Quality Signaling through Crowdfunding Pricing

Problem definition: This paper studies an entrepreneur’s pricing strategy in a reward-based crowdfund-ing campaign under asymmetric product quality information. We propose two signaling mechanisms and investigate the relative performance of these mechanisms under different market conditions.

Academic/practical relevance: This problem is relevant to practice, as asymmetric quality information is a major concern in reward-based crowdfunding; high-quality entrepreneurs are looking for credible mechanisms to signal their quality to customers.

Methodology: We develop a stylized game-theoretic signaling model with both funding and regular selling periods that captures asymmetric quality information between an entrepreneur and customers.

Results: For a high-quality entrepreneur who lacks a strong fanbase, we propose a new theory on quality signaling. In many cases, a low funding price might be the only signaling tool needed (i.e., one-price signaling); a high-quality entrepreneur should offer a good deal to customers in the funding period to increase the chance of a successful campaign to reach the regular selling period. However, such an entrepreneur can increase his funding price, if he commits to his future price in the regular selling period (i.e., two-price signaling). We characterize financing target levels that allow entrepreneurs to signal quality through one- or two-price mechanisms. In particular, we show that two-price signaling is plausible for a broad range of financing target levels. When both one- and two-price signaling are plausible (i.e., when the financing target level is not large), the gap in potential high- and low-quality levels and the accuracy of the market signal on customers valuation of the product in the regular selling period determine the more efficient signaling mechanism.

Managerial implications: Entrepreneurs should be mindful of pricing in both funding and regular selling periods, as it plays an essential role in signaling quality information. Our findings suggest practical quality signaling in crowdfunding. We demonstrate a trade-off between signaling costs and the value of learning of consumer preferences in reward-based crowdfunding. We demonstrate how price commitment significantly increases the possibility of quality signaling for high-quality entrepreneurs without serious funding price compromises, thus making crowdfunding platforms attractive to high-quality entrepreneurs.