Pay What You Want — But Pay Enough: Information Asymmetries and PWYW

ThecurrentissueofM&Mcanbefoundat:www.managementmarketing.ro

Correspondence:MatthiasGreiff

[email protected]‐giessen.de

PayWhatYouWant–ButPayEnough!InformationAsymmetries

andPWYWPricing

MatthiasGreiffJustus‐Liebig‐UniversityGiessen,Germany

HenrikEgbert

AnhaltUniversityofAppliedSciences,Bernburg,Germany

KreshnikXhangolliAnhaltUniversityofAppliedSciences,Bernburg,Germany

Abstract: Pay What You Want (PWYW) pricing has received considerable attentionrecently. Through PWYW, companies entrust the buyers in determining the prices ofspecific products. Empirical studies show that when PWYW pricing is implementedbuyersdonotbehaveselfishlyinanumberofcasesandthatsomesellersareabletousePWYWtoincreaseturnoveraswellasprofits.Thetechniquemayalsobeusedtoattractmorecustomersandincreaserevenues.Inthispaperwepresentatheoreticalmodelofbuyerbehaviorunderasymmetricinformationaboutproductioncosts.Startingfromtheassumption of a not‐completely‐selfishly motivated buyer who follows individualfairnessperceptionswhenaskedtopay foraproductwhichshehasconsumedorwillconsume,ourmodelshowsthatinformationasymmetriesinrelationtocostsprovideanexplanation for the results found in empirical studies. The theoretical model can beexpandedsuchastoembodyuncertaintywithrespecttothescaleofproduction. Keywords:PWYWpricing,informationasymmetry,fairness,buyerbehavior,willingnesstopay(WTP).Pleasecite thisarticleas following:Greiff,M.,Egbert,H.andXhangolli,K. (2014), “PayWhatYouWant–ButPayEnough!InformationAsymmetriesandPWYWPricing”,Management&Marketing.ChallengesfortheKnowledgeSociety,Vol.9,No.2,pp.191‐202.1.IntroductionPay What You Want (PWYW) pricing mechanisms have been grantedsubstantialattentionbothintheliteratureandinpracticerecently.PWYWisaformofparticipativepricing inwhichbuyers [1]aregiventheopportunity todetermineprices.Incontrasttootherparticipativepricingmechanisms,suchasreverseauctions,PWYWallowsbuyerstomaximizetheirownutilitybydoingmonetaryharm toaseller.Contrary to thepredictionof traditionaleconomictheory, but in line with the experimental results from dictator games, many

Vol.9No.2Summer,pp.191‐202,ISSN1842‐0206|Management&Marketing.ChallengesfortheKnowledgeSociety

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M&M buyersofproducts[2]soldviaPWYWpaypositiveprices.Sellers,ontheotherhand,donotseemtobeatriskoffallingvictimtoselfishbuyers.Theymayevenuse PWYWpricing in order to attractmore buyers and enhance revenues ascomparedtofixedpricesystems[3].

In recent empirical studies buyers’ behavior is interpretedbypreferencesfor fairness, inequity aversion, shame, reciprocal behavior, income level ofbuyers, or moods. Although there is a literature on PWYW pricing, showinghow reference prices, sellers’ reputation, and product quality affect buyers’behavior,theroleofinformationasymmetrieswithrespecttoproductioncostshas not been addressed from a theoretical perspective. This is surprisingbecausefromtheempiricalliterature(Isik,2006)itisknownthatuncertaintyis negatively related to willingness‐to‐pay (WTP), which is defined as themaximum amount of money, for which a buyer is indifferent between theproduct and the amount of money. Our goal is to show the importance ofinformationasymmetriesinthecontextofPWYW.

We outline a theoretical model, which we use to show how informationasymmetries with respect to fixed costs affect prices paid under a PWYWpricing mechanism. In particular, the model reveals that under certaincircumstances, PWYWpricing can be profitable in the long run. This impliesthat PWYW can be used not only as amarketing strategy that brings a newproductorcompanytotheattentionofpotentialcustomers,butalsoasaviablelong‐termpricingstrategy.

