Digital Concept: Pay What You Want, Part 2

>> Now that we have defined pay what you want, let's take a deeper dive into this interesting concept. I'd like to focus on three issues in particular. 

First of all, do people actually pay when they don't have to? According to standard economic thought, customers are seeking to maximize their utility. In other words, they want to get as much as they can for as little, little as they have to pay. 

Thus, from a strictly economic perspective, a pay what you want strategy seems quite foolish, as rational, rational economic actors would just take a product without paying anything for it. 

However in reality, many people are not just self-interested economic actors, but also social beings who are governed by norms of honesty and fairness. 

Thus, while some do behave as economics suggest, many do not. 

For example, a recent two-year study of the buying behavior of patrons at a pay what you want restaurant in Vienna, Austria, found that over 99 percent paid something for the food they bought. 

Second of all, how can a firm make money by giving its product away for free? This is a really good question. A firm can make money, or stay in business, if it constantly gives away its products for free, that doesn't make any sense. Fortunately, many people will pay something for a product even under a pay what you want strategy. Indeed, as we will see in the Radiohead case, under a pay what you want strategy, some people actually paid more than the firm would attain using a typical pricing approach. 

Also because a pay what you want strategy is novel and newsworthy, when a firm employs this approach, it usually gets lots of attention. 

This often results in increased traffic and higher customer volume. 

For example, in January 2015, the U.S. National Aquarium in Baltimore held a pay what you want day, in which just patrons could pay anything they wanted for admission to the aquarium. This event attracted over 75 hundred visitors and it raised more than 33 thousand dollars in one day. Both of these amounts are well above the typical level for this aquarium. 

Third, is this pricing strategy sustainable? 

As we'll discuss shortly, the emerging academic research suggests that a pay what you want strategy is more likely to succeed if it's offered for a limited duration available to a small subset of firm's product offerings, or limited to a certain set of buyers. 

Moreover, most, most of the successful examples of pay what you want have employed this strategy on a rather limited basis. 

For example, Radiohead used this strategy for the release of one of its albums, but employed a more traditional pricing approach for its next album release. 

Thus, pay what you want appears to be an approach that is a good change of pace, but not sustainable as a long-term pricing strategy. Now let's take a look at some of the research about this fascinating topic. Research on pay what you want is still quite new and emerging, so there's a lot that we don't know yet about this new pricing strategy. However, a number of key insights are starting to emerge. I want to discuss two studies in particular. 

The first study was published in 2009 in the Journal of Marketing, this study was conducted by a group of scholars in Germany and was the very first academic study about pay what you want pricing. In addition to introducing this concept and explaining how it works, this article contained a series of field experiments in which the researchers convinced three different businesses, two restaurants, and one movie theater, to employ a pay, pay what you want strategy for a period of time. 

They then studied the behavior of over 600 customers across these three businesses. The results they found were quite interesting. First of all, they found that every single person paid something. None of the customers were asked to be given the product for free. On average, the prices paid were about 15 percent lower than the prices typically charged by these firms. However, the average volume of sales during the pay what you want period was about 10 percent higher. Thus price went down, but quantity went up. In total, the pay what you want strategy resulted in higher than average revenues, for both restaurants, but lower than average revenues for the movie theater. This article provides early evidence that a pay what you want pricing strategy, it'd actually be profitable under certain conditions. 

The second study is more recent, published in 2013, in a journal called Marketing Letters, and this more recent study, another group of German scholars examined how customers respond to pay what you want over time. 

These scholars conducted a field experiment, in which they examined the payment behavior of a group of students who patronize a coffee bar in Germany. 

For the purpose of this study, this coffee bar added ice coffee to its menu, and priced it using a pay what you want strategy. The researchers then used loyalty cards to track the payment patterns of these patrons over an eight-week time period. The results were very interesting. In particular, they found that, on average, the price paid declined over time. 

The average price for their first purchase was 80 cents, went down to 66 cents for the second purchase, and 57 cents for the third. 

So this article suggests that pay what you want pricing is more likely to be profitable for first-time customers rather than repeat customers. It also suggests that this strategy may be better suited as a special pricing promotion rather than a permanent strategic approach. 

This brings us to our recommendations. I have four in particular. First of all, set a reference price. 

As we discussed earlier, most customers have a reference price in mind when evaluating a potential purchase.

This reference price effect can also be employed in a pay what you want pricing scheme. 

One way of doing this would be clearly display the price of a comparable item. 

For example, if a firm offers pay what you want for vitamin C, it could announce this next to its price for vitamin D. Most people want to think of themselves as fair and honest. Thus setting a reference price should decrease their temptation to pay little, or nothing for a product as offered as a pay what you want strategy. 

Second, focus on marginal cost. 

Although customers will likely pay something, even when they can name their own price, this is a risky strategy. 

Thus pay what you want is best employed for products, they have low marginal costs, thus this strategy is especially attractive for digital goods, such as music, text, and video. For these types of products, each additional unit has a very low marginal cost.

A firm can take this one step further by pairing a digital pay what you want product with a physical good that has a high list price. For example, as part of its pay what you want strategy, Radiohead also offered customers the opportunity to buy a limited edition box set of its music for 82 dollars. It sold 100,000 of these disc boxes for a total of 8 million dollars in revenue, in addition to what it received for its pay what you want strategy for its album. 

Third, try a limited rollout. 

As discussed earlier, most successful pay what you want strategies are applied to a limited range of a firm's product offerings, or for a limited duration of time. 

For example, headsets.com employs pay what you want for only two of its many hundred headsets that it sells. 

In addition, this pricing strategy is only available to its returning customers. This type of limited rollout reduces the risk of a pay what you want strategy while maintaining its attention-getting benefits. 

Fourth, use charity appeals. Both academic research and practical experience indicates that a pay what you want strategy is more likely to be successful if the seller announces that some, or all of its proceeds, will be given to charity. 

This sends a signal that the seller is generous, which, in turn, should encourage customers to exhibit generosity and thus be more likely to pay a higher price. As noted earlier, Humble Bundle employs this strategy as a means of encouraging higher payment levels from its customers. 

Those are my thoughts about pay what you want. I'd like to see and hear your thoughts, especially if you have any local examples of firms that are, are employing this strategy where you shop and live.