Crowdfunding: tapping the right crowd

The basic idea of crowdfunding is to raise external finance from a large audience (the “crowd”), where each individual provides a very small amount, instead of soliciting a small group of sophisticated investors. The paper develops a model that associates crowdfunding with pre-ordering and price discrimination, and studies the conditions under which crowdfunding is preferred to traditional forms of external funding. Compared to traditional funding, crowdfunding has the advantage of offering an enhanced experience to some consumers and, thereby, of allowing the entrepreneur to practice menu pricing and extract a larger share of the consumer surplus; the disadvantage is that the entrepreneur is constrained in his/her choice of prices by the amount of capital that he/she needs to raise: the larger this amount, the more prices have to be twisted so as to attract a large number of “crowdfunders” who pre-order, and the less profitable the menu pricing scheme.