Pay What You Want as a Marketing Strategy in Monopolistic and Competitive Markets *

Transcription

1 Pay What You Want as a Marketng Strategy n Monopolstc and Compettve Markets * Klaus M. Schmdt a), Martn Spann b), and Robert Zethammer c) Revsed, September 21, 2013 Abstract Pay What You Want (PWYW) can be an attractve marketng strategy to prce dscrmnate between farmnded and selfsh customers, to fully penetrate a market wthout gvng away the product for free, and to undercut compettors that use posted prces. We report on laboratory experments that dentfy causal factors determnng the wllngness of buyers to pay voluntarly under PWYW. Furthermore, to see how competton affects the vablty of PWYW, we mplement markets n whch a PWYW seller competes wth a tradtonal seller. Fnally, we endogenze the market structure and let sellers choose ther prcng strategy. The expermental results show that outcome-based socal preferences and strategc consderatons to keep the seller n the market can explan why and how much buyers pay voluntarly to a PWYW seller. We fnd that PWYW can be vable n solaton, but t s less successful as a compettve strategy because t does not drve tradtonal posted-prce sellers out of the market. Instead, the exstence of a posted-prce compettor reduces buyers payments and prevents the PWYW seller from fully penetratng the market. If gven the choce, the majorty of sellers opt for settng a posted prce rather than a PWYW prcng strategy. We dscuss the mplcatons of these results for the use of PWYW as a marketng strategy. Keywords: customer-drven prcng mechansms; pay what you want; prce dscrmnaton; revenue management; socal preferences. * ) Fnancal support from the Excellence Intatve of the German government through MELESSA s gratefully acknowledged. a) Klaus M. Schmdt, Department of Economcs, Unversty of Munch, D Munch, Germany, emal: klaus.schmdt@lmu.de b) Martn Spann, Munch School of Management, Unversty of Munch, D Munch, Germany, emal: spann@spann.de b) Robert Zethammer, The Anderson School of Management, UCLA, Los Angeles, USA, emal: robert.zethammer@anderson.ucla.edu

2 1 Introducton In several ndustres ncludng museums, software, and charty sales some sellers use a marketng strategy that lets buyers pay what they want for the goods or servces provded. The band Radohead used t to sell a new musc album onlne; restaurants n London, Berln, and the Panera Cares Communty Cafes n several ctes n the US let ther buyers pay what they lke for lunch; a theatre near Frankfurt tred t for generatng revenue from move screenngs (Km et al. 2009); and an amusement park n Calforna dd the same for souvenr photos (Gneezy et al. 2010). Other examples nclude churches, museums, software and charty sales. Proft results are mxed, rangng from a reported success for Radohead to a loss for the move theatre. But n all cases, many customers were wllng to pay postve prces voluntarly, and some sellers have been usng PWYW proftably for many years now. In ths paper, we report on several nduced-value laboratory experments on PWYW as a marketng strategy n monopolstc and compettve markets. The lab experments are desgned to dentfy the causal factors that determne the success and vablty of PWYW. Frst, we dentfy whch motvatons nduce buyers to pay postve (and often qute generous) prces voluntarly. We fnd that postve payments are manly drven by (outcome-based) socal preferences such as altrusm or nequty averson, and by the strategc motve to keep the seller n busness. We do not fnd evdence for ntenton-based recprocty. Second, we compare the behavor of buyers on a monopolstc market wth only one PWYW seller to ther behavor on a duopolstc market n whch a PWYW seller and a tradtonal seller offerng posted prces compete. We fnd that a sgnfcant mnorty of buyers prefer to buy the product from the tradtonal seller. Furthermore, the posted prce of the tradtonal seller acts as a reference pont that reduces the prces buyers are wllng to pay voluntarly to the PWYW seller. Thus, PWYW s less proftable on a compettve market but stll vable under our expermental condtons. Fnally, we let sellers choose whether to use PWYW or a posted prce. Choosng PWYW f the other seller charges a posted prce s a very aggressve strategy that takes away most of the market share of the compettor and reduces hs proft sgnfcantly, but the PWYW seller makes an even lower proft. However, f the other seller uses PWYW, then choosng PWYW as well relaxes competton and ncreases profts of both sellers. The lterature