The disruptiveness of crowdfunding in the retail banking industry

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Master Thesis

MSc Business Administration: Strategy & Innovation

The disruptiveness of crowdfunding

in the retail banking industry

Sietse van der Meer

S1618105

sietsevandermeer@gmail.com

University of Groningen

Faculty of Economics and Business

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Abstract

This research investigates the degree of disruptiveness of crowdfunding in the retail banking industry. Main aspects of this study are the relative advantages and disadvantages of crowdfunding, contextual factors that influence the willingness to engage into crowdfunding, relevant regulation, the disruptiveness of crowdfunding and the reaction of retail banks. Eight extensive in-‐depth interviews were conducted with experts in the crowdfunding industry, which show that crowdfunding currently is not really disruptive for the retail banking industry. The main reason is that retail banks withdraw from issuing loans to starting entrepreneurs and small businesses. Crowdfunding, however, is enlarging the market by offering new value propositions and lower costs. It is also a way to fund companies who otherwise could not obtain a loan. Therefore, in the future crowdfunding can become disruptive within the small sized enterprise market of the retail banking industry.

Keywords: crowdfunding, crowdfunding platforms, disruptive innovation, capital seeking ventures, retail banking industry

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1. Introduction

Crowdfunding already exists for centuries, as the American Statue of Liberty was funded by roughly 125.000 people who funded over $125,000 in six months. But in recent years the concept is renewed and growing fast through the use of Internet, which makes it easier to connect capital seeking ventures to consumers who want to invest money (Belleflamme, Lambert and Schwienbacher, 2011). Crowdfunding is “a collective effort by people who network and pool their money together, usually via the Internet, in order to invest in and support efforts initiated by other people or organizations (Ordanini, Miceli, Pizzetti and Parasuraman, 2011, p.443).” It involves an open call, mostly through the Internet, for the provision of financial resources either in form of donation or in exchange for a future product or monetary rewards (Belleflamme, Lambert and Schwienbacher, 2011). Crowdfunding is growing fast, with an estimated total funding volume for 2012 of $ 2.8 billion worldwide, doubling the estimated $ 1,470 million for 2011. In 2011, more than 1 million campaigns were successfully funded. And as of April 2012, there were 452 active crowdfunding platforms worldwide. This number is expected to increase to 530 by the end of 2012 (Massolution, 2012).

Crowdfunding has the potential to disrupt the current business models of retail banks and to transform the way companies raise money (Corl, 2012). Disruptive innovations change and redefine markets by introducing products and services that are not as good as currently available products, but offer other benefits (e.g. simplicity, convenience, less expensive products) to appeal to new or less-‐ demanding customers. Once the disruptive innovation gains a foothold in the market, it improves at a high rate because of technological developments. Eventually, the innovation is suitable for the needs of more demanding customers and has the ability to replace previous products, services or business models. For incumbents it is often difficult to react to disruptive innovations because of their past investments in the “old” technology. (Christensen, 1997; Christensen and Raynor, 2009).

The goal of this research is to investigate the degree to which crowdfunding is disruptive for the retail banking industry.1_{Particularly,
this
research
investigates
the
motivations
of
capital
seeking
ventures}

to choose crowdfunding over a bank loan, the potential of crowdfunding, the reaction of retail banks to crowdfunding, if crowdfunding is disruptive, and if yes what kind of disruptive innovation crowdfunding is. The relevance for crowdfunding platforms and capital seeking ventures is the ability to assess the potential of crowdfunding and the contextual factors that influence the willingness to engage into crowdfunding. The relevance for retail banks is the assessment whether crowdfunding could be disruptive for their industry. This study contributes to the literature by researching