InthesecondsectionwebrieflysummarizetherecentliteratureonPWYWpricing. In section threeweoutline informationasymmetrieswhich influencethe effectiveness of PWYW pricing and provide a model. In section four wediscusssomeimplicationsofthemodelandconclude.2.PriorInvestigationsonPWYWKim et al. (2009) pioneered the empirical investigation onPWYWpricing. Inthree short‐term field experiments they test the applicability of a PWYWmechanism to different goods, a lunch buffet at a restaurant, a movie at acinema, and a hot beverage at a delicatessen (idem). They observe buyers’behavior in a time‐span between three days (cinema) and six weeks(delicatessen).PWYWpricingseems tohavepositiveeffects in therestaurantand at the delicatessen (idem). There, sellers’ advantage of implementing aPWYW pricing mechanism is an increase in revenues (see also Kim et al.,2010a). At the cinema, PWYW pricing may be rather problematic. Althoughbuyers paid positive prices, these prices were too low to cover the costs,resultinginalossinrevenue.

OtherrecentstudiessupportthefindingthatthePWYWpricingmechanismmaybebeneficialforsellers.RienerandTraxler(2012)arethefirstwhotestaPWYWpricingmechanisminthelongrun.Theyanalyzebuyers’paymentsinarestaurantfortheperiodoftwoyearsandfindthatdespiteanaveragedeclineofpayments, total revenues increased.Thus,PWYWpricingmayoffera long‐termbusinessstrategybyenhancingbuyers’loyalty(seealsoTrif,2013).


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Assumingrational,selfishandmaterialisticbuyers,thepredictivepaymentin PWYW pricing is zero because no minimum threshold price is employed.However, nearly no buyer pays zero [4]. Theoretical explanations for theobserved behavior can be found in behavioral economics, sociology, andpsychology.Mosttheoreticalexplanationsarebasedonsocialpreferences,suchasapreference for fairness, reciprocity, inequityaversion,or image concerns(Gneezy et al., 2012, see alsoLimet al., 2012). In addition, the quality of theproduct,buyers’incomelevels,andtheavailabilityofreferencepricesaffecttheprices paid (for a discussion on the relevant literature in experimentaleconomics andpsychology seeKimet al., 2009).Results of field experimentsindicate that buyers’ fairness perceptions and satisfaction with a productpositivelyinfluencepricespaid,i.e.pricesatwhichproductsaresoldarehigher.Particularly, at the cinema, buyers’ perceived fairness of the price seems tohaveanimportantinfluenceonpricespaid.Fairnesspreferencesandreferenceprices, however, are not sufficient for the success of PWYW pricing, as thePWYW study at the cinema reveals. The authors state that: “The level offairnesssignificantlyandpositivelyinfluencespricespaid.Althoughthebuyerspaidonly66%oftheirreferencepricetotheseller,theybelievedthattheyhadbehaved fairly; the survey data show that approximately 90% of the buyersconsidered a price ≤ € 6 fair.” (Kim et al., 2009, p. 52). This finding isremarkable for our aim because we show how asymmetric informationinfluencesthepricethatbuyersconsiderasfair.

Regner and Barria (2009) investigate the payment behavior of buyers inrespectofonlinemusic.Inthiscase,apositiveminimumpriceandareferencepricewereprovided.Theyfindthat,onaverage,buyerspaymorethanthepricerecommendedbytheseller.Theyexplaintheirfindingswithreciprocity,whichdrives buyers’ decisions (see additionally Regner 2010). Kim et al. (2010b)emphasizetheroleofbuyers’referenceprices[5]andfindthatreferencepricesaswellassatisfactionwiththeproductdohaveaninfluenceonthepricespaid.

Recently,buyerandsellerbehaviorunderaPWYWpricingmechanismhasalso been tackled in experimental studies. Schmidt et al. (2014) test in theirexperimentswhether it is outcome‐based social preferences, intention‐basedreciprocity or self‐interest strategic behavior that affect buyers’ paymentdecisions. In a monopoly treatment one seller interacts anonymously via acomputer with three buyers. The seller decides first whether to offer theproductunderPWYWand laterwhether to invest in theproduct.Thebuyersdecide if theywant topurchase theproductandwhatprice topayafter theyhavebeen informedabout theseller’smarginalcostsand theirown(buyers’)valuation of the product offered. These interactions are repeated for fiveperiods. Their results show that there is a high heterogeneity in buyers’behavior.Positivepricespaidareinlinewiththepredictionsofoutcome‐basedpro‐social theories such as altruism and inequity aversion. However,participants did not pay higher prices to reciprocate for investmentsundertakenbysellersas intention‐basedmodelsof reciprocitywouldpredict.Theseresultsareimportantforthepurposeofourmainargumentbecausethey


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M&M reveal that fair‐minded buyers condition their prices on sellers’ costs, i.e.buyerspaymorewhensellers’costsarehigh.However,sinceinalltreatmentsbuyers are informed about sellers’ costs, the experiment provides no insightintoPWYWpricingunderasymmetricinformation.

