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Ask customers to pay whatever they want and earn money

In October 2007 the British band Radiohead launched their latest album – In Rainbows – on the Internet. The band allowed fans to download the album freely and offer, in retribution, any amount of money they would like.

If consumers were purely self-interested agents seeking to maximize the value and minimize the costs of their transactions, such a pricing strategy should have proven disastrous for the band. Actually, if that would be the way consumers behave no one should have decided to pay anything for the album. Yet, in 2008 Thom Yorke, Radiohead’s lead singer, disclosed that the download of their new album generated more profit than the accumulated downloads from all previous albums. Why did Radiohead fans decide to pay for such downloads when given the option to pay nothing? One could argue that the devotion of fans to their favorite rock artists might lead them to deviate from pure self-interest. Researchers Ju-Young Kim, Martin Natter and Martin Spann decided to explore this phenomenon and better understand how consumers react to ‘pay what you want’ (PWYW) pricing mechanisms.

Social norms
They found that fairness concerns and social norms seem to guide consumers and guarantee a fair payment to the seller. In particular, consumers seem to have a natural tendency to be fair or fear social disapproval if they decide to pay a low price for the product or service they purchase.
However, the amount consumers decided to pay was also driven by their satisfaction with the quality of the product or service received and by economic considerations (i.e. depended on the consumers’ income and price consciousness).

Variable costs
Consequently, it seems that PWYW is profitable when variable costs are low (even though fixed costs might be relatively high) and when the amount consumers decide to pay is visible to others. In fact, the authors disclaim that this mechanism might be inadequate for high-priced transactions, where fairness and social concerns might be insufficient to guarantee a fair price to the seller. Still, in many daily transactions such a pricing scheme might be profitable.

These results were obtained by conducting pricing experiments in three different types of transactions: (1) restaurant meals, (2) cinema tickets and (3) hot beverages in a delicatessen store. They convinced managers to specify an experimental period where they would let customers decide what price to pay. The authors then recorded the sales before and during the experimental period and information about consumers’ income, reference price and attitudes (fairness, altruism, price consciousness, and satisfaction).

Higher
In the restaurant and cinema, as expected, the average price paid by each customer decreased. However, such decrease was not as large as managers might have feared. In the restaurant the average prices dropped by 19.37 percent and in the cinema by 28.72 percent. In the case of the delicatessen the results were even more striking. In this case the average price paid was even 10.62 percent higher during the PWYW period.

In terms of revenue the situation was even better. Probably due to its novelty, innovativeness and, eventually, sense fairness and trustworthiness, the pricing mechanism attracted a significant number of new customers which contributed to an increase in revenues in the case of the restaurant, despite the decrease in average price paid per customer.

The experiment was so successful that the restaurantowner decided to keep the pricing mechanism after the experiment and started making plans to open a second restaurant using the same pricing format as a positioning strategy.

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Source door: Ju-Young Kin, Martin Natter and Martin Spann
in: Journal of Marketing

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