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2. Literature review

2.1. Crowdfunding

The concept of crowdfunding has its roots in the broader concept of crowdsourcing. Crowdsourcing represents the act of a company or institution taking functions once performed by employees and outsourcing it to an undefined and generally large network of people in the form of an open call (Howe, 2006). A type of crowdsourcing is crowdfunding. According to Ordanini, Miceli, Pizzetti and Parasuraman (2011, p.443) crowdfunding is “a collective effort by people who network and pool their money, usually via the Internet, in order to invest in and support efforts initiated by other people or organizations.”2_{In
the
case
of
crowdfunding,
the
objective
is
to
collect
money
for
investment.
This
is}

generally done through Internet and in particular by using online social networks. The development of crowdfunding has been boosted by technological developments like Web 2.0, which offers new opportunities where consumers can use, create and modify content and interact with other users through social networks. Almost all of the capital seeking ventures active in crowdfunding use Internet very extensively as a mode of communication with the ‘crowd’ (Belleflamme, Lambert and Schwienbacher, 2010; Hemer, 2011; Ordanini et al., 2011). For capital seeking ventures this provides new opportunities. Instead of raising money from a small group of business investors like banks, money is now obtained from a large group of individuals (the crowd), in which each individual provides a small amount of the total investment needed. The crowdfunders, those who provide the money, can at times also participate in strategic decisions or even have voting rights. Therefore, a distinction can be made between a passive role by the crowd (solely investment) and an active role by the crowd (the crowdfunders become active in the initiative, for example by offering feedback or advice (Belleflamme, Lambert and Schwienbacher, 2010; Capgemini Consulting, 2012; Lambert and Schwienbacher, 2010; Schwienbacher and Larralde, 2010). Well known examples of crowdfunding platforms are Kickstarter.com, Crowdaboutnow.com and Seeds.nl. In Appendix 2 an overview and description of the three crowdfunding platforms included in this research can be found.

2.1.1. Crowdfunding industry

The crowdfunding market is relatively young with most of the crowdfunding initiatives taking place in the last 3-‐4 years, of which about 60% are undertaken in Anglo-‐Saxon countries. Initially, the concept of crowdfunding was primarily applied by individual artists and movie makers, but now it is widely

2_{Peer-‐to-‐peer
lending
is
a
similar
phenomenon
as
crowdfunding,
however
it
is
focused
on
credit
needs
of
private} individuals (often used for personal loans rather than organisations or entrepreneurs). Therefore it is excluded from this research.

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dispersed. In their empirical analysis on crowdfunded ventures and projects, Lambert and Schwienbacher (2010), found that the median amount of raised money is €28,500. This is comparable with microloans aimed at starters or small businesses, which have a maximum height of €50,000.3

The concept of crowdfunding is particularly relevant for start-‐ups and small businesses. Normal funding is particularly difficult to obtain for those firms in respect of their size and their high risk, because of a lack of available historical data creating information asymmetry for potential investors. Hence, traditional financing methods like bank loans, business angels or venture capitalists are out of reach or difficult to convince for these small companies. In more general terms, crowdfunding should function well when a relatively small amount of money (under €50,000) is needed to launch the project (Agrawal, Catalini and Goldfarb, 2010; Hemer, 2011; Schwienbacher and Larralde, 2010). What is most important according to Hemer (2011, p.28) is that “a start-‐up concept must have some sort of fascination, must be compelling and exciting to a certain group of people. […] Under these preconditions crowdfunding could be one informal financing alternative to close the early-‐stage gap which represents one of the major obstacles when getting start-‐up projects off the ground.” In the creative industry (arts, media/entertainment and creative professional services), crowdfunding is already established because it is one of the few financing instruments available here. The reason is that the value of creativity is hard to judge and demand is uncertain, the so-‐called ‘nobody-‐knows’ principle (Caves, 2010). This principle explains that success is difficult to predict, nor easily understand afterwards. Therefore investment involves a high risk. For the same reasons crowdfunding is also suitable for technology-‐ or knowledge-‐oriented start-‐ups. (Caves, 2000; Hemer, 2011). Additionally, crowdfunding is an established way to fund social and/or not-‐for-‐profit projects, particularly in the Third World. Many organisations which have a long tradition of fund-‐raising for social and/or not-‐for-‐profit projects (e.g. the Red Cross and Oxfam) employ the instrument of crowdfunding. They benefit from being well networked on a global scale and from the positive image and reputation they enjoy among the public (Hemer, 2011).

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2.1.2. Actors active in crowdfunding

Ordanini et al. (2011) distinguish three actors involved in crowdfunding. First, there are the subjects who propose ideas and/or projects to be funded, the capital seeking ventures. These people or organisations want to use crowdfunding to get direct access to the market in order to gather financial support from interested supporters.

