Effect of a Wholesale Price Contract with a 'No-Production' Penalty on the Risk of Delivery Failure in a Crowdfunding Campaign

We study how a backer’s risk of not getting delivery of a product, even after a “successful” crowdfunding campaign, is affected by an entrepreneur’s incentive to set a funding goal that is lower than the amount needed to start product development. The entrepreneur makes an estimate of the size of a positively correlated secondary market conditional on the subscription levels in a crowdfunding campaign. Unless the total market size is large enough the entrepreneur does not produce, incurs a cost to its reputation and pays a penalty to a supplier who is contracted prior to starting the crowdfunding campaign. We call this penalty the “option premium” paid by the entrepreneur to exercise the option to \emph{not} produce. In a contract where a supplier decides on the wholesale price and the option premium endogenously, we study the effect of these parameters on the risk of delivery failure. We find that unlike conventional wisdom, with a supplier involved, a more informative crowdfunding signal can increase a backer’s risk of delivery failure. In an environment where the entrepreneur price discriminates between backers and consumers in the post-campaign market, we find that there is a greater risk of delivery failure to those who are “impatient”. Together, we shed light on the operational issues of why some crowdfunding campaigns fail to deliver to backers even when the campaigns themselves are very successful