Chenetal.(2009)investigatetheprofitabilityofPWYWinanindustrywithlow marginal costs. They show that PWYW can be used as a pricediscriminationmechanismandtheirtheoreticalmodelrevealsthatzeroorlowmarginal costs is not a precondition for using PWYW. In fact, PWYW can bebeneficial to sellers as compared to fixed priceswhen there are enough fair‐mindedcustomerswillingtopurchasetheproduct,orwhenbuyers’willingnesstopayisratherlow.Also,inindustrieswherethereishighcompetition,mainlybecause of low product differentiation, PWYW can bring more revenues tosellersthanthetraditionalpricingmechanism.

JangandChu(2012)conductaseriesofexperimentstoinvestigatetheroleoffairnessinPWYWpricingandshowhowfairnessperceptionsareaffectedbysocial cues. To the best of our knowledge, they present the first experimentaimedatinvestigatingtheroleofinformationaboutproductioncostonPWYW,and their results can be explained by the theoretical framework which weprovideinthispaper.Intheirexperiment2atheyaskparticipantsabouttheirWTP and the prices they would be willing to pay under PWYW pricing fordifferentproducts(arecordingalbumandamobilephone).Participantsweredivided into control and experimental groups and only participants in theexperimental group received information about the cost of theproducts. Theresults show that the price/WTP‐ratio is significantly higher in theexperimentalgroup[6].

The effects of external reference prices ‐ such asminimum,maximum orrecommended prices ‐ were investigated by Johnson and Cui (2012). Theauthors asked undergraduate students about the price they would pay on ahypothetical purchasing scenario of concert tickets offered under PWYW.Participantsinexperimentalgroupsweregiveninformationaboutaminimumor maximum accepted price or a recommended price. Analyzing the resultsfrom four field experiments, Johnson and Cui found that providing externalreference prices in PWYW may shift buyers’ paying behavior toward theprovidedprices,i.e.theseexternalreferencepricesmayactasananchoronthepricespaid.Moreinterestingly,JohnsonandCuifindthatsellers’profitsarethehighest if no reference price is provided. A minimum recommended pricedecreases the prices paid. On the contrary, a maximum recommended pricemayworkasaprice‐ceilingwhichinfluencesnegativelytheaveragepricepaidofthosebuyerswhoarewillingtopayhighprices.

Takenforgrantedthattheavailabilityofreferencepricesaffectsthepricesbuyers are willing to pay under PWYW pricing, one way to reduce theinformationasymmetrywouldbetoprovideareferencepriceequaltoaveragecost.This,however,isproblematicifthereferencepriceisnotperceivedasfair.Experimentalevidence(Boltonetal.,2003)indicatesthatbuyersoverestimateprofitsandunderestimatecosts.Hence,areferencepricemightnotbeagood


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signal for costs. Although dual entitlement theory (Kahneman et al., 1986)suggeststhatasellerisentitledtoprofitsandbuyersareentitledtobuyagoodatacertainprice,buyersperceivethepriceasunfairiftheyperceiveprofitsasbeing too high. This perceived exploitation can be reduced by making costsmorenoticeable(Boltonetal.,2003).

SimilarfairnessconsiderationstopricechangesarestudiedbyKahnemanetal. (1986) who show that buyers perceive a price increase as fair if higherprices reflect higher costs but perceive higher prices as unfair if they reflectexcessdemand.Putbluntly,theperceptionofbuyersisthatsellersareentitledtoahigherprice,andthatbuyershaveamoralobligationtopayahigherpriceifcostsarehigh,butbuyersfrequentlyunderestimatecosts.

