Mannconomics: A Kick In The Pants
Kickstarter: teh new hawtness. Thanks to DoubleFine and others, practically anyone who's anyone has at least one Kickstarter or other crowd-funded project running right now. But where does this lead? How do the creators and backers view this arrangement differently? Kickstarter is not just handing money over for a product at Wal-Mart or through Steam; it is a payment for the promise of ... something. If that promise is just that you will help them continue with their project and here's a pat on the back, that's okay, but often Kickstarter is used as a pre-beta storefront: You pay me money, I will make you a game. This arrangement, no matter how hard everyone tries to deny it, is an investment. And investments carry risk.
Like ebony and ivory, mom and apple pie, risk and reward are constant companions in business. In order to grow, nearly every business needs capital, (e.g., money and resources). There are several ways to obtain capital investment, but the hoped-for result is always the same: The finished product earns more money than it cost to create — this is the reward. Investors always hope for success, but a great many projects fail, and the investment is lost — herein lies the risk.
Many small businesses are bootstrapped — that is, funded solely by their founder(s). Others require no real investment to speak of, like a home-based cupcake bakery. Still others require millions of dollars of funding, and require backing by external companies usually in the form of Venture Capitalists (VCs). Regardless of the way a business is funded, though, there is risk: Roughly 90% of businesses will fail within their first five years. Those who have invested the most money have the most on the line.
Risk and reward are directly proportional. A very low-risk investment like a money-market account, which is basically guaranteed to not go bust, also has a very low reward: currently a truly abysmal 0.2% annual return. Very high-risk investments like penny stocks and cutting-edge technology firms fail often, but when they pay off, they pay off 100x over. Anyone can make a low-risk investment, but for the high-risk investments … well, even doing your homework is no guarantee of success. VC firms still have close to a 90% failure rate with their investments, hoping that the one out of ten that does pan out will pay off at least 30x of the investment. (This link is a clean and concise primer on how risk and reward are spread out for both the business owner and the venture capitalist depending on the type of funding procured.)
Most modern video games cleanly fall into the VC category. The payoff is generally six months to four years away and requires multiple people working during that time, which means many mouths to feed, utility bills to pay, and so forth. Generally, developers' VCs are publishers. Sometimes each game is shopped around individually, sometimes they form a sort of “Sugar Daddy” partnership where a particular publisher has first refusal or even total control over a developer’s content by purchasing the developer. At any rate, the outcome is the same: Publishers finance a game, have “board of director” input, and stand to benefit financially (along with the developer) if the game succeeds.
Of course, this means a lot of ideas never get published at all. Many more get funded, but never recoup their initial expense. Precious few wind up selling 20 million units and keeping everyone in the black. At the very least, though, no VC or publisher is going to fund something without at least some potential for reward.
That would be silly … right?
A Brave New World
Kickstarter and other crowdfunding mechanisms have changed the top level of the game pretty considerably. The traditional idea of carrying around a pitch deck to various VC houses has been transformed into a pitch video and prodigious use of social media to cut above the noise floor of all your potential “backers”. Instead of hoping to land that one big fish, the goal is to land thousands and thousands of minnows. It all tastes the same anyway, so to speak.
Make no mistake, though: Despite its innocent appearance, crowdfunding is still a way to give resources for future and uncertain products, i.e. "investing." And like every other form of investment, it still carries very real risks. A recent study of Kickstarter showed that as many as 75% of projects deliver late, or still have yet to deliver, and it’s very possible that we will see some high-profile failures in the next few years. We've already seen it begin, actually, from mismanagement to mysteriously absent product to claiming that the sun itself is speaking to them in their dreams to delay/change the project and keep those changes a secret.
Crowd-funding mechanisms and savvy projects try hard to hide the fact that there's risk involved, and they try really hard to hide the lack of reward, but those issues are there, nonetheless. You can no more get rid of risk in business investment than you can remove the oink from a pig. People do have a history of forgetting about risk, though: Every time the stock market tanks, there are people who are shocked, just SHOCKED that their investments have a potential for loss. The trick is to accurately assess what is an investment and stay far away unless the potential rewards are great enough to more than offset the risk.
However much they may try to hide it, the risk is still there. That EULA is most likely completely unenforceable and is almost entirely a CYA statement for Kickstarter itself. Kickstarter isn't going to try to go after someone who has misallocated $50,000; the legal fees alone would cost far more than that, and Kickstarter themselves don't have any skin in the game. Even a class-action by backers seems very unlikely. If money has been spent on salaries or utilities or whatnot, you can't just take it back. It's gone. In a severe case one may be able to confiscate property or assets, but this would leave no money for the backers after legal fees and would have the additional negative effect of running any sane businesses far away from Kickstarter — at least with a bank loan the terms are easier to deal with, if they're going to lose their shirts regardless.
Backers' reactions to the first whiff of funding failure, Code Hero, shows a lot of anger and a lot of lack of understanding of the fundamental principles of risk. It shows that they really are treating Kickstarter as a storefront, not a dicey investment proposition. Let's imagine that it was Amazon: It would be like for every ten items that you bought through Amazon, Jeff Bezos mailed you eight and decided to keep two. If that was consistently true, who would continue to shop there? It's bad enough if you only received eight $2 toothbrushes; now imagine that each item was a board game for which you pledged $150. It adds up fast.
In VC funding, the VC floats almost all the risk while the business owner holds very little risk. In return, the reward potential is very great. In Kickstarter, the risk can run from $30 to $30,000. Arguably this runs from throwaway money to a very serious investment, on par as a percentage of resources as a major VC investment. But here's the kicker (heh): There is no fungible reward in the Kickstarter world. A backer risks money in return for a product that, once it makes it to market, can be purchased with no risk whatsoever — sometimes even more cheaply than the lowest backing tier. Higher levels of funding obviously incur higher levels of risk, but typically the only things gained are tawdry baubles and that would likely be included in a Collector's Edition of the game or pure vanity rewards, like the backer's name or likeness in the game.
This is the dirty little secret of crowd-funding, the shell game of deception that has been played through the medium's infancy: There is no reward. There is no chance of tripling one's investment on Kickstarter. Crowd-funding is set up so that the risk is spread out over so many people that no individual will feel a failure too severely. But running any sort of non-zero risk for zero reward is a sucker's bet. TANSTAAFL, and all that.
Still, in economic terms, each individual investor has a very low marginal utility of the money invested, whereas a VC's marginal utility is enormous. If one pays $20 in a Kickstarter, that money has a pretty low opportunity cost for most people — there's not a lot else they could do with it that would have a huge impact on their lives. Maybe they could earn like three cents in interest. Yippee!
If you spread risk out over many thousands of people, each individual's risk approaches zero — but near zero is most decidedly not zero. Some Kickstarter heavy-users are beginning to realize this; many who backed 30-40 projects are still waiting for 15 of them to deliver, well past due date. If risk is not zero, but reward is, well: There's a sucker born every minute, right?
At the end of the day, crowd-funding is most likely here to stay; the US congress even passed a law making it easier for people to execute it. If it’s here to stay, potential investors need to be able to properly weigh the risks and rewards in order to best use their money. In order to do that, everyone needs to recognize that if it walks like an investment, and quacks like an investment … you get the drift.