Crowdfunding versus pre-orders

A rewards-based crowdfunding transaction is very similar to a pre-order; indeed, many crowdfunding advisors and “how to guides” describes rewards-based crowdfunding as a pre-order. Furthermore, the look and feel of crowdfunding platforms is similar to that of an online retailer, and the delay between pledging and when the campaign ends is analogous to the wait in a pre-order.

It is often argued that crowdfunding is not a pre-order because the crowdfunding transaction is speculative and the rewards are intangible, unlike a pre-order with tangible rewards. Let’s unpack this claim below .

Key takeaways

  • Criteria for a pre-order are met by the crowdfunding transaction.
  • The crowdfunding platform is not an online retailer but rather a platform for supporting entrepreneurs.
  • There are two key differences between crowdfunding and a pre-order: when money is exchanged and when legal title over the product is transferred.
  • The two main risks inherent in the crowdfunding transaction are related to manufacturing and shipping the product. Because money is only exchanged when a product ships in a pre-order, these two risks don’t impact a pre-order as heavily as a crowdfunding transaction.
  • The key difference is that in crowdfunding, backers’ money is taken upfront without delivering the product. In a pre-order, money is only taken once the product is shipped and delivered.

Understanding the definition of crowdfunding and a pre-order

Let’s unpack the argument whether crowdfunding is a pre-order or not by reviewing the definition of rewards-based crowdfunding, as published on Wikipedia:

“… in which the backer receives a reward with a clear monetary value in exchange of the pledge. The reward is often a product or a pre-series item that the backer helped producing by pledging money. In this case the money pledged is similar to paying for a pre-order of a product or service. (emphasis added)“.

Wikipedia’s definition seems to clearly imply that the crowdfunding process is similar to pre-order, and may be regarded as one.

Let’s now consider the definition of a pre-order, also as from Wikipedia,

“A pre-order is an order placed for an item which has not yet been released. Pre-orders allow consumers to guarantee immediate shipment on release, manufacturers can gauge how much demand there will be and hence how large initial production runs should be, and sellers can be assured of minimum sales.”

This definition of a pre-order strongly aligns to key stages in the crowdfunding process, namely:

  • order placed = pledge for a reward;
  • item not yet released = project creator has still to manufacture the product;
  • to guarantee immediate shipment on release = if the project creator allows for pre-orders post the Kickstarter campaign, Kickstarter backers typically get preferential shipping;
  • manufacturers can gauge how much demand = the number of backers backing a Kickstarter project is the demand for the Kickstarter campaign and can be indicative of future demand;
  • sellers can be assured of minimum sales = the project creator has a minimum level of sales, as per the number of backers and the total value of pledges made for each reward level.

Comparing the crowdfunding transactions to other commercial transactions, specifically a pre-order

We can also understand the crowdfunding process further by comparing this type of transaction to other types of commercial transactions, using a timeline of product development. The crowdfunding process can then be represented alongside other types of commercial transactions as follows:

Depicting the early stage of crowdfunding compared to other commercial transactions, using product development

Depicting the early stage of crowdfunding compared to other commercial transactions, using product development

There is a clear overlap between crowdfunding and a pre-order. Both transactions seem to occur at the:

  • product idea stage;
  • product beta testing stage;
  • manufacturing stage.

The main differences between crowdfunding and a pre-order are:

i) the type of platform used to conduct the transaction;

ii) when money is actually exchanged; and

iii) the legal options a backer can exercise during the transaction (such as cancelling, right to refunds etc.).

The crowdfunding platform is not a retailing platform; it is more like a portal for ideas, similar to a community notice board. It also act as a conduit between the project creator and backer.

In crowdfunding, money is exchanged as soon as the campaign ends whereas in a pre-order, money is exchanged only once the product is shipped.

Transfer of legal title of the product occurs at the same point (at the time of shipping) for both transactions.

The two transactions can be compared as follows:

Comparing a pre-order to a crowdfunding campaign

Comparing a pre-order to a crowdfunding campaign

Keep in mind that the funds raised from a rewards-based crowdfunding campaign is treated as income from sales in the project creator’s accounts. This implies that the underlying transaction is a sale, and accordingly that the crowdfunding transaction is a pre-order. I explore the underlying transaction and why it is seen as a sale in this post.

So, why are crowdfunding platforms reluctant to define crowdfunding as a pre-order?