Incontrast to theabovecomputerand laboratoryexperiments,Leónetal.(2012)conductafieldexperimentwithPWYWpricingforholidaypackagesinSpain.Intheexperimentthebuyersexhibitamuchstrongerselfishbehaviorincomparison to previous studies. They pay only 5.1% of the value of theproducts(2012,p.395).Theyexplaintheresultsbybuyers’preferencesandbyframingeffects(2012,pp.401‐402).Framingeffectsoccurredasaconsequenceof the presentation of the campaign, e.g. by slogans such as “Go on holidaywithoutpaying”(2012,p.303).Inlinewiththeresultsofthisfieldexperimentwe offer a possible alternative explanation below. We consider informationasymmetries between buyers and sellers, an aspect which has not beenspecificallyaddressedintheabovementionedliterature.3.InformationAsymmetriesinPWYWPricingAsKimetal.(2009)show,PWYWpricingisapricingstrategywhichissuitablefor somegoodsbutnot forothers.Theyoutline that fairnessperceptions areimportant for prices paid by buyers. Here, we offer a more conventionaleconomicexplanationandamodelandwearguethatinformationasymmetriesinfluence prices paid under PWYW pricing [7]. We contend that the‘observability’ of fixed and marginal costs can influence buyers’ paymentdecisions.

Our argument is related to information asymmetries with respect toproduction costs. Let us assume a not‐completely‐selfishly motivated buyerwho follows individual fairness perceptionswhenasked to pay for a productwhich she has consumed or will consume. As a consequence, she may pay(withinaPWYWpricingmechanism)apricewhichsheconsidersfairaccordingtohersetofinformation[8].However,ifshehasincompleteinformationaboutthecostfunctionoftheseller,thepricewhichsheperceivesasfairmaybetoolowor toohigh (or,moreprecisely,higheror lower than theprice thebuyerwouldpayifshehadcompleteinformationaboutproductioncosts).Notethatinformationasymmetriescannotbesolvedbyreferencepricesbecausewithoutinformation about cost, buyers have no information in order to judge thefairnessofthereferenceprice.Andifbuyersassumethatthereferencepriceisthe fair price, the fair price will be distorted unless the reference priceaccuratelyreflectstheseller’scosts.


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M&M Letusprovideanexample:restaurantvisitorshave, inmostcases,a fairlygoodexperience inhowmuchthepriceof ingredientsare,howmuchlabor isrequired to prepare a meal and how much approximately the rent for arestaurantinagivenareacouldbe.Sotheymayhaveareasonableguessaboutthe overall costs of running a restaurant and preparing a meal. Restaurantvisitorsareabletocalculateapricewhichcancoverpartofthecostsandwhichtheyperceiveasfair.Quiteincontrasttothecaseofarestaurantvisit,abuyerwhogoestothecinemaisratherunabletocalculatethecostswhichtheownerof a cinema faces when showing a movie. Buyers are normally unable toprovide an educated guess about the fixed costs for running a cinema, e.g.monthlyrent,capitalcosts,costs forrentingmovies,etc.However,buyersareabletoobservethatthemarginalcostforavisitorinacinemaiszero–aslongascapacityutilizationisbelow100%.Thegeneral‘observability’ofproductioncostsinonecaseandthe‘unobservability’ofproductioncostsinthesecondcaselead to different results when buyers are asked to pay under a PWYWmechanism[9].Infact,aPWYWmechanismislikelytoimproverevenuesandprofitsifinformationasymmetriesarelowonthesideofbuyersandthesamemechanismmay lead tocontrary results if informationasymmetriesarehigh.Thelatterappliesonlyif thepriceregardedasfairbyabuyeristoolowwithrespecttocosts,whichismostlikelytohappenwhenfixedcostsofproductionare relatively high. If this is not the case and the price considered as fair ishigher than the costs, the seller should have an interest in preservinginformation asymmetries. The problematic case from the perspective of theseller is the firstone,wherebuyersconsiderapriceas fairthat is lowerthanproductioncosts.

Toillustratetheimportanceofinformationaboutproductioncosts,assumethat a riskneutral representativebuyerknows the seller’s cost structure, i.e.,she isawareof the fixedcosts,F,andmarginalcosts,MC,whichareconstant.The buyer’s willingness to pay (themaximum price she is willing to pay) isgiven byWTP. For simplicity we assume a buyer whose WTP exceeds theseller’s unit costs, UC, which are given byUC = F/N +MC (N is the scale ofproduction) [10]. The gains from trade are given by the difference betweenWTPandUC,WTP‐UC>0.Assumethatthebuyerwhoisnotcompletelyselfishiswillingtosplitthegainsfromtradesothatherownshareisq(with0<q<1)andtheseller’sshareis(1‐q).Then,thepriceperceivedasfairinthecompleteinformationcaseisgivenby

1

1 .

