The obvious risk of pay-as-you-wish pricing is that customers may be tempted to offer unreasonably low payment. Here’s how companies are dealing with that risk in the real world.
In “When Customers Help Set Prices,” in the Summer 2014 issue of MIT Sloan Management Review, authors Marco Bertini (ESADE Business School) and Oded Koenigsberg (London Business School) lay out the pros and cons — and ins and outs — of involving customers in pricing decisions.
They explain that although company-imposed pricing is common, prices can also be set in collaboration with customers and even by customers themselves.
Letting customers have input on prices provides opportunities for customization and can promote greater customer engagement. At the same time, the decision to move away from fixed prices has organizational impacts and entails its own costs.
Many companies are wary of pay-as-you-wish pricing because they fear it will encourage freeloaders. Under pay-as-you-wish pricing, the company delegates responsibility for pricing to the customer. Customers can pay whatever they want, and sellers are committed to honoring their obligation. So what’s to keep too many people from choosing to pay nothing?
“The ideal safeguard against freeloading is to ensure that the pricing model aligns self-interest and truth telling,” write Bertini and Koenigsberg. “That is, that customers reveal their personal valuations because it is in their best interests to do so. A price menu, for example, must be designed so that customers choose the option priced closest to their individual willingness to pay. Similarly, a successful auction is one that motivates people to bid what the item is worth to them.”
But this kind of precision is not always possible, the authors note. They suggest three other ways to help keep payments fair and to keep people from choosing “free”:
1. Nudge customers by citing benchmarks.
Admission to the Metropolitan Museum of Art in New York, for example, is pay-as-you-wish, but the website and the ticketbooth have large notices recommending a $25 donation for adults. The notice includes the explanation: “To help cover the costs of exhibitions, we ask that you please pay the full recommended amount.”
2. Emphasize fairness, altruism and reciprocity.
Disney tested a pay-as-you-wish pricing program for photographs taken of visitors during a theme park ride. The authors write: “surprisingly, pay-as-you-wish substantially increased the amount of profit earned per rider, but only when visitors were informed that half of the price they chose went to charity — presumably because pay-as-you-wish allowed people to express their individual generosity.”
3. Educate customers about the negative long-term consequences of pursuing their immediate self-interest.
“Acting to maximize one’s payoff may make sense if the exchange is unique or infrequent,” write Bertini and Koenigsberg. “But if a seller and buyer hope to transact over time, then the seller must explain that the future is contingent on the model being financially viable: If enough customers don’t offer to pay their fair share, the company can say that it won’t be able to offer the product or service at a loss; if customers care, they will agree to pay more.” In other words, explain the consequences of selfish behavior.
Many companies are using these pricing strategies successfully.
Wikipedia has used the pay-what-you-want model since its founding in 2001, and often encourages users to contribute by invoking the idea of fairness.
San Francisco-based Humble Bundle, which sells collections of video games and other digital content, allows purchasers to name their price and lets them decide how they want to allocate the payments among game developers, charities and Humble Bundle’s organizers — “thereby advancing feelings of fairness and altruism,” note Bertini and Koenigsberg. It’s a model that’s been wildly successful: “In its first three years, Humble Bundle generated more than $50 million in revenue, with more than $20 million of that amount directed to charities such as the Electronic Frontier Foundation, the San Francisco AIDS Foundation and the American Red Cross,” the authors add.
For more on pricing strategies, including a look at collaborative pricing models, see the full article.