Pay-what-you-want pricing may pull in the customers, but it’s often risky for the business

Prithwiraj Mukherjee June 1, 2017 5 min

Imagine the following situation: You have eaten a sumptuous Bengali meal at a fancy restaurant. After wolfing down bekti fish fry with tangy mustard sauce, mutton curry with rice and a few rossogollas, you ask for the bill.

The manager comes up to you and asks you to pay what you like. Surprise! You could get away with a free meal if you want. So, do you walk out without paying? Or do you pay up an amount that is reflective of your social standing? Or do you pay a fair price for the meal you just consumed?

At first thought, you may think it is completely irrational to pay any amount at all when you have the opportunity to just walk away, right? But you don’t do that. Same reason you tip waiters when you are not obliged to, or tip a good roadside musician when she passes around a hat for collections. Or, for that matter, give money to NGOs and charities.

At first thought, you may think it is completely irrational to pay any amount at all when you have the opportunity to just walk away, right? But you don’t do that  

Why? The answer is twofold. One reason is there is social pressure on you to appear acceptable — nobody wants to appear a cheapskate. The other reason is that you possibly derive some sort of mental or emotional pleasure from the act of paying — like contributing to a child’s future by donating to charity, or simply a smile from your waiter — which may motivate you to pay even when you are not required to.

Tipping and charities are well-established forms of so-called pay-what-you-want schemes. However, services and businesses like tourist agencies, restaurants and even resorts sometimes resort to this uncommon pricing mechanism — letting you decide how much you want to pay after the service is rendered. Tourist destinations all across Europe, for example, organise walking or bike tours of a city for free, requesting you to pay whatever you want at the end of the experience.

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Naturally, this quirky phenomenon has attracted some marketing research. A study by Ju-Young Kim, Martin Natter and Martin Spann finds that the presence of a pay-what-you-want pricing scheme significantly increases the intent to purchase of consumers, and that most consumers pay amounts that are significantly more than zero. Further research by Gerhard Reiner and Christian Traxler, who studied the evolution of payments at a pay-what-you-want restaurant, found a steady decline in prices and an increase in the number of clients over a two-year period, before converging to a steady state. The end result resulted in higher revenues, as the increase in demand offset the dip in amounts paid.

Unsurprisingly, the anchoring bias plays a major role in determining the process paid at pay-what-you-want schemes  

Unsurprisingly, the anchoring bias plays a major role in determining the process paid at pay-what-you-want schemes. For example, we are conditioned to tipping anywhere between 5% and 20% of the bill value to waiters, with cultural differences and satisfaction levels deciding the final amount paid.

Similarly, we have a rough idea of how much a bottle of coke or a meal at a fancy restaurant would typically cost us — our previous experiences in these situations and the prices we paid often act as reference prices for future prices paid, including in pay-what-you-want-schemes.

However, such references may not exist with unfamiliar products, like say a unique work of art, handicrafts, etc. Research by Ju-Young Kim, Katharina Kaufmann and Manuel Stegemann (paywalled) shows that sellers could suggest higher prices for a product or service in a pay-what-you-want scheme and thus influence prime consumers to actually pay more.

Finally, how sustainable is pay-what-you-want pricing for your business? For one, if you are new to the market, it can be a good way to build awareness, and possibly undercut your competitors and build market share. However, as a seller you have absolutely no direct control over the prices that your customers pay, and thus may have to bear significant risks, especially in cultures where underpaying a seller may not be considered socially unacceptable.

If you are new to the market, pay-what-you-want can be a good way to build awareness and market share. However, if you have absolutely no direct control over the prices your customers pay, you may have to bear significant risks  

There are some alternate pricing strategies marketers could look at. for example, the name-your-own-price scheme allows buyers to decide prices, but the seller can refuse if she does not like the price quoted, altering the dynamics considerably.

Pay-what-you-want schemes can also be a good way to test a new market, where you are unsure of what may be a good price for your product or service, of course with the rider that prices paid voluntarily may not be indicative of actual willingness to pay.

Furthermore, a study by Klaus Schmidt, Martin Spann and Robert Zeithammer suggests that pay-what-you-want schemes can do well if you have no competitor, but posted prices by competitors can act as reference prices, and low prices of competitors could end up in consumers paying you lower in a pay-what-you-want scheme.

This column is intended to showcase interesting academic research in marketing. The technically oriented reader is encouraged to read the original research articles cited in the column.

Prithwiraj Mukherjee is Assistant Professor of Marketing, IIM Bangalore. Views are personal.