A new study carried out by economics and management professors at LMU shows that, in certain situations, the seller gets a better deal if he allows customers to decide what they want to pay for an item or a service.
In interactive pricing schemes like the Pay-What-You-Want (PWYW) model, the customer decides whether and how much he wants to pay. "That can actually be a very attractive pricing mechanism for the vendor," says Professor Klaus Schmidt of the Institute for Economic Theory at LMU. In a DFG-funded project, carried out in collaboration with Professor Martin Spann of LMU's Institute for Electronic Commerce and Digital Markets, Schmidt has investigated how customers behave when no price has been fixed for an item which they wish to buy. The first publication to emerge from the project appeared in the journal Management Science last year, and earned its authors a prize for the best publication in its category.
"In such situations, most customers do pay," says Martin Spann, and people who have a well-developed sense of fairness pay more than others. The relationship between the buyer and the seller also plays an important role. If the customer has an interest in ensuring that the vendor remains in business, they then have a clear motivation to pay.
Schmidt and Spann studied customers' willingness to pay for non-ticketed items in a number of experimental situations. The participants were randomly assigned the roles of buyers and sellers. In each experiment, participants repeatedly interacted with others in the same group in several trials. "Those who wished a given seller to return to the market in the next round were motivated to pay at least something for their purchase in the hope that he or she would survive, and in this case over 70% of the buyers did in fact pay. Not only that, 50% of them paid more than the item had cost the seller," Schmidt reports. In a different experiment, in which the buyer encountered the seller only once, and was aware that deciding not to pay would have no further consequences, around 40% of participants still paid.
"The PWYW model is used primarily in situations in which the seller's principal goal is not to maximize profits, but to interest as many consumers as possible in a good or service, e.g. to entice people to visit a museum," Spann explains. Commercial firms use the mechanism primarily as an advertising tool. "PWYW can pay off for the seller who wishes to penetrate the market, or if one is interested in selling related goods that complement the items for which the buyer can set the price." Software firms, for example, will often offer a basic version free of charge, when they have their eye on the market for an attractive add-on. "The basic prerequisite for PWYW is that the unit costs are low. This makes it easier for the seller to cover the costs incurred because some customers pay little or nothing for the item. That is why this pricing mechanism is employed mainly in the service sector," Spann explains.
The experiments also showed that, in a competitive market, most customers prefer to shop at outlets that use the PWYW model. But up to 15% of participants do rather not use the new pricing model and prefer to pay a fixed price. In the context of the DFG-supported project, the LMU professors are also studying other interactive pricing mechanisms, such as Name-Your-Own-Price models used in auctions on the internet. For their study of the viability of PWYW, Schmidt and Spann have been awarded the Best Paper Award by the German Academic Association for Business Research. In cooperation with the publisher Thieme, they will also analyze a new open-access publication to be based on a PWYW mechanism.
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