proposes three man reasons for why PWYW can be an attractve prcng strategy. Frst, PWYW s a means of endogenous prce dscrmnaton because dfferent consumers pay dfferent prces for the same product even though no exogenous constrants are mposed on them. Customers who are farmnded pay more than customers who are selfsh, and a far-mnded customer may pay a hgher prce the hgher hs valuaton for the product or the hgher the seller s producton costs. Furthermore, n contrast to tradtonal prce dscrmnaton methods, PWYW does not set a reference prce. A buyer may not be wllng to pay a hgh prce for a product f he sees that the same product s sold at a much lower prce to other customers or at another tme or place. Ths problem s avoded by PWYW. However, to effectvely use 1

3 PWYW as a prce dscrmnaton mechansm one has to better understand why buyers pay at all and what affects how much they pay voluntarly. Our experments allow us to dentfy whch factors have a causal effect on the prces pad voluntarly by consumers n anonymous PWYW markets. Second, PWYW can be attractve for frms that want to maxmze unt sales (Gneezy et al. 2010). Maxmum market penetraton s a natural objectve for many non-proft organzatons (such as museums or churches), but t s also the objectve of some commercal frms that want to make profts from sellng a complementary product, enter a new market, realze experence curve gans, or acheve network effects. PWYW supposedly domnates gvng away the product for free because t generates postve revenues that cover at least some of the producton cost. However, there s some feld evdence (Gneezy et al. 2012) showng that many people prefer buyng at a posted prce to buyng from a PWYW seller, so PWYW need not maxmze market penetraton after all. We can show expermentally under what condtons PWYW s an effectve strategy for maxmum market penetraton. Thrd, PWYW can be used as a compettve strategy. PWYW effectvely undercuts all competng sellers usng posted prces and thus threatens to drve them out of the market. Furthermore, f only PWYW sellers reman n the market, PWYW softens competton because sellers no longer compete on prce. On the other hand, competng sellers usng posted prces could negatvely affect the proftablty of PWYW. These posted prces could form an upper bound on the prces that buyers are wllng to pay voluntarly (Gneezy et al. 2012). Furthermore, a buyer may prefer to buy from a seller offerng posted prces rather than enter moral delberatons about how much he ought to pay voluntarly. Our experments show the condtons under whch PWYW s vable as a compettve strategy. Before dscussng our man results n more detal we brefly outlne the expermental desgn. We nduce dfferent valuatons for the buyers and dfferent producton costs for the sellers. A group of buyers and one seller or two sellers form a market and nteract repeatedly for fve perods n a row. Sellers can decde whether to make a costly nvestment n the qualty of ther product, whch doubles buyers valuatons for t. In the Base (monopoly) Treatment, one seller has to use PWYW whle nteractng wth three buyers for fve perods. In each perod, the seller decdes whether to enter the market and whether to nvest n the qualty of hs product. In the competton treatments, we have two sellers nteractng wth sx buyers. In the Competton Treatment wth Fxed Roles, one seller has to offer a posted prce whle the other seller has to use PWYW. In the Competton Treatment wth Flexble Roles, sellers can choose ther prcng method and the market structure s determned endogenously. Our subjects nteract anonymously va a computer network wth no scope for personal nteractons. No complementary products exst for whch PWYW can act as a loss-leader promoton tool, nor are network effects or learnng-by-dong effects present that would make the seller nterested n maxmzng sales early n the product lfecycle. Therefore, our desgn s conservatve n that t delberately makes the proftablty of 2