Now assume that the buyer has only incomplete information about fixedcosts,whicharelow(FL)withprobabilityr(with0<r<1)andhigh(FH)withprobability(1‐r).FisreplacedbytheexpectedvalueE(F)=rFL+(1‐r)FH,andthe price which the buyer considers a fair price is (in the incompleteinformationcase)givenby


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11

.

Assuming that fixed costs are high ( ), the difference between bothpricesis

≡

0,

and assuming that fixed costs are low ( ), the difference between bothpricesis

≡ 1

0.

If fixed costs are high (or low) but buyers have incomplete informationabout them, they underestimate (or overestimate) the costs. Hence, withasymmetric information about fixed costs and fixed costs being high, PWYWpricingresultsinlowerrevenueandprofits(comparedtothesituationinwhichbuyersandsellershavesymmetricinformation).

For given q and r, the difference in revenue will depend on the scale ofproduction,N,andthedifferenceFH‐FL.Thelattercanbeinterpretedasaproxyforuncertainty,whichmeansthatwithincreasinguncertainty,PWYWpricingislesslikelytoincreaserevenue.Regardingthescaleofproduction,itfollowsthatif production takes place on a larger scale (higher N), it is more likely toincreaserevenues,becausealargerscaleallowsforfixedcoststobecoveredbyalargernumberofunitssold.

Themodelcanbeextendedto incorporateuncertaintywithrespect to thescaleofproduction,N.AssumethatbuyershaveincompleteinformationaboutN,andletthebuyer’sestimatebegivenby .Ifbuyersunderestimatethescaleofproduction,Nwillbehigherand willbelower.Ifbuyersoverestimatethe

scaleofproduction, willbelowerbutwillremainpositiveand willbehigher but will remain negative. Hence, uncertainty regarding the scale ofproduction does not affect our main result: With fixed costs being high andbuyershaving incomplete informationabout thecoststructure, theprice thatbuyersconsiderasfairisbelowtheunitcost.

Note that the argument above relies solely on the amount of informationthat buyers have about the seller’s cost structure. This does not imply thatfairness considerations are unimportant, but it shows that in addition tofairness thedistributionof information isa crucialvariable forexplaining thesuccessorfailureofPWYWpricing.Indeed,inordertoallowbuyerstorealizetheirpreferenceforfairness,theyneedinformationaboutproductioncosts.4.ImplicationsandConclusionsInthispaper,wehaveshowntheimportanceofinformationasymmetrieswithrespect to production costs as an explanation forwhich products the PWYWpricing mechanism may be a viable alternative to traditional fixed pricing.

L

H L


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M&M This aspect has not beenmentioned in previous interpretations of empiricalfindingsonPWYWpricingandcancomplementexistingmodels.Inparticular,our twomain findings relate to buyers' expectations about costs and to thescaleofproduction.

First, we find that buyers’ expectations about fixed costs (i.e., theparameters FH, FL, and r, or more generally, the distribution of fixed costs)matter for what they perceive as a fair price. The larger the range of thedistributionoffixedcosts(FH‐FL)orthelargertheprobabilitythatfixedcostsare low (r), the lower the price which a buyer is willing to pay. It followsdirectly that if fixed costs are high, PWYW is more likely to be successful ifbuyers are informed about seller’s fixed costs because if they have suchinformation, thepricetheywillpayreflectscosts.Hence, forsellerswithhighfixedcostsPWYWcanonlybeasuccess if the informationasymmetry is low,i.e.,ifbuyershaveinformationaboutfixedcosts.

Second, information asymmetries are less important if the scale ofproductionislarge(e.g.,buyinghotbeveragesatadelicatessen)orifthereisnocapacity constraint at all (e.g., online music). The first finding concerns thedistributionof informationaboutproduction costs and reveals thatPWYW ismoresuitableforproductsforwhichbuyershaveinformationaboutcosts.ThesecondfindingconcernsthescaleofproductionandrevealsthatPWYWismoresuitableforproductsproducedonalargescale.

