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Pay what you want: does it work?

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This article also appeared in Finweek Magazine in their 09-May-2013 issue

Dave was in the market for a new car. One afternoon he happened to be driving past the Ferrari showroom when he thought: “Why don’t I take one for a test drive?” An hour later he returned from an exhilarating drive in a Ferrari 458 Spider, with the top down and the engine roaring like a caged panther. Dave was sold. He asked the manager: “So, how much will this one set me back?” The manager responded: “Tell me how much you want to pay….”

If you were like Dave, you probably would have also done a double take. Pay what you want for a brand-new Ferrari? Seriously?

As much as we wish it would, Pay What You Want (PWYW) has not penetrated the luxury sports car industry, at least not yet. But worldwide, more and more business people are experimenting with this controversial new business model across many industries: from restaurants, the music industry, to gaming and movies and free online services like Mozilla Firefox and Wikipedia. So far all of these industries centre around goods and services that don’t cost a lot. Could PWYW spread to industries with big ticket items like cars and property? More importantly, does the PWYW model work? And do the numbers make business sense?

Firstly, exactly what is Pay What You Want? As the name implies, it is a pricing model where customers pay what they think is fair for a product or service. In some cases, the seller may set a minimum (floor) price, and/or they could give a recommended price to help customers decide. So if you were the customer and there were no minimum price, you could choose to pay nothing at all. Or on the other extreme, you could pay even more than the standard price. It’s really up to you.

PWYW has been around for a long time on the fringes of the economy: think of charities, waiters’ tips, street performers and special promotions in theatres. However in recent years it is becoming increasingly popular as a mainstream business model. You’ve probably been exposed to it without even realising. Think of the last auction you went to.

What’s in it for the buyer and seller? At face value, giving buyers the freedom to pay what they want is risky and makes little sense for a seller. However, in some cases, it can be very successful. Why? Because it removes many of the downsides of ordinary pricing for both parties:

  • Buyers love paying what they want because they no longer have to feel afraid of whether a product is worth the price that they pay for it. So the danger of dissatisfaction or “buyer’s remorse” falls away.
  • For sellers, gone is the challenging and sometimes pricey job of finding the “right” price (which may differ for different market segments).
  • For both buyer and seller, it turns an adversarial struggle into a friendly transaction.
  • PWYW takes into account that price sensitivities and perceptions of value can differ widely from buyer to buyer.

1984 at Annalakshmi Restaurant in Kuala Lumpur, Malaysia marked the birth of one of the earliest known “Pay What Your Heart Feels” concepts. It wasn’t long before the idea caught on at some of the Annalakshmi restaurants in other cities too.

In the music industry, über-successful, innovative rock band Radiohead made history in 2007 with their ground-breaking foray into Pay What You Want. Not only did their album In Rainbows have no retail price, but it also had no record label. Instead, they released it as a digital download available only on the band’s web site, Radiohead.com. Unlike with its previous albums, there was no label or distribution partner to eat into the band’s profits. In Rainbows was the first major album where customers could choose the price they wanted to pay, even if that meant nothing at all. After Radiohead’s agreement with EMI/Capitol finished in 2003, singer Thom Yorke told Time Magazine, “I like the people at our record company, but the time is at hand when you have to ask why anyone needs one. … [It is a] decaying business model.” Record labels were reeling from the aftershock of Radiohead’s move. In the words of an executive at a leading European label “This feels like yet another death knell. If the best band in the world doesn’t want a part of us, I’m not sure what’s left for this business.”

Six years after the Radiohead experiment, the burning question is: “Did they make more from the PWYW model than they would’ve made from the record label route?” The answer isn’t clear as Radiohead’s publisher didn’t disclose exactly how much the band earned. However in 2008 Warner Chappell did reveal that the digital publishing income from the first licence (for the Radiohead PWYW site) alone exceeded all the band’s previous digital publishing income and made a “material difference” to Warner Chappell UK’s digital revenue. The publisher also confirmed that Radiohead made more money before In Rainbows was physically launched, than they made in total on the earlier album Hail To the Thief. However bear in mind that Radiohead’s current digital revenue was low, since they had suspended licensing iTunes.

In 2010, the producers and distributors of the Freakonomics movie organised a PWYW sneak-preview screening. This was for one night only in a number of US cities. It had a floor price of 1 cent and a ceiling of $100. There was no choice for zero, nor was there an option for giving some of the money to charity.

The latest to hit the PWYW bandwagon is the Panera Bread chain in St. Louis in the US. Since 27 March 2013, 48 of Panera’s cafes have sold their turkey chili as a PWYW item. Panera knows the PWYW model well. They have five non-profit locations. These operate the same as for-profit Panera cafes – except none of the menu items has a fixed price. This turkey chili item was the first PWYW item at Panera’s for-profit locations. Interestingly, Panera’s data shows that when they buy a PWYW item, roughly 60% of diners pay the recommended price, while 20% pay more, and the remaining 20% pay less or nothing at all. According to Ron Shaich, Panera’s founder and CEO, the aim of this pricing is somewhat charitable: if customers pay more than the chili costs Panera to produce, the profit subsidises meals for customers who are unable to pay as much. Diners are told upfront, when choosing the price to pay, that this is how the model works. Panera’s non-profit stores usually make 70-80% of what one of their for-profit stores generates. Shaich says that’s still enough to make a profit and to do good.

