Pay What You Want. It Works... Sometimes.

Friday, August 15, 2014

I'm very interested in picking out prices. I firmly believe that if a company doesn't choose a pricing strategy carefully, it's likely to leave a lot of money on the table.

But many others disagree!

The band Radiohead received a lot of free attention for allowing customers to pick their own prices. While some have argued its case is unique, others have replicated their experiment, including the famous Humble Bundle which sells software applications and the makers of the card game Cards Against Humanity.

While this pricing methodology can bring in money, there are times when this business approach clearly fails - Panera Bread just ended its experiment.

When it comes to software - especially those with substitutes, it can be notoriously difficult to predict how much money a firm could have earned with a traditional pricing strategy. For all we know, even those who raise large sums of money under pay what you want systems could make substantially more using traditional pricing. Further, it's possible that a portion of the income brought in under pay what you want schemes may be due to its novelty rather than its merits. If true, incomes would be reduced should "pay what you want" become more common.

That said, I suspect that the following characteristics would lead to higher profits using a pay what you want pricing model (whether for software or another product):

• Familiarity with seller or product - reduced familiarity could result in lower mental valuation of the product
• Belief that money is going to a deserving cause - donating a subset of the funds to a charity (as does Humble Bundle) would give payers a "good feeling" about paying a higher purchase price
• Unique product that is not available elsewhere - scarcity and uniqueness will generally cause a customer to predict a higher value for a product
• Likely to be interested in future products from the same seller - although the free rider problem still exists, a person would be more likely to pay more - if he believed it would encourage the production of future products that he desires
• Product exists as part of the buyer's persona - the tighter the connection between spender and seller, the less a buyer would feel as if he is losing money so much as exchanging money
• Low variable production costs - when the marginal cost of each unit is low, companies would not be harmed by customers who pay low amounts of money
• Visibility of purchase price to acquaintances of the buyer - mild shaming tactics have long been demonstrated to influence behavior
• Belief that payment is not out of obligation but out of support - the act of payment is transformed from a cost (which is detested) to a vote of affirmation (which is valued)