4 PWYW dffcult. Thus, f certan factors sustan the vablty of PWYW and nduce buyers to pay postve prces under the anonymous condtons of the lab, then they are lkely to have an even stronger effect on real markets n whch there s personal nteracton and sellers have addtonal motves for maxmal market penetraton. Our man results are as follows: Despte the conservatve desgn, we fnd that almost all potental sellers who can choose between enterng the market wth PWYW prcng or stayng out actually enter, nvest n the qualty of ther products, and make postve profts. Almost full market penetraton occurs under monopolstc condtons. Some buyers take the product and pay nothng, but most buyers are wllng to pay postve prces. By comparng the Base Treatment to a control treatment n whch entry and nvestments are mposed exogenously, we can dentfy two reasons for why postve payments are made: Frst, buyers pay more the hgher ther own valuaton for the product and the hgher the seller s cost, but they do not react to the nvestment of the seller per se. Ths fndng s consstent wth theores of outcome-based socal preferences such as altrusm (Andreon and Mller 2002) and nequty averson (Fehr and Schmdt 1999) but not wth theores of ntenton-based recprocty (Rabn 1993). Second, some buyers pay postve prces n the early perods of the game to keep the seller n busness, but they do not pay n the last perod. Ths fndng s consstent wth reputaton models (Kreps et al. 1982) n fntely repeated games wth ncomplete nformaton, whereby self-nterested buyers mmc the behavor of altrustc or far-mnded buyers n the early perod of the game. Competton sgnfcantly alters the pcture. If a competng seller s offerng the product at a posted prce, market penetraton of a PWYW entrant s no longer perfect. A sgnfcant fracton of buyers turns to the seller offerng posted prces. Ths fndng s consstent wth the hypothess that some people dslke decdng on voluntary contrbutons but also wth some models of outcome-based socal preferences. Furthermore, wth competton, the prces that buyers pay voluntarly are sgnfcantly lower than under monopolstc condtons. In fact, the posted prce of the competng seller lmts the amount that buyers are wllng to pay voluntarly. Even though PWYW attracts a larger market share, posted-prce sellng turns out to be sgnfcantly more proftable. PWYW does better only f t s used by both sellers. However, when sellers can decde whch prcng method to employ, the large majorty opts for posted prces. Thus PWYW s not successful as a compettve strategy. Nevertheless, f the seller s nterested n maxmzng market penetraton at the expense of proftablty, then PWYW can be attractve even under compettve condtons. Our paper s related to three strands of the lterature. Frst, t s related to a small emprcal lterature on PWYW prcng. Several feld studes descrbe and analyze cases n whch PWYW has been mplemented n practce, ncludng the rock band Radohead and the Magnatune record label (Regner and Barría 2009), the Google answer servce (Regner 2009), restaurants, snack bars, and cnemas (Km, Natter and Spann 2009, 2010; Rener and Traxler 2012), and sales campagns of hotels and travel agences (Gauter and van der 3

5 Klaauw 2012; León, Noguera, and Tena-Sánchez 2012). Gneezy, Gneezy, Nelson, and Brown (2010) conducted a feld experment on the sale of photos n an amusement park, showng that people pay much more f the PWYW seller announces that half of the revenues wll be donated to charty. Our paper s the frst to use a laboratory experment to dentfy the causal effects that determne voluntary payments under PWYW, and to study the potental of PWYW as a compettve strategy. The only other laboratory experment on PWYW prcng that we are aware of s Mak et al. (2010), who focus on how communcaton among partcpants affects payments. Second, our paper s related to the expermental lterature on trust games (Berg, Dckhaut, and McCabe 1995). In a trust game, the frst mover has to decde whether to make an nvestment that benefts the second mover. Then the second mover has to decde whether to voluntarly return some of ths beneft to the nvestor. For example, Fehr et al. (2007) consder the use of voluntary bonus payments n an expermental labor market. A worker decdes how much effort to nvest, whch ncreases the gross proft of hs employer. The employer observes the worker s effort and decdes on a voluntary bonus payment for the worker. Even though the nteracton s one-shot, many employers recprocate to hgh effort wth hgh bonus payments. Ths response n turn nduces many workers to spend hgh effort. Our experment has a smlar but rcher structure and s adapted to the PWYW context. In partcular, one seller deals wth several buyers, rasng the possblty of free-rdng. In addton, we vary costs and benefts of the partes, and the nteracton s fntely repeated. 