Pay-what-you-want pricing: playing tag with price tags

It wasn’t so long ago that “pay what you want” was being touted as the hot new way to make money in an economy transformed both by the banking crisis and by digital commerce. In 2007, Radiohead released In Rainbows, inviting fans to download the album and pay what they chose. In 2010, Panera, a chain of bakery-cafés in the US launched Panera Cares, cafés with a social mission and PWYW pricing.

Peak PWYW may have come with a widely shared talk by the musician Amanda Palmer at this year’s TED conference. Palmer sprang to prominence after raising more than a million dollars on the crowdfunding website Kickstarter – and her TED talk hinted at how she’d achieved it. (In some ways, easy: just ask for money and make it straightforward for people to respond. In other ways, hard: Palmer’s intense and longstanding relationship with her fans sometimes verges on performance art itself.)

Where do we stand now with PWYW? Since textbook economic agents would choose to pay nothing, the idea defies economic assumptions. But those assumptions may be reasserting themselves. Panera introduced a PWYW meal in all its cafés in March, but axed the experiment in July. Some other high-profile PWYW restaurants have closed after a year or two, or switched to conventional pricing.

As for Radiohead’s In Rainbows, creative projects are released with voluntary pricing every day. But it has been a long time since I remember any such project hitting the headlines. And, since some of the PWYW appeal was surely publicity, the model was always reliant to some extent on novelty.

Tyler Cowen, a professor of economics at George Mason University in Virginia (also a thoughtful food critic and author of An Economist Gets Lunch) predicted in 2010 that the model would rarely work for restaurants. The novelty would wear off, and repeat customers might find the burden of choosing the right price discomfiting. The margin for error is small: musicians such as Radiohead or Palmer can carry free riders because the cost of distributing digital music is low. Restaurants will swiftly be wiped out if many customers pay little or nothing.

Experiments by marketing professors Ju-Young Kim, Martin Natter and Martin Spann found that PWYW schemes tended to reduce profits, particularly if marginal costs were significant – as with restaurant meals.

To make PWYW stick, perhaps retailers need to be a little more crafty. Ayelet Gneezy, Uri Gneezy, Leif D Nelson and Amber Brown, also marketing academics, experimented with different pricing schemes for people invited to buy photographs of themselves on a rollercoaster.

Some people were told that half the money they paid would go to a charity for sick children. Some were invited to pay whatever they wished. But it was those two options in combination that worked wonders: if patrons were invited to pay what they pleased, and told that half their payment would go to charity, revenues and profits surged.

But this scheme seems to rely on a cognitive illusion. It could equally be described thus: “we’ll grab half of your charitable donation and give you this photo in exchange; the more you give to the charity, the more we’ll take.” Not so appealing.

And there is a twist. Gneezy et al found that, while profits jumped, fewer people actually bought photos if they were told half the money was going to charity. Were the people who would have paid a little and taken the photograph afraid of looking cheap once the charity was mentioned? Perhaps they found it easier to walk away.

As a business strategy, “pay what you want” usually translates as slim pickings. As a topic in psychology, it remains deliciously rich.

Tim Harford’s ‘The Undercover Economist Strikes Back: How to Run – or Ruin – An Economy’, is published by Little, Brown this month. Its price will be determined by the booksellers