This ties in with new research showing that combining PWYW pricing with a plea to charity maximises profits and gets customers to pay more. In 2010 in Science Magazine, Lief Nelson of the Haas School of Business at Berkeley published the results of a field experiment on PWYW and charitable pricing. They presented over 113 000 visitors to a funfair with different ways to buy a keepsake.  One group was given a set price. The second group could choose the price they paid, even if this was zero. Of this second group, half were informed that charity would get 50% of the price they paid. Nelson found that at a standard, set price, the charitable alternative raised demand only a little. Interestingly, when participants could pay what they wanted, the same charitable option generated significantly more profit.  Prof. Ayelet Gneezy at the University of California-San Diego, conducted a similar experiment and got a very similar outcome.

What key elements should be in place for the PWYW model to work? In their 2010 book Smart Pricing, Raju and Zhang of Wharton suggested that successful Pay What You Want programmes have the following criteria:

  1. A product with low marginal cost. This means the cost of producing one more item is low.
  2. A reasonable customer. As a buyer, you’re depending heavily on the kindness of your customers, as well as their willingness and ability to pay. So if you’re attracting cash-strapped teenagers, students, pensioners and bargain hunters looking to pay next to nothing, PWYW won’t work. On the contrary, it could bankrupt your business if you don’t sufficiently cover your costs.
  3. A product that can realistically be sold at a wide range of prices. So high-ticket assets like art, used cars and property tick yes for this criterion.
  4. A strong connection between buyer and seller. For example, you may support a cancer charity (and give them bigger donations more often) because a close friend passed away of cancer.
  5. An extremely competitive market, for example in the restaurant business, where there is little to distinguish one restaurant from another. So if your restaurant offers a PWYW model, this could give you a unique differentiator compared to your competitors, create buzz and help you attract more patrons.

Add to this the charitable element that Nelson’s and Gneezy’s studies uncovered, and PWYW becomes more profitable and sustainable.

What are the key pros and cons?

  1. It all comes down to perceived value, willingness and ability to pay. So if you’re selling, don’t try this model unless you believe 200% in your offering and the value it holds for your customers, otherwise you’ll come up short on the income side.
  2. The location and customer demographic could make the PWYW model unsustainable. In 2008, Ervin Peretz started a PWYW café known as Terra Bite Lounge in the US. The goal was to break down the stigma of getting free food. Fast forward one year, when Terra Bite was forced to charge fixed prices for its offerings because PWYW wasn’t sustainable in its location, frequented by cash-strapped teenagers. So choose your location and target market very carefully.
  3. Because of the novelty value it currently holds, PWYW creates buzz, helping you attract more customers. This is in fact what happened with Panera and Radiohead. However as PWYW becomes more mainstream, it will lose this effect.
  4. PWYW is risky for sellers, as it could be open to customer abuse and you could earn less than a fixed price model. This is what happened with Terra Bite. However you could also end up getting more.

To add more uncertainty to the PWYW model, a 2012 study indicated that PWYW may discourage some customers from buying a product altogether. Why? The researchers proposed that “individuals feel bad when they pay less than the “appropriate” price, causing them to pass on the opportunity to purchase the product altogether.”

A relatively new form of PWYW is crowdfunding, where supporters can invest whatever amounts of funding they want in a new concept. Music artist Amanda Palmer raised $1.2m from fans in 2012 via crowdfunding platform Kickstarter. This was for her latest project, Theatre Is Evil, which included an album, concerts and a book. It was the biggest music crowdfunding project so far. Not bad for a starting goal of $100,000. In Palmer’s view, a PWYW “patronage” model is the future for the music industry, the shifting relationship between artists and fans, and the role of record labels.

In other cases, PWYC can lead to venture capital funding if the model is successful. Launched in May 2010, the Humble Indie Bundle was a group of six independently developed digitally downloadable video games sold via a PWYW model. It included a charitable portion that buyers could control. At the close of the sale, they had raised a sizeable $1.27m. Humble Bundle has since completed over 20 more bundle sales, amassing a total of over $19m in revenue. In April 2011 Sequoia Capital invested to the tune of $4.7m.

So for now the jury is out for Pay What You Want. It is still very new to the business world. To some, it is a hot new trend to watch, to others it is simply wishful thinking or a fad. Will PWYW work for big ticket items like cars and property when not sold on auction? Can it work in South Africa, where there don’t seem to be business examples outside of auctions, tips, street entertainers or charity? More research and real-life examples are needed. Nonetheless, the idea of customers choosing what they pay has gained traction over the last decade. Because of the charity elements linked with PWYW, many see it as an offshoot of the birth of social entrepreneurs — those who believe that making a profit and doing good can go together. It is this angle that could well be the way of the future for PWYW.

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Author: Colette Symanowitz

Managing Director of www.BeatingBullies.com and www.MBAconnect.net. Passionate about entrepreneurship, personal branding and networking. I also tweet under @mbaconnect_net and @Beating_Bullies

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