1 Fnally, our paper s related to the theoretcal lterature on socal preferences that tres to explan prosocal behavor (see Fehr and Schmdt 2006, for a survey). If all people were only concerned about ther own materal payoffs, nobody would ever pay a postve prce f the PWYW prcng mechansm were used (ths predcton also holds n all of our expermental treatments because of the fnte number of repeated nteractons). However, there s substantal expermental and feld evdence showng that many people are also concerned about farness and recprocty and are wllng to sacrfce own resources to acheve a more equtable allocaton. Several theores try to explan the observed behavor, ncludng altrusm (Andreon and Mller 2002), nequty averson (Fehr and Schmdt 1999; Bolton and Ockenfels 2000), and ntenton-based recprocty (Rabn 1993; Dufwenberg and Krchsteger 2004). Moreover, pror work fnds substantal populaton heterogenety n ndvdual socal preferences (Andreon and Mller 2002), gvng rse to ncomplete nformaton each seller possesses about the preference types of the partcular buyers he faces. We 1 An expermental lterature also exsts on reputaton mechansms based on repeated nteracton (e.g., Brown et al. 2004) and on customer ratngs as provded by ebay or Amazon (e.g., Bolton et al. 2004). Here a seller has an ncentve to delver hgh qualty n order to keep a good reputaton. A seller who succumbs to the temptaton to delver low qualty loses hs reputaton and s out of busness n future perods. In PWYW markets, customers not only decde whether to buy or not, they also decde the prce. Thus they can punsh the seller for delverng low qualty by takng hs product and payng zero, whch s even more costly to the seller than losng a customer. On the other hand, customers have to actvely support the seller by payng postve prces voluntarly f they want to keep hm n busness. 4

6 dscuss the specfc mplcatons of the dfferent theores for PWYW behavor wthn our experments n more detal n secton 2. The remander of ths artcle s organzed as follows. In the next secton, we dscuss n more detal the three man reasons for usng PWYW, relate them to the theoretcal lterature on socal preferences, and derve predctons that we test n the experments. Secton 3 outlnes our expermental desgn and descrbes the expermental procedures. The results of the experments and the tests of our predctons are dscussed n secton 4. Secton 5 concludes. 2 Theory and Predctons Ths secton dscusses the three man advantages of PWYW over tradtonal prcng methods. We relate these arguments to the theoretcal lterature on socal preferences and recprocty, and derve several general behavoral predctons that can be tested by our experments. In Appendx 1 most of these predctons are derved formally for the setup and the parameters of our experment n a model of outcome based socal preferences. 2.1 Prce Dscrmnaton PWYW s a prce-dscrmnaton mechansm whereby dfferent consumers pay dfferent prces for the same product. Customers who are far-mnded pay more than customers who are selfsh, and far-mnded customers pay more the hgher ther valuaton for the product and the hgher the seller s producton costs. Wth PWYW, prce dscrmnaton s endogenous n the sense that the seller does not exogenously mpose dfferent prces on dfferent types of buyers or on dfferent choces of buyers. It arses endogenously from the buyers unconstraned behavor. Furthermore, PWYW has a potental advantage over other prce-dscrmnaton methods. A buyer may not be wllng to pay a hgh prce for a product f he sees that the same product s sold at a much lower prce to other customers or at another tme or place. PWYW avods ths problem because t does not set a reference pont. 2 Thus t prce dscrmnates wthout nfluencng consumers reference prces. But why would a buyer pay any postve amount f he s not requred to do so? The tradtonal selfnterest model predcts that all buyers wll take the product and pay a prce of zero. Even f there s a (fntely) repeated relatonshp and buyers are nterested n purchasng the product n several perods, a standard backward-nducton argument mples that the market unravels, that buyers never pay and that a PWYW seller wll never enter the market. 2 However, there may stll be other reference ponts shapng the expectatons of customers, for example the prces posted by competng sellers or posted prces used by the PWYW seller before he turned to PWYW. 5