Second, there is the crowd of people that decide to financially support these projects, bearing a risk and expecting a certain payoff. The crowdfunders co-‐produce the output, selecting –and sometimes developing– the offers they think that are most promising or interesting (Ordanini et al., 2011). The motivations of these actors will only be theoretically explored in this study.

A third actor is the crowdfunding platform, which brings together the capital seeking ventures and the crowdfunders. The processes behind crowdfunding can be complex if a large number of funders and transactions have to be managed. Many initiators of ventures are either inexperienced or not interested in managing the crowdfunding process themselves and prefer to hand over this task to intermediaries, the crowdfunding platforms. They act as neutral facilitators both for the capital seeking ventures and the crowdfunders. The platforms vary in their range of activities and intensity: most platforms offer an online platform, websites to present the projects, proven procedures and the software through which the financial pledges are collected and administered. But some platforms also give advice, organise public relations, make arrangements with micro-‐payment providers and offer

Figure 1. Growth in number of CFP’s worldwide, 2007=100%. (Massolution, 2012, p.13).

1_{:
Based
on
Crowdsourcing.org
Directory
of
Sites} 2_{:Estimates
are
based
on
historical
market
projections}

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other value added services like due diligence, consulting and managing co-‐investment. Because most capital seeking ventures only go once or only a few times in their lifetime through a crowdfunding project, it is unlikely they will gain the experience and professionalism that crowdfunding platforms develop. This explains the rapid emergence of those platforms, which are necessary in order for this new market to function properly (Hemer, 2011; Ordanini et al., 2011).

This study adds a fourth group of actors that indirectly influences the crowdfunding process via regulation: regulators. Since crowdfunding is relatively new, the legal and guiding frameworks of the concept are not yet completed. In the United States specific legislation of crowdfunding is beginning to form with the recently ratified JOBS act, which excludes private investors in many cases from the obligation to register. In Europe however, the legislation on crowdfunding is still unclear. Furthermore, the form of crowdfunding (share issues, loans or donation) plays an important role in the legal rules that must be met (Capgemini Consulting, 2012). Regulation may limit the extent to which crowdfunding can be a viable alternative to bank loans, because making a general solicitation for equity offering is limited to publicly listed equity of firms. In this situation, capital seeking ventures cannot ask publicly for funds unless they receive a prior authorization from their national securities regulator. In many countries, there is also a limit on how many private investors a shareholders company can have. Therefore, most crowdfunding initiatives do not offer shares but provide other types of rewards such as a product-‐to-‐be-‐developed or membership (Lambert and Schwienbacher, 2010; Schwienbacher and Larralde, 2010).

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Another example is when publicly traded shares are issued, in these cases the platform is under supervision of the AFM and an approved prospectus is required. Exemptions are possible when shares are offered to not more than 150 people or when the total equivalent value of the effects is not higher than € 2,5 million (AFM, 2012). Because of the many different crowdfunding forms, the Dutch financial supervisors caution market parties to carefully consider which statutory provisions could be applicable to their activities (International Financial Law Review, 2011; Van den Boogaard, 2011). In the new coalition agreement of October 2012, the Dutch government stated that new alternative forms of financing like crowdfunding will be supported through the use of promotion, the removing of regulatory barriers and the use of existing knowledge and tools (Rijksoverheid, 2012).

Figure 3. Actors in crowdfunding

2.1.3. Methods and rewards of crowdfunding

Lambert and Schwienbacher (2010) made a distinction between passive investments and active investments by the crowd:

-‐ Passive role by the crowd: Capital seeking ventures that seek passive investments in the crowd are solely interested in raising money, they are not using the crowd as active consumers who give advise or feedback. Most forms offer a reward to the crowdfunders, but there is no possibility for crowdfunders to become actively involved in the project.

-‐ Active role by the crowd: Capital seeking ventures that offer investors to become active in the crowdfunding project, next to offering rewards to them. The crowdfunders may provide valuable feedback to the capital seeking venture on potential market demand and product characteristics that the market may prefer most, or give other forms of advice.

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In the research of Schwienbacher and Larralde (2010) passive investments account for 60% and active investments account for 32% of their sample of crowdfunding initiatives. Schwienbacher and Larralde also name a separate category of crowdfunding: donations. In this form, no financial or other direct rewards are offered to crowdfunders. Donations may for example facilitate fundraising for not-‐ for-‐profit organisations. Because donations are not a direct threat for retail banking business models the category of donations is not included in this research.

