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Myth: Crowds are dumb as often as not, or worse.
This is our response to point #4 in the HBR blog post, “The Road to Crowdfunding Hell”
The Reality: Here are 2 reasons why the crowd is not as unintelligent as one may assume.
(1) The Crowd’s Investments & Selections Are a Proxy for Startup’s Future Performance
While VCs are well-trained investors with a keen eye for the next big breakthrough, their success rate is far from impeccable. This is largely due to the capricious nature of startup success. But when you boil it down, VCs and other investors are successful if and when they accurately predict how the crowd will respond to the issued product or service. When it comes to an investment that the public at large will consume, who is better to weigh in than the public themselves?
Crowdinvesting portals such as Return on Change allow the public to vocalize their interest by way of investing. The more interest the crowd shows, the more likely the product will be consumed, and hence the more likely the venture will succeed. You can think of every investment as a vote from the public as to which product they want to have commercialized. Their selections can be viewed as a proxy for how the product will perform in the real market.
(2) Crowd Allows for Collective Wisdom
Additionally, crowdinvesting harnesses the wisdom of the crowd, and that is not to be underestimated. What unsophisticated investors may lack in training and expertise, they compensate for through their aggregated wisdom. Simply put, the wisdom of the crowd is a phenomenon by which the collective opinion of a crowd can lead to far more accurate outcomes than the input of individuals within the group. This is true for problem solving cases such as estimating how many jellybeans are in a jar or deriving directions between two unfamiliar locations, to name a few.
Applying this to online crowdinvesting implies that the crowd is not disadvantaged for being unsophisticated investors, but actually advantaged for having diversified perspectives that converge collectively to point to successful ventures that an independent investor may not have pointed to. I will be to the first to admit that in the spectrum of ventures some are complex and present esoteric information which a subject matter expert would be best suited for deterring its marketability. For the remaining ventures, which are apparent and digestible, the crowd remains a valuable asset in determining marketability.
There are of course some caveats worth mentioning. In most problem solving cases, the wisdom of the crowd is optimized when the crowd’s size is manageable. After the crowd reaches a critical mass the marginal contribution of each member diminishes and can begin to actually become counter effective. In the case of crowdinvesting this critical point does not necessarily exist because the crowd represents the potential consumer base, and their approval is ultimately what founders seek. This case differs from a problem solving exercise where we have diminishing returns and is more closely represented by a voting structure. Which means that the more input from the crowd, the greater the accuracy of predicting startup success.
What do you think? Let us know your thoughts!