7 Theores of prosocal behavor predct that postve prces are pad voluntarly but they dffer n ther explanatons for why buyers do so, and they come up wth dfferent predctons under what condtons people are wllng to pay more. Understandng whch theory drves behavor has mportant mplcatons for the use of PWYW as a prce-dscrmnaton mechansm and for ts overall vablty. Theores of prosocal behavor can be grouped nto three broad classes, as follows: a) Outcome-based theores of socal preferences such as altrusm (Andreon and Mller 2002) or nequty averson (Fehr and Schmdt 1999) argue that many people are not purely self-nterested but also care about the well-beng of others. They are wllng to gve up own resources to help another person, especally f the other person s worse off than they are. These models predct that the larger the buyer s beneft from consumng the product and the hgher the seller s cost of producton, the hgher the payments wll be. 3 In other words, PWYW prcng nvolves prce dscrmnaton and at least partal compensaton of the seller. If other-regardng preferences are strong enough, buyers pay strctly more than the seller s margnal cost whenever ther valuaton s hgher than the seller s cost, and forego a purchase otherwse. Beyond the scope of our expermental varaton, outcome-based models of socal preferences also predct that people are wllng to pay more to a non-proft organzaton or to a frm that s small and poor than to a large and rch corporaton. b) Intenton-based models of recprocty (e.g., Rabn 1993; Dufwenberg and Krchsteger 2004) are based on the hypothess that some people recprocate to knd ntentons that are expressed by knd actons. For example, f the seller chooses to offer hs product usng PWYW or f he makes a specal nvestment that ncreases the value of the product to the buyer, then such an acton s nterpreted as an act of kndness that the buyer s wllng to recprocate by payng a hgher prce. Accordng to these theores, the buyer s payment does not depend on the wealth of the seller or on exogenous varatons of costs and benefts, but rather on the actons taken by the seller. Thus these models predct that f the seller takes an acton that s benefcal to the buyer, for example, by offerng the product usng PWYW or by makng a specal effort to ncrease ts qualty, then a buyer who s motvated by ntenton-based recprocty wll react by payng a hgher prce, but he wll not pay more f hs valuaton ncreases for reasons that are unrelated to the seller s actons. 4 3 Ths s shown formally n Proposton 2 of Appendx 1. It s nterestng to relate the predcton that the buyer s prce ncreases wth the seller s cost to the Dual Enttlement Prncple by Kahnemann, Knetsch and Thaler (1986). They dscuss under what condtons buyers consder a prce ncrease proposed by the seller to be far. The Dual Enttlement prncple mples that t s not far for sellers to ncrease the prce n order to explot ncreased market power, but t s far to ncrease the prce f costs ncrease. Appled to our PWYW market, the DE prncple mples that a far buyer should pay a hgher prce f the cost ncreases. 4 Models of ntenton-based recprocty are based on psychologcal game theory that assumes that the utlty of a player depends not only on hs materal payoff (and the materal payoff of hs opponent) but also on hs belefs about why hs opponent has taken a certan acton. See Fehr and Schmdt (2006) for a survey and dscusson of these models. 6

8 c) Reputatonal models (e.g., Kreps et al. 1982) of fntely repeated games wth ncomplete nformaton can explan why even purely self-nterested buyers have an ncentve to pay postve prces n early perods, as long as there are some far-mnded or recprocal buyers who pay postve prces n all perods (ncludng the last perod). If the seller has ncomplete nformaton about the type of the buyer, self-nterested buyers want to buld up a reputaton for payng postve prces that cover the seller s cost n order to keep the seller n busness. The seller antcpates ths behavor and s wllng to enter and stay n the market. In the last few perods, a self-nterested buyer randomzes whether to pay or pay not, whereas a far-mnded and recprocal buyer contnues to pay a postve prce wth probablty one. The reputatonal model predcts that average prces declne when the market comes to an end. 5 Furthermore, they predct that f a competng tradtonal seller s present (offerng the product by postng a prce), then selfsh buyers have a much smaller ncentve to keep the PWYW seller n busness, so the prce they pay n early rounds wll be lower. The reduced ncentve suggests that PWYW s more lkely to be vable under monopolstc than under compettve condtons. Note that models of outcome-based socal preferences as well as models of ntenton-based recprocty and reputatonal models all assume heterogenety n socal preferences, so the three classes of models dscussed above are not mutually exclusve. They gve rse