It pays to give
Allowing consumers to set their own prices can be good for business; even better if the firms give some of it to charity
IN OCTOBER 2007 Radiohead, a British rock group, released its first album in four years, “In Rainbows”, as a direct digital download. The move drew a fair bit of attention (including from this newspaper) not only because it represented a technological thumb in the eye to the traditional music industry, but also because the band allowed listeners to pay whatever they wished for it. Some 60% of those who seized the opportunity paid nothing at all, but the band seemed pleased with the result; one estimate had it earning nearly $3m from the experiment.
One group outside the music industry taking an interest was a trio of professors then at the Rady School of Management at the University of California, San Diego: Ayelet Gneezy, Uri Gneezy and Leif Nelson (who is now at the Haas School of Business at the University of California, Berkeley). Inspired, they designed a series of experiments to gauge whether pay-what-you-want pricing would work for other businesses. Their most recent experiment, co-authored with Amber Brown of Disney Research and published in Science, also stirred in a new element: would it make any difference if firms donated some of the pay-what-you-want fee to charity?
The authors set up their pricing experiment at the exit of a roller-coaster ride at a large amusement park. Riders were offered a photograph of themselves, snapped mid-coast. The usual price was $12.95, but on one day riders were told they could pay what they wished, including taking the photo for free. A second group was charged the full price but told that half the money would go to a well-regarded health charity. Yet a third group could set the price and see half of their chosen amount donated.
Allowing customers to set the price dramatically increased the percentage of buyers—from less than 1% to 8%. Even accounting for those who took a free photo, the amusement park collected more revenue on the pay-what-you-want day than when selling for the usual fixed price.
The authors also found that of the customers who were allowed to pay what they want, those who were told that half the money would go to a good cause paid substantially more than those who were not told about the charitable donation—to the point that revenue more than tripled. (The charity did, indeed, get its promised cut.) The smallest number of purchases, meanwhile, came the day that customers had to pay the full $12.95 but half was donated.
Therefore more than simple altruism was motivating the customers who gave money for a photo they could have had for free. “One of the quirks about paying what you want,” suggests Mr Nelson, “is that it starts to signal something about who you are. Every dollar you spend is a direct reflection of how much you care about this charity and what kind of person you are. No one wants to go cheap with a charity.” He calls this phenomenon “shared social responsibility”: instead of passively accepting a firm’s assertion of its charitable donations, the customer must actively agree to give money to charity, and determine how much.
But how widespread could shared social responsibility be? Ms Gneezy is the first to point out that customer-determined pricing works best for products with low marginal costs. Since publishing their findings, the researchers have spoken to several companies interested in pursuing similar experiments with their products, including software developers and video-game designers. But offering flexible pricing on a virtual product online, instead of in person at an amusement park, may make it easier for people to “go cheap” even if a charity is involved. Combining customer-determined pricing, corporate social responsibility, and increased profits will be tricky to pull off, and not every company will be able to do it—just like not every band can put their album online for free and still profit.
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Would be interesting to know if they've looked at the Humble Indie Bundle computer games package.
http://www.humblebundle.com/
It bundles together a group of games from independent designers, with the buyer setting the amount (minimum $0.01 if I remember correctly). The money is split between the game designers as a block, 2 charities, and a 'tip' for the organisers, with the buyer deciding what amounts go where.
Cleverly, they also show the average amount paid, split by operating system. When I bought, the overall average was around $6.50, whilst the Linux average was around $13.00. As Linux is my preferred operating system, sure enough I felt I had to do my bit to keep up appearances, so paid $15.00.
The scheme has run twice now, and there could be some interesting data to mine.
WIth a photo from a roller coaster ride, you'll buy one, and keep it for yourself. Now, I wonder what would happen if a consumer was allowed to choose a price on an item that could be resold e.g. a book.
If I was allowed to purchase a book at any price, say $0.01 USD, I'd take that book and resell it elsewhere and make a business out of it. In turn, the person who allowed me to choose the price is losing greatly.