Crowdfunding platforms adamantly argue that the rewards-based crowdfunding process is not a pre-order. Why? There are two possible reasons:

i) Think of their business model and the type of online platform: as it currently stands, a crowdfunding platform operates very similarly to a community notice board.

Co-founder Yancey Strickler Kickstarter expressed this sentiment in an interview with Popular Science:

“On Kickstarter, people fund the ideas that they think should exist. People have always had great ideas, and others have always wanted to be a part of them. We’ve made a space where that can happen on a massive scale. … We believe the real disruption comes from people supporting things because they like them, rather than finding things that produce a good return on investment.”

If it acknowledges that the crowdfunding process is indeed a pre-order, this impacts on the operating model. The crowdfunding platform then becomes an online retailer, similar to Amazon’s marketplace for third-party sellers. This impacts the accounting, strategy, and legal nature of the crowdfunding platform.

ii) Even in rewards-based crowdfunding, there are still instances when the funding is treated as a gift to the project creator and not income received. This occurs when the rewards are token or intangible, and not commensurate to the value of the pledge. This type of transaction is definitely not a pre-order but more a donation. By keeping the terminology focused on crowdfunding, an online platform can cover both income and gift funding campaigns.

And why are project creators reluctant to define the crowdfunding as a pre-order?

Even though the underlying contract in the crowdfunding process is between the project creator and backer, the project creator shies away from describing the process as a pre-order. I think there are three main reasons for this.

i) The project creator may simply be influenced by the terminology used by the crowdfunding platform. From a business and operational perspective, the project creators would actually treat the transaction as a pre-order, especially if the current funding campaign is not the project creator’s first campaign.

ii) The backers’ money is taken as soon as the funding campaign ends, which is usually a pre-manufacturing stage for the product. All the backers’ money is pooled, and the project creator can spend it as needed, including, but not limited to, manufacturing the product. Even though the money is intended to fund the manufacturing of the product, the money may, unfortunately, be spent somewhere else. For example, if the project creator is a start-up, the money may be spent marketing and negotiating business relationships instead of on the actual manufacturing. The total costs of the business may have been incorrectly budgeted for and backers take the hit.

iii) The use of the word “pre-order” takes a bit away from the emotional aspect of the crowdfunding process. After all, inherent in this transaction are elements of trust and support for launching a dream.

Interestingly, some project creators offer the option for a pre-order during or directly after the crowdfunding campaign. The distinction between crowdfunding backers and pre-order consumers on the back of a crowdfunding campaign is simply:

  • where you are in the queue for manufacturing (backers are supposed to have preference); and
  • whether you receive crowdfunding exclusives with your product (again, another backer incentive).

Lastly, why are some payment processors reluctant to call the transaction a pre-order?

Unlike Amazon Payments, which smoothly processes crowdfunding payments, PayPal argues that crowdfunding is not the same as a pre-sale or pre-order, because “crowdfunding is speculative” and that unlike crowdfunding, there is an expectation of a tangible product in a pre-sale.

I agree that crowdfunding can be speculative; indeed this is part of the risks of crowdfunding. I disagree that only in a pre-sale is there an expectation of a tangible product. In rewards-based crowdfunding, project creators specifically offer tangible rewards, and the accounting treatment for the funds raised is that of income or revenue from sales. I argue that in both crowdfunding and pre-orders, customers have an expectation of a tangible product. The differences between the two transactions are the platform type, when money is transferred from backer to project creator, and when legal title is transferred.

PayPal’s stance on crowdfunding may have been influenced by a number of issues, including processing chargebacks and vetting of crowdfunding projects.

Final thoughts

I understand why crowdfunding platforms and project creators don’t want to call the crowdfunding transaction a pre-order; but, until there is stronger consumer protection for backers who crowdfund on rewards-based platforms, the concept of a pre-order comes close to describing the process.

All in all, similarly to the risks in crowdfunding, there are commensurate risks in any pre-order transaction. Just because I place a pre-order for the next Playstation console via Amazon does not guarantee delivery of my Playstation on the due date. In the same way that a small business or start-up may face manufacturing delays, so too can Sony experience manufacturing issues, with a knock-on effect to shipping.

But, in crowdfunding, Kickstarter and the project creator takes my money upfront, whereas in a pre-order, Amazon and Sony will only take my money once the product is shipped and delivered. And this is the fundamental difference between a crowdfunding transaction and a pre-order.

Advertisements