Business Life: Pay what you want

30th October, 2009

First published in Business Life, April 2009

Deciding how much to charge customers is a crucial decision for most businesses, and many devote huge effort to complex pricing schemes. Not all, though: some businesses turn the whole task over to customers. “Pay what you want” seems to be a new business fashion – but is it taking customer sovereignty too far? And is the model sustainable?
Pay what you want has two clever features. The novelty attracts customers and publicity, too. And affluent or price-insensitive customers tend to pay more. Any well-run business will try to offer low prices only to customers who demand them, not to every customer; pay what you want might achieve the same result without the fuss.
The Achilles heel of pay what you want is, of course, blindingly obvious: what if people don’t want to pay anything at all? No wonder the model has caught on in two very specific contexts: digital goods such as music files, software or blogs; and cafés or restaurants. With digital goods, the cost of providing an extra copy is close to zero, and collecting real money is difficult thanks to piracy and a customer base that is used to getting what it wants without paying. Inviting contributions is better than nothing. In a café, customers are used to tipping staff and find it hard to accept service from a smiling waitress and then pay little or nothing. Honour – or guilt – can be a powerful motivator. So can social norms: Americans, well used to tipping, were reported to have paid much more than others when invited to pay what they wanted to download Radiohead’s album “In Rainbows”.
My concern is that when the novelty wears off, pay what you want will collapse as a model, at least for restaurants and cafés. Not only will the free publicity ebb away, but there is every reason to suppose that customers will start to exploit the offer. The economists John List and Uri Gneezy have carried out an experiment that sheds light on this tendency. They hired temps to perform various tasks, and paid some of them well above the hourly wage that had been agreed. The question was whether the workers would put in extra effort out of guilt or simple gratitude. The answer: yes, but the effect wore off in a matter of hours. Selfish exploitation of the generous wage became the norm by lunchtime on day one. I suppose if the same thing happens to restaurant owners, they can always install a cash register.

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