A distinction also can be in made in the type of compensation, acknowledgement or reward that can be given to the crowdfunders. According to Kleemann, Voss and Rieder (2008), participants can either have intrinsic or extrinsic motivations. Intrinsic motivation relates to the pleasure or fun of doing the particular task, whereas an extrinsic motivation calls for a personal external reward, such as money and goods, career benefits, learning, recognition or even dissatisfaction with current products.

Extrinsic rewards

-‐ Sponsoring: The capital seeking venture and the crowdfunder agree on a defined reward that the capital seeking venture is obligated to give. Often these rewards take the form of services like PR or marketing for the crowdfunder (Hemer, 2011).

-‐ Pre-‐selling of products/services: In many cases crowdfunding takes the form of pre-‐selling. The funding is meant to help produce something (a film, software, a new product etc.) and the promised return is the delivery of an early version of the product or service. In such a case, crowdfunding is basically an advance order of a product (Hemer, 2011).

-‐ Monetary rewards: Here the rewards are normally the interest and the payback of investment after a period agreed upon. An alternative is the revenue sharing principle, in which the crowdfunder receives at the defined end of the lending period an agreed share of the earnings of the capital seeking venture. This could be a multiple of the original loan but could also be nothing in the case of bad performance. Monetary rewards also can be shares of the capital seeking venture, dividends and/or voting rights (Hemer, 2011).

Intrinsic rewards

The intrinsic or immaterial rewards are the more emotional motivations for a crowfunder to become active in a crowdfunding project. It is the reward of doing the activity itself, apart from extrinsic rewards. Examples of those rewards are:

- Personal identification with the project's subject and its goals - Contribution to a socially important mission

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- Enjoying contributing to an innovation or being among the pioneers of new technology or business

- The expectation of attracting funders in return for one's own crowdfunding project (Hemer, 2011, p.14).

In the empirical study of Lambert and Schwienbacher (2010), 76.5% of the capital seeking ventures offer their crowdfunders a reward, mostly in the form of a right to receive the product (66.7% of the cases of those that offer a reward), or shares that may yield dividends in the future (33.3%). Direct cash payment is expected in 22.2% of the cases where a reward/return is promised.

2.1.4. Advantages of crowdfunding from the capital seeking venture’s perspective

This paragraph assigns the advantages of crowdfunding in comparison with bank loans from the capital seeking venture’s perspective. In other words the relative advantage of crowfunding (Rogers (1995, p.212).

The advantages are divided between passive investment (the crowd solely invests money) and active investment (besides investment, the crowd also becomes active by giving advice or feedback to the capital seeking venture).

Advantages of passive investment Advantages of active investment

Accessibility of funders Accessibility of funders

Less or no risk coverage requirements for

entrepreneurs Less or no risk coverage requirements for entrepreneurs Identification of early adopters Identification of early adopters

Information about market potential Information about market potential Lower costs of funding Lower costs of funding

Cost reduction of NPD

Potential marketing and promotion of the

company

Higher customer satisfaction

Table 1. Advantages of crowdfunding from the capital seeking venture’s perspective

Accessibility of funders

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attempts to find and convince investors. Crowdfunding can be a useful alternative route by which the accessibility of capital seeking ventures to funders is increased. In many cases crowdfunding is a source of funding where retail banks loans cannot be obtained (Belleflamme, Lambert and Schwienbacher, 2010; Hemer, 2011; Zaat, 2011).

Less or no risk coverage requirements for entrepreneurs

Especially in the wake of the credit crisis, financial institutions are much more cautious in providing credit to entrepreneurs, unless default risk coverage collateral4_{or
guarantees
can
be
given.
With}

crowdfunding, this is in most cases not required. This makes it a very accessible alternative for entrepreneurs when no capital can be obtained using retail banks (Capgemini Consulting, 2012; Hemer, 2011).

