Network effects related to participation

Crowdfunding platforms (CFPs) facilitate the interaction between entrepreneurs trying to raise funds and contributors willing to participate in the financing of new projects. Several forms of crowdfunding exist. They mainly differ by the type of compensation that they propose to contributors. Compensations can be monetary or not. In the former case, contributors are investors and may be offered equity stakes (‘crowdinvesting’), interest payments (‘crowdlending’), or a fraction of profits (‘royalty-based crowdfunding’). In the latter case, contributors are consumers or donors and may be offered a product in pre-sale, combined with some perks (‘reward-based crowdfunding’), or some warm glow (‘donation-based crowdfunding’).

Different types of network effects are at work on CFPs. It makes sense to distinguish network effects according to whether they result from decisions to participate in the platform or to use the platform. In this post, we focus on the first type. We study the second type in another post.

Cross-side network effects

Typically, any crowdfunding platform becomes more attractive for the users of one group as participation increases (or is expected to increase) in the other group. One talks here of cross-side network effects:the extent of participation of one group (entrepreneurs or contributors)affects the benefits accruing to the participants of the other group. In general, one would expect that this type of network effect is positive (Belleflamme, Omrani and Peitz, 2015). More contributors make the platform more attractive to entrepreneurs since it increases the probability of having their projects funded. Similarly, contributors will appreciate the fact that the platform has more entrepreneurs (thus, more projects posted) since it increases their chances of funding a project of their liking, and of receiving the most suitable reward.

Same-side network effects

Other types of network effect stemming from participation decisions are same-side network effects: the participation decision by one user in a particular group not only affects participants of the other group but also participants of this user’s own group. For instance, the participation of an additional entrepreneur affects the value of other entrepreneurs using the platform. The same holds for contributors. The impact of these network effects is a priori ambiguous (Belleflamme, Omrani and Peitz, 2015). Within the group of entrepreneurs, on the one hand, an increased participation leads to greater competition for available funds, leading to negative same-side network effects within the group of entrepreneurs. On the other hand, the effect may also be positive as it can generate scale economies for the platform, increase exchanges of best practices, or lead the platform to offer more services to entrepreneurs (thus, better quality). The overall effect of these opposing forces is unclear and is thus an empirical question.

Conflicting effects may also arise within the group of contributors. A positive same-side network effect arises due to the increased availability of funds overall. All contributors benefit as their preferred projects are more likely to be funded if more contributors participate. A similar positive effect exists when the first contributors attract subsequent contributors either through direct solicitations or through word-of-mouth. On the negative side, more contributors may lead to increased competition for a limited number of rewards. Indeed, entrepreneurs typically propose a menu of rewards, with some rewards being offered in limited numbers. This may create a form of rationing, forcing some contributors to select in the menu a reward different from the one that they initially hoped to receive. Similarly, competition between contributors is likely to exist for equity crowdfunding since there, the entrepreneur always sells a limited number of shares. Negative same-side effects may also exist across different types of contributors; for instance, Lin, Sias and Wei (2017) show that institutional investors tend to discourage ‘retail investors’ (who have typically less expertise) to participate in a lending-based CFP.

"Platform-wide" network effects

Finally, the total volume of participation in a CFP (from entrepreneurs and contributors alike) has the potential to make this CFP more attractive, thereby generating what can be called "platform-wide" network effects. Such effects may stem from two main sources. First, a ‘collective-attention’ effect (Kuppuswamy and Bayus, 2018) may exist at the level of the platform: the more participants a CFP attracts, the larger its market share in the crowdfunding market, the more attention it will receive in the media and in social networks, which contributes to attracting even more participants. Second, by managing more participants and more interaction among them, a CFP may move up the learning curve and gradually improve its operations and services, which makes it more attractive to new users. Jiang et al. (2016) suggest that such effects may be at work: they document that larger lending-based CFPs tend to further increase their market share, as subsequent contributors are more likely to join a platform the larger its current base of contributors.