to the followng three predctons. Predcton P1: PWYW acheves prce dscrmnaton f at least one of the followng mechansms apples: (P1a) If some buyers have outcome-based socal preferences such as altrusm or nequty averson average PWYW prces are hgher the hgher the buyers valuatons and the hgher the sellers costs. (P1b) If some buyers are motvated by ntenton-based recprocty average PWYW prces are hgher f the seller chooses PWYW voluntarly and f he nvests n the qualty of hs product. (P1c) If there s some postve probablty that some buyers pay voluntarly n all rounds then self-nterested buyers pay postve prces n early rounds n order to nduce the seller to stay n the market. However, ths ncentve vanshes n the last perod of each block or f a competng seller s offerng the same product. Thus, average PWYW prces wll declne over tme and be lower wth competton than on a monopolstc market. 5 These results follow mmedately from textbook models of reputaton buldng and the Folk Theorem for repeated games wth ncomplete nformaton. See, e.g., Fudenberg and Trole (1995), p

9 We know from the emprcal lterature and from several case studes that PWYW does acheve some prce dscrmnaton (e.g., Km et al. 2009), but ths lterature cannot dstngush the reasons why prce dscrmnaton works. In an expermental study, we can change the parameters of the market exogenously and thereby dentfy causal effects for the behavor of buyers. Thus we can test whch of these three forces drves buyers behavor and what ther relatve mportance s. Our fndngs provde mportant nsghts regardng the condtons under whch PWYW s most lkely to be a successful prce-dscrmnaton strategy. 2.2 Market Penetraton In some stuatons, frms are more nterested n maxmzng the number of unts sold rather than profts. For example, non-proft organzatons such as museums or churches typcally want to attract as many customers as possble. Maxmal market penetraton also appeals to sellers who want to promote a complementary product, partcularly f the (tradtonal) sale of the complementary product s hghly proftable. For example, for the Brtsh rock band Radohead, some argue that offerng ts album Ranbows on the nternet by usng the PWYW mechansm dramatcally ncreased the popularty of the album and thereby ncreased the profts from the (tradtonal) sale of the CD and the concert tour. 6 Furthermore, maxmzng sales may appeal to a seller who wants to enter a new market, test a new product, generate network effects, or realze learnng-by-dong effects. PWYW seems to be an deal strategy for maxmzng market penetraton. Of course, one can also acheve maxmal market penetraton by smply gvng away the product for free. In fact, ths s what many companes do. 7 The advantage of PWYW s that t makes the product avalable to everybody free of charge, but t also generates postve revenues f some buyers pay postve prces voluntarly. As long as the potental transacton s effcent (as wll be the case n our expermental desgn), the self-nterest model as well as models of ntenton-based recprocty and reputatonal models make the followng predcton: Predcton P2: When the potental trade between the seller and the buyers s effcent, PWYW s a strategy that acheves maxmal market penetraton. Models of outcome-based socal preference make the same predcton for a monopolstc market. 8 However, f there s competton between a PWYW seller and a PP seller a buyer motvated by altrusm or nequty Examples nclude nternet servce provders (such as Google) or meda (such as rado and TV statons) that offer ther servces for free to one sde of the market and sell complementary products (such as advertsng) to the other sde, or the government that offers publc servces (such as schools, roads, law enforcement, etc.) free of charge to users. 8 See Proposton 1 n Appendx 1. 8

10 averson may also buy from the PP seller f ths seller s worse off, so maxmal market penetraton need not be acheved. 9 We also note that when the potental transacton s not effcent (.e., the seller s margnal cost s strctly hgher than the buyer s valuaton), the three classes of models do not come up wth a clear-cut predcton about market penetraton. 