Identification of early adopters for the CSV

Crowdfunding can also be a way to identify early adopters. When pre-‐ordering is used early adopters can be identified and crowdfunding can be used to finance up-‐front fixed costs of production to quickly recoup investments. In this way, crowdfunding could be one informal financing alternative to close the early-‐stage gap, which represents one of the major obstacles when getting start-‐up projects off the ground. With pre-‐ordering crowdfundings also allos for price discrimination between pre-‐ordering consumers (the crowdfunders) and the remaining customers who wait till production takes place before purchasing directly (Agrawal, Catalini and Goldfarb, 2010; Belleflamme, Lambert and Schwienbacher, 2011; Hemer, 2011).

Information about market potential

Crowdfunding can provide valuable signals of the market potential of a product a firm wants to launch. Crowdfunding is a unique way to validate original ideas in front of a specifically targeted audience. This may in turn provide insights into market potential of the product or service offered. For the company, it can provide an indication whether there will be a demand for the product. For example, when artists used the platform Sellaband.com, consumers committed to purchase the CD if did go into production. Crowdfunding serves as a first test to gauge the extent to which the product or idea of the entrepreneur can be successful in the market. Only the ideas and products that the market believes in are ultimately financed by the crowd. Having found a large number of supporters means, on the one hand, that these already form a core market and, on the other hand, that they can be easily mobilised as multiplicators and sales agents within their personal (social) networks (Capgemini Consulting, 2012; Hemer, 2011). Hemer (2011, p.28) calls this signalling and states that “signalling is one of the

4

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loan.
In
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event
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most important functions of crowdfunding and there are indications that its effect ranks strategically higher than the funding results.”

Potential marketing and promotion of the company

Crowdfunding may increase the company's reputation and the potential to build a first customer base. A crowdfunder usually shares his/her enthusiasm for his/her investment within its social environment, and this word-‐of-‐mouth publicity is an important and low-‐cost form of advertisement for the entrepreneur in the market. According to Lambert and Schwienbacher (2010, p.12) “a strong advantage of this form of financing [crowdfunding] is the attention that the entrepreneur may attract on his/her project or company.” At times the use of crowdfunding can be used to generate a hype around a new product, and consumers are able to participate in marketing campaigns. Furthermore, in many cases participating crowdfunders are visible to everybody who visits the crowdfunding platform, these crowdfunders can be easily mobilised as multiplicators ans sales agents within their personal social networks (Belleflamme, Lambert and Schwienbacher, 2010; Capgemini Consulting, 2012; Hemer, 2011; Schwienbacher and Larralde, 2010).

Lower costs of funding

With crowdfunding, capital seeking ventures can determine for themselves, or sometimes in consultation with the crowdfunding platform, which financial reward they offer to the crowd. This can be at a lower cost of capital than traditional sources of finance, like bank loans. Furthermore, at many platforms it is the case than when the target amount is not reached, there are little costs incurred by the capital seeking ventures (Zaat, 2011).

Cost reduction of NPD

Capital seeking ventures often make use of the crowd for the reason of cost reduction of new product development activities. By participating in the product design and improvement, users contribute to creating value for the company. Moreover, this allows the company to reduce the time of new product development as well as its costs, have a better customer acceptance, and increase the customers’ perception of product newness (Kleemann, Voss and Rieder, 2008; Schwienbacher and Larralde, 2010). Crowds may be more efficient than individuals or small teams (Howe, 2008). Surowiecki (2004) explains that the wisdom of crowd exists because the crowd’s solutions aggregate to each other, as opposed to average each other out. In other words, members of the crowd may build up their own solution using others’ suggestions and hence end up having better solutions overall (Belleflamme, Lambert and Schwienbacher, 2011; Schwienbacher and Larralde, 2010).

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Higher customer satisfaction

Crowdfunding allows individuals to invest relatively small amounts of money directly in projects or start-‐ups with which they have personal affinity. According to Capgemini Consulting (2012), the main output is not so much the return on investment, but more importantly the return on involvement, satisfaction through (publicly) supporting initiatives and undertakings in the crowfunders interest. Schwienbacher and Larralde (2010) state that it is important whether the participant obtains rewards (tangible or not), have their say in making the related decisions, and have intellectual rights over the ideas they submitted. Furthermore, in some cases the crowfunders can provide ideas and tips to the firm. This creates an interaction that increases the involvement with the company and the pleasure of the crowfunder (Capgemini Consulting, 2012). Advantages for the capital seeking venture that can result from this are positive word of mouth effects and increased loyalty (Belleflamme, Lambert and Schwienbacher, 2011).