In the end, if a business such as Wal-Mart or Best Buy allowed customers to choose their prices-they'd be bankrupt.
@ MicrosoftSam:
not if user is informed that you can buy that book at free pay conditions.
If I know I can go to Wal-Mart and pay whatever I want I can skip you freeloader.
It's an interesting idea, and I hope others will try it. I've read about "pay-what-you-want" restaurants that were successful. In business there's folklore that says that people don't value what's free, but I will take experimental results such as these over conventional wisdom any day. The wrinkle in this new version is the charitable portion. That makes for an interesting study, but it complicates things tremendously in real life. For one thing, I might particularly dislike the charity and might decide not to buy the product for that reason. To avoid that, the vendor would have to offer a choice of charities. Ebay does a version of this, but with two catches -- the seller chooses the charity, and Ebay's charity-processing subsidiary siphons off most of the "donation" (read the fine print), which makes one cynical about the whole concept.
The roller-coaster photo also has several unusual features compared to most products. It's totally an impulse purchase. It's unique (no one else is offering photos of you on the roller coaster). It has a near-zero cost of production and hence a very high margin and almost nothing to be lost if the person simply takes the photo without paying. It's harder to envision a commodity vendor such as a gas station making money with this concept.
The model of this should just be used in some special industries, the price of goods should be cheap and can be substituted easily
How about governments offering a pay-what-you-want tax offer?
The article offers few insights for which industries this pricing approach could be applied. I'm not sure that this was even the point.
I think that the experiment says much more about how we use purchases to signal something about who we are, to paraphrase Mr Nelson.
A similar process is at work when we choose to display brand names on our cars, clothing, and technological jewelry (like iPhones). For a very entertaining discussion of how we make consumer choices, I would recommend Geoffrey Miller's book, Spent: Sex, Evolution, and Consumer Behavior.
I should have known that the Economist had already written about Mr Miller. Here is a link:
http://www.economist.com/node/9581656
A nice idea but there are two caveats: low marginal cost, as you point out, and individual purchases - not corporate ones.
I've recently launched an e-learning programme aimed at corporate buyers, but I'm also interested in individual users and am having problems establishing a price, particularly as I want to sell into developing countries as well as developed ones. It's giving me food for thought.
By the way, would the publishers of your esteemed publication care to adopt the same pricing model? (Please).
Finally, the last sentence of the article contains the phrase 'for free', specifically banned in your style guide. Stoppit. Now.
You can apply this strategy only in developed and very deleoped countries.
oliverthebear wrote: "the last sentence of the article contains the phrase 'for free', specifically banned in your style guide" ...
The same sentence also contains a grating mis-use of the preposition 'like'. To quote from the Economist Style Guide: "'Like' governs nouns and pronouns, not verbs and clauses." The correct conjunction here is 'as'.
An alternative explanation (which the researchers might have tested again but not reported in this article) is that the original fixed price was mis-priced.
Moreover, if this self-pricing continues indefinitely, most customers may gradually become aware that a very large percentage (or most) of fellow customers choose to pay nothing. This knowledge might (or might not) move more and more people into paying nothing.
Moreover, the customers' behavior might highly depend on which society or culture or country they are in.
This is an experiment in altruism, rather than an experiment in an efficient clearing price auction.
While questions of altruism and collective decision making have come more and more to the fore in the subject of experimental economics, such studies are not very useful when it comes to studies in improving how the economic system operates: for a very simple reason (to an economist) - those who pay nothing gain a great deal of what is known as "consumer surplus". Those who have taken Economics I will know such an outcome is economically inefficient, and any system designed to do this should be avoided. (All right, what is charity? But we are heading off in another direction).
Nice idea, but unless there is a very good alternative reason for doing your entrance pricing this way, this pricing procedure should be avoided.
This economic curmudgeon is sorry for hitting this idea over the head.