10 However, n only 22 out of 2636 cases n all treatments of our experment does the seller enter and offer PWYW, and a buyer s valuaton s smaller than the seller s cost. Even n markets wth effcent potental trades, PWYW may not acheve maxmal market penetraton f some buyers experence addtonal psychologcal costs that our theoretcal development does not consder. For example, a customer may feel uneasy about takng a product wthout knowng what he ought to pay. In fact, Gneezy et al. (2012) report on three feld experments showng that more people buy the product f t s offered at a fxed prce than f the PWYW mechansm s used. They argue that concerns for self-mage and dentty drve ths behavor. People feel bad f they pay less than the approprate prce, whch causes them not to buy the product at all. The exstence of such concerns suggests that the lower a customer s valuaton, the less lkely he s to accept the product under PWYW. Furthermore, f the product s offered both at a posted prce and usng the PWYW mechansm, a customer may prefer buyng the product at the posted prce rather than enterng moral delberatons about what prce he ought to pay a PWYW seller. In our lab experment, we can control the wllngness to pay for the product of each customer and we observe whether he buys the product and how much he pays voluntarly. Furthermore, we can compare behavor under monopolstc and under compettve condtons. Thus we can test how the reacton to PWYW s affected by these factors and whether and under what condtons PWYW s an effectve market-penetraton strategy. 2.3 Competton PWYW can also be used as a compettve strategy. It can be ether an aggressve or a conclatory strategy dependng on the prcng format used by the compettor. PWYW s an aggressve strategy f the compettor charges a posted prce because the PWYW seller offers to gve away hs products for free (.e., below cost), whch threatens to drve out tradtonal sellers from the market. If the posted-prce seller does not get any customers, he has to ether leave the market or adopt PWYW as well. Ths ncentve to respond n knd leads to the possblty of both sellers choosng PWYW n equlbrum. When all sellers decde to use PWYW, then PWYW softens competton by elmnatng prce competton. Thus, f enough far-mnded or recprocal buyers are wllng to pay postve prces voluntarly 9 Ths s shown by Proposton 3 n Appendx In ths case, parameters of the buyer s utlty functon exst such that the buyer refuses to trade f the transacton s neffcent. He does so to beneft the seller ether because he s concerned about the seller s welfare, or because he wants to recprocate the kndness of the seller by beng so knd not to buy, or because he wants to keep the seller n the market. 9

11 and f producton costs are low, then PWYW duopolsts mght acheve hgher profts than posted-prce duopolsts engaged n ferce prce competton. 11 These two consderatons gve rse to our thrd predcton: Predcton P3: (P3a) PWYW s a compettve strategy that drves tradtonal posted-prce (PP) sellers out of the market. (P3b) If buyers are suffcently altrustc/recprocal and pay (on average) prces that are suffcently hgh, then there s an equlbrum n whch both sellers use PWYW. However, f buyers are less far-mnded there s also an equlbrum n whch both sellers offer posted prces. Predcton P3a s an mmedate mplcaton of P2. However, n the dscusson of predcton P2, we argued that P2 need not hold f buyers are motvated by outcome-based socal preferences or f concerns for selfmage and dentty affect behavor. In ths case, some customers may opt for a PP seller because they are happy to buy the product for a low posted prce, but they would feel cheap f they pad ths low prce voluntarly. Thus, t s an open queston whether tradtonal sellers wll be drven out of the market. The second part of P3 requres that there are enough buyers who are altrustc or recprocal. These buyers pay postve prces no matter how many PWYW sellers there are. In contrast, a selfsh buyer pays a postve prce only because he wants to keep at least one seller n busness. If there are several PWYW sellers t s less lkely that all of them wll leave the market. Thus, a selfsh buyer has a lower ncentve to pay a postve prce f there are several PWYW sellers than n the case of a monopolstc PWYW seller. Ths argument suggests that PWYW s less vable n a compettve market than n a monopolstc stuaton. Our last predcton concerns the nature of prce competton between a PWYW seller and a PP seller. We propose that the posted prce may act as a reference pont for prces that customers pay the PWYW seller: Buyers are unlkely to pay a hgher prce voluntarly to a PWYW seller than the posted prce at whch they can buy the same product from a PP seller. Furthermore, as long as two sellers are present, buyers have less of an ncentve to pay hgh prces voluntarly to keep the PWYW seller n the market. Therefore, we predct the followng