2.1.5. Disadvantages of crowdfunding from the capital seeking venture’s perspective

This paragraph assigns the disadvantages of crowdfunding in comparison with bank loans from the capital seeking venture’s perspective. Again, the disadvantages are divided between passive investment (the crowd solely invests money) and active investment (besides investment, the crowd also becomes active by giving advice or feedback to the capital seeking venture).

Disadvantages of passive investment Disadvantages of active investment

Many funders needed Many funders needed

No brought-‐in expertise No brought-‐in financial expertise Public disclosure of ideas Public disclosure of ideas

Investment of time/effort to convince

crowdfunders

Table 2. Disadvantages of crowdfunding from the capital seeking venture’s perspective

Many funders needed

Because the needed capital is divided into several smaller amounts, a capital seeking venture active in crowdfunding needs to deal with a large amount of investors. As Lambert and Schwienbacher (2010, p.12) state: “the amounts received from each investor are small, generating potentially substantial transaction costs.” So the necessity of many funders to achieve to target amount can be a potential disadvantage.

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No brought-‐in financial expertise

In comparison with bank loans, crowdfunding generally does not bring financial expertise to the firm which many (starting) entrepreneurs need. In general, the crowd can offer knowledge but no financial advice and/or advice on the implementation of an idea (Lambert and Schwienbacher, 2010).

Public disclosure of ideas

Entrepreneurs making use of crowdfunding will often need to disclose some of their ideas to the crowd well in advance, creating risks of idea stealing due to the fact that potentially valuable information is put into the public domain (Schwienbacher and Larralde, 2010). This, however, depends on the crowdfunding platform. At some platforms a capital seeking venture has to disclose detailed information about the product it’s seeking capital for, while at others only a limited amount information has to be given. When ventures have easy-‐to-‐understand and easy-‐to-‐copy business concepts or products, crowdfunding may be less suitable. In start-‐up financing in general, the entrepreneur has to disclose a large part of his/her concept he/she wants to bring to market, in order to win supporters (sponsors, lenders or investors). This also applies to crowdfunding, but with the difference that the number of (potential) supporters here is, by definition, much larger (up to thousands) and it is either impossible or legally very difficult to arrange non-‐disclosure agreements with all of them. In the crowdfunding process the entrepreneur virtually discloses his business concept and competitive details to the public at large (Hemer, 2011). However, according to Teece (1986) only a few instances exist where ironclad patents, copyright protection or trade secrets effectively deny imitators access to the relevant knowledge (tight appropriability regimes). More often, weak appropriability regimes exist, where these protection mechanisms do not have much power. When a dominant design emerges in a weak appropriability regime, access to complementary assets (e.g. marketing or after sales support) becomes absolutely critical.

Investment of time/effort to convince crowdfunders

Capital seeking ventures have to spend time and resources in order to make crowdfunding possible. Especially with active investment, the capital seeking venture has to have conversations with its crowdfunders and to convince them, which generally takes more time than traditional funding (Belleflamme, Lambert and Schwienbacher, 2011; Lambert and Schwienbacher, 2010; Ordanini et al., 2011; Zaat, 2011).

2.1.6. Contextual factors that influence the capital seeking venture’s willingness to

engage into crowdfunding

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disruptiveness of crowdfunding. The contextual factors that shape the willingness to engage into crowdfunding are divided in the categories: offering characteristics, capital seeking venture characteristics, crowdfunding platform characteristics and regulation. A final category is crowdfunder characteristics, this aspect is beyond the scope of this study.

Offering characteristics

- Product or service: Lambert and Schwienbacher (2010) made clear that entrepreneurial initiatives that yield a product tend to attract larger amounts of capital than those who offer a service. Reasons are that a activities that yield a product on average require larger investments than providing a service, and the crowd may be more tempted to provide money if they expect a tangible outcome; consumers may favour initiatives that yield a product as opposed to a service. - Height of required investment: The amount of money capital seeking ventures need is needed is another influencer that determines the degree of crowdfunding demand. Financiers have different pre-‐defined amounts they are willing to invest. For example, venture capitalists usually have high minimum investments (e.g. above €100,000) that are unsuited to the needs of small ventures. This may lead to a crucial trade-‐off of when to use a particular investor type for a particular height of investment (Schwienbacher, 2007).