We theoretically demonstrated how the (un)observability of productioncostsandofqualitycaninfluencethepriceabuyeriswillingtopayforagood.Our theoreticalargumentprovidesanexplanation forbuyers'behavior in thefield experiment conducted by Léon et al. (2012). Since production costs ofholidaypackagesaredifficulttoobserve,theratherselfishlyorientedbehaviorof customers fits into our explanation. Also, our theoretical explanation iscompatiblewith the behavior observing in Jang and Chu’s (2012) laboratoryexperiments,especiallyexperiment2a,wheresubjectsindicateahigherWTPifinformationaboutproductioncostsareprovided.

ThemajorargumentoftheprecedinganalysisisthatthesuccessofPWYWpricing depends on buyers’ information about costs. A question thatimmediately comes to mind concerns the implications for sellers: How cansellerscrediblysignaltheircosttobuyers?Fromatheoreticalperspective,thisisasignalingproblemwheresellersareofdifferenttypesandsignaltheirtruetype.Onewaytosendacrediblesignalaboutcosts is to informbuyersaboutthequalityoftheproductbyusingproductcertification.Productcertificationisacrediblesignalofquality,andqualityisacrediblesignaloftheproduct’scosts.

The(un)observabilityofproductioncostsaswellasofqualityareproblemswhichmay causemarket failure ormoral hazard, both being suboptimal forsellers. Thus, they do deserve attention in the currently evolving debate onPWYWpricingmechanism.Theargumentpresented in thispapercontributesto gaining more insights into the important question about the types ofproducts,forwhichPWYWisasuitablepricingmechanism.


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AcknowledgementsPreliminary versions of this paper have circulated under the same title asMAGKSDiscussion PaperNo. 4‐2013 and asMPRAPaper 52766. For helpfulcomments on earlier versions of this paper we thank Max Albert, GeorgeMengov,NadeemNaqvi,ChristianScheiner,SimoneSchweizer,andparticipantsofworkshopsandlecturesinBernburgandSkopje.Allerrorsareours.Notes[1]Throughoutthetextweapplythetermsbuyeralsoasasynonymforcustomer.[2]Forsimplicitywespeakofgoodsorproducts.However,itwouldbemoreprecisetospeakofbundlessinceallgoodsdealtwithinthispaperareinfactofferedaspartofabundle(e.g., themealatarestaurantconsistsof,at least,thefood,theservice,andtheatmosphere).[3]Ourargumentsrefertopricesandrevenuesasmostoftheempiricalliteraturedoes.The literature provides only limited information about the profitability of differentpricingmechanisms for the seller. Our arguments refer to production costs only. Thecostofusingaspecificpricingmechanismdeterminestheprofitaswell.PWYWpricingandfixedpricinggeneratelowtransactioncostsincontrasttoindividualbargaining.[4] In the laboratory study by Schmidt et al. (2014) between 19.4 percent and aboutone‐third of all buyers choose a price of zero. In field experiments,where there is noanonymity,thenumbersaremuchlower.InRegnerandBarria(2009)14.5percentofallbuyerspaytheminimumpriceof$5,inRienerandTraxler(2012)only0.63percentofallbuyerspaidlessthan€1,andinKim,NatterandSpann(2009)nobuyerpaysapriceofzero.[5]Weusethedefinitionofreferencepriceasapricepreviouslypaidbybuyersforanidenticalgoodoraclosesubstitute.Wedonotdistinguishbetweeninternalandexternalreference price since for our purpose it is irrelevantwhether the reference price hasbeen formed by a buyer’s previous experience with the same good or with similarcompetinggoods.[6]Higherprice/WTP‐ratiosintheexperimentaltreatmentcouldalsobedrivenbythehypotheticalnatureof thedecisionsandanexperimenter‐demandeffect. It ispossiblethat participants think that the experimenter expects them to choose PWYW priceswhicharenot too farawayfromcosts.Assumingthattheexperimentwasnotdouble‐blind,itisalsopossiblethatparticipantsstatehigherpricesinordertobeperceivedasfairbytheexperimenter.[7]Our explanationdoesnotdependonbuyerheterogeneity in reservationprices. Inour model, we compare the price paid by a buyer with complete and incompleteinformation, and the price based on the seller’s cost. In other words, we look atindividual transactions, which give rise to profits or losses. Of course, there can bebuyerswhoareheterogeneouswithrespecttotheirwillingness‐to‐pay(WTP)ortheirfairnesspreferences.Inthiscase,theprofitabilityofeachindividualtransactiondependsonabuyer’sWTPand fairnesspreferences,and theseller’s totalprofit isgivenby thesum of profits over all transactions. Whether PWYW is profitable depends on thedistributionofWTPandfairnesspreferences.[8]Aseller’scostisonlyoneoutofseveraldeterminantsofpricefairness.Forareviewofpricefairnessperceptions,seeXiaetal.(2004).[9]Inthecaseoftherestaurant,thepricebuyersconsidertobefairmaycoincidewiththereferenceprice.Inthecaseofthecinema,thepriceconsideredasfairislowerthanthereferencepriceifbuyersunderestimatefixedcosts.[10]Inthetextwemodelthesimplestcase.Forfurthercases,inwhichtheWTPissmallerthantheseller’sunitcost,seetheAppendix.


