crunchers and pretty much nothing else.

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    1. Yes, but the ownership isn't given away to investors - just like in a regular business model they take shares in ownership. They don't take over a company. It's like going for an IPO, you don't give away your company, you just use investor's money to finance your company's growth.

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  4. Anyhow my essential purpose behind composing the remark was to say, that it was a great astound without much fanfare when I got my Lider in the post box and saw you in a Lider characteristic, along some other Croatian economists .

    ReplyDelete
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