Capital seeking venture characteristics

- Organisational form of capital seeking ventures: Crowdfunding initiatives that are structured as non-‐profit organisations are significantly more likely to achieve their target level of capital in comparison with other organisational forms (corporation, individual or in connection with a single project). Not-‐for-‐profit organisations may find it easier to attract money for initiatives that are of interest for the general community due to their reduced focus on profits (Belleflamme, Lambert and Schwienbacher, 2010; Lambert and Schwienbacher, 2010; Schwienbacher and Larralde, 2010).

- Capability to create a community: With crowdfunding, a community must be built that ultimately enjoys additional private benefits from their participation. If the entrepreneur is not able to create such benefits, no consumer will find it worthwhile to engage in crowdfunding, unless a discount is offered. However, crowdfunding then becomes less financial attractive compared to traditional funding. So a community-‐based experience created for crowdfunding is important to be a viable alternative for tradional lending (Belleflamme, Lambert and Schwienbacher, 2011; Ordanini et al., 2011).

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of financing, local investors are more likely to engage earlier in the funding cycle. The authors explain this difference in the timing of investment almost entirely by a particular type of investor, who they characterise as ‘family, friends, and fans.’ These individuals, who are disproportionately co-‐located with the entrepreneur, have offline information about the entrepreneur and are therefore more likely to invest (Agrawal, Catalini and Goldfarb, 2010). - Need for expertise: The entrepreneur might need additional managerial advice in sales,

marketing, accounting, distribution or any other field when it lacks experience or expertise. While crowdfunders can give their support and advice to the entrepreneur they fund, they may not have any specialised knowledge about the industry of financial knowledge, unlike banks (Schwienbacher and Larralde, 2010).

- Willingness to disclose relevant business information publicly: The entrepreneur might be more reluctant to disclose business information to crowdfunders, because the high number of people and their lack of professionalism. There is a threat of idea stealing, because the capital seeking needs to disclose sensible information to a wider audience than under traditional forms of fundraising (Schwienbacher and Larralde, 2010, p.10; Zaat, 2011).

Crowdfunding platform characteristics

- Maximum of total investment: While the amount of required investment is a characteristic of the offering, crowdfunding platforms have rules about the maximum total investment that can be done via their platform. The capital seeking venture has to take this into account. In appendix B the maximum offered investment of several crowdfunding platforms is stated (Schwienbacher and Larralde, 2010).

- Number of crowdfunders: In order to be successful as a crowdfunding platform, a certain amount of consumers have to be willing to invest their money via crowdfunding. When there is not enough supply of crowdfunders, it is not possible to meet the target investments of the capital seeking ventures active on the crowdfunding platform.

- Creation of a community: Not only the amount of funders, but also community feeling is important, as it may impact the crowd’s willingness to invest. The model of Belleflamme, Lambert and Schwienbacher (2011) highlights the importance of community-‐based experience for crowdfunding to be a viable alternative to traditional funding. A community must be built where crowdfunders ultimately enjoy additional benefits from their participation. This is a characteristic of the capital seeking venture, but the crowfunding platform also influences the ability to create a community (Ordanini et al., 2011).

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Regulation

Regulation on equity issuance for private companies may limit the extent to which crowdfunding can be a viable source of financing and the capacity of firms to seek funding from the crowd. (Inter)national regulations typically limit the extent to which ventures can advertise security offerings to the public, limiting it often to qualified investors and people with whom the entrepreneur already has clear links. Moreover, in some countries there is a limit on the number of shareholders that some forms of business organisations are allowed have. A solution is that crowdfunding can be structured in the form of making the participating crowd a member instead of a shareholder, or offering part of the revenues without issuing shares (Schwienbacher and Laralde, 2010).

Figure 4 gives a summary of the relevant characteristics, advantages and disadvantages of crowdfunding found in the literature.

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Figure 4. Advantages, disadvantages and contextual factors that influence the intention to use crowdfunding.

2.2. Disruptive innovation

This sector explains the concept of disruptive innovation, with a focus on sustainable versus disruptive innovation, the different forms of disruptive innovation, the impact of disruptive innovation on incumbents, the inhibitors and enablers of disruptive innovation for incumbents and finally the measurement and predictability of disruptive innovation. This is done to determine how to measure disruptiveness and to be able to determine the factors that shape the degree of disruptiveness of crowdfunding in the retail banking industry.

2.2.1. What is disruptive innovation?

The term disruptiveness was first used by Christensen in 1997. Back then, it was only reserved for technologies. Christensen made a distinction between sustaining technologies and disruptive technologies. Sustaining technologies are innovations that make a product or service perform better in ways that customers in the mainstream market already value. The industry’s incumbent firms often lead in developing and adopting these technologies. In contrast, disruptive technologies disrupt or redefine performance trajectories and often result in the failure of the industry’s leaders. Disruptive technologies are technologies that provide different values from mainstream technologies and are initially inferior to mainstream technologies along the dimensions of performance that are most important to mainstream customers (Christensen, 1997; Christensen and Overdorf, 2000). Christensen and Raynor (2009) replaced disruptive technology with disruptive innovation to include not only technological products, but also services and business model innovations. Yu and Hang (2010) concur that disruptive innovation is a more appropriate term than disruptive technology to describe the entire scope of innovations, as business models innovations are also frequently used.

In this research, disruptive innovation is defined as follows: “A disruptive innovation introduces a different set of features and performance attributes relative to the existing products and is offered at a lower price, a combination that is unattractive to mainstream customers at the time of product introduction due to inferior performance on the attributes that mainstream customers value. However, a new customer segment (or the more price-‐sensitive mainstream market) sees value in the innovation’s new attributes and the lower price. But, over time, subsequent developments raise the new product’s attributes to a level that is sufficient to satisfy mainstream customers, thus potentially attracting more of

the mainstream market (Govindarajan and Kopalle, 2006, p.198).”5_{According
to
Govindarajan
and}

Kopalle (2006) a disruptive innovation should (1) be inferior on the attributes that mainstream

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customers value; (2) offer new value propositions to attract a new customer segment or the more price sensitive mainstream market; (3) be sold at a lower price; and (4) penetrate the market from niche to mainstream.

Disruptive innovation provides new functionality, for example by offering more convenience, simplicity, affordability or accessibility. This, in turn, creates new markets, transforms the current market or disrupts existing market linkages. So while a disruptive innovation scores lower on the key performance dimensions of the traditional market, it offers a lower price and/or new functionality (which are other performance dimensions). Disruptive innovation does not necessarily have to displace established products, but also can enlarge and broadening markets through providing the new functionality (Luftenegger et al., 2010; Utterback and Acee, 2005; Yu and Hang, 2009). An example of disruptive innovation is the MP3 music format. When introduced the quality of music stored in the MP3 format was lower in comparison with that of the compact disc. However, due to the digitalization new functionality was offered: the storage size requirements were much lower so more songs could be stored on the same format. Additionally, consumers could download music from their home, there was no need to go to a music store anymore. These new functions initially appealed to a niche of customers. However, over time the technology, including the music quality, was able to improve and eventually MP3 music became mainstream.

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Figure 5. Disruptive innovation (Christensen and Raynor, 2003.)

2.2.2. Understanding the failure of incumbent firms

Disruptive innovations are generally introduced by companies new to the industry, within niche markets, because they are often not attractive to the incumbent’s customers and they offer a different package of attributes, valued only in emerging markets remote from, and unimportant to the mainstream market. The innovations do not address the next-‐generation needs of leading customers in existing markets, but they have other attributes that enable new market applications to emerge. The growth of these new markets is often ignored by incumbents, because they are considered too small, not-‐profitable and the technologies used are often considered too different. The incumbent will not do much to retain its share in this not-‐profitable segment and will move up-‐market and focus on its more attractive customers. However, disruptive innovations can improve at a faster rate than the existing technology in the mainstream market. The volume is therefore able to grow significantly and eventually the new technology can address the needs of customers in the mainstream market as well. The incumbent is squeezed into increasingly smaller markets, consisting of the most demanding customers. Eventually, in some cases the disruptive innovation is able to meet the demands of the most demanding segments and drives the incumbents out of the market (Adner, 2002; Christensen, 1997; Christensen and Overdorf, 2000).

The disruptiveness of crowdfunding in the retail banking industry

Master Thesis

MSc Business Administration: Strategy & Innovation