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AppendixSection 3 shows the effect of buyers’ information asymmetries on prices,revenues and profits in a PWYW pricing mechanism. With asymmetricinformationandfixedcostsbeinghigh,thepriceregardedasfairbybuyersistoo lowwith respect to production costs. In this situation it is in the seller’sinteresttoinformbuyersaboutcosts.Intheoppositecase,inwhichfixedcostsare low and fair prices are too high compared to costs, preserving theinformation asymmetry is in the seller’s interest. In both situations it isassumed that buyers’WTP (maximumwillingness to pay) exceeds product’sunitcosts(UC)sotherecanbeapositivegainfromtrade(WTP‐UC>0),whichissplitbetweenthesellerandthenon‐selfishbuyer.

The assumption ofWTP exceeding unit costs restricts the analysis to twocases. In this section we relax this assumption and consider other possiblecases.Denotingtheseller’srealunitcostby andtheunitcostasperceived

bythebuyerby ,thesixcasesare:

1.UCp<UCr<WTP 4.UCp<WTP<UCr2.UCr<UCp<WTP 5.WTP<UCp<UCr3.UCr<WTP<UCp 6.WTP<UCr<UCpIn the above discussed cases 1 and 2 the buyer buys the good and pays

1 .In case 3, perceived unit costs by buyers are higher than average WTP,

which in turn ishigher than theproduct’s realunit costs. If buyersknowtherealunitcosts,theywillpayaperceivedfairpriceof(1‐q)WTP+qUCr,whichislower than theWTP but higher than real unit costs, thus increasing revenueandprofit.Withasymmetricinformation,however,theincreaseinrevenueandprofitwillbeevenlargersincebuyersoverestimateunitcostsandpayahigherprice. In this case, it is in the seller’s interest to preserve informationasymmetries.

Incase4,theproducts’realunitcostsarehigherthanWTP,despitethefactthat buyers regard that the costs as lower than themaximumprice they arewillingtopay.Inthiscase,withasymmetricinformation,thepricebuyerswillpayliesbetweentheWTPandtheperceivedunitcostbutbelowrealunitcostso that the seller will make a loss. And if sellers inform buyers about theproduct’s real unit costs, PWYW pricing makes no sense. Buyers who careaboutfairnesswillnotbewillingtopaythefairprice(1‐q)WTP+qUCrbecauseif theywould, the sellerwould suffer losses.Theywould refrain frombuyingsincethefairpriceexceedstheirWTP.Buyerswhodonotcareaboutfairnesswill pay a price lower or equal to theirWTP, i.e. a price that is below costs.Thus,withasymmetric informationandwithsymmetric informationthepricepaidbybuyers isbelow the seller’sunit cost, resulting in losses. In this case,PWYWpricingmechanism isnot advisable since generated revenueswill notexceedproductioncosts.


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M&M In cases 5 and 6 an average buyer’s WTP is lower than both real andperceivedunit costs. In these cases thepricebuyers consideras fair is lowerthanthecostofproduction, .Asincase4withsymmetricinformation,fairbuyerswillnotbuythegoodandselfishbuyerswillbuyatapricebelowcost.Thisholdsregardlessofbuyers’ informationabout fixedcosts.PWYWpricingmechanismshouldnotbeusedinthesecasessincerevenueswillbelowerthancosts,resultinginalossfortheseller.

Documents

Pay What You Want — But Pay Enough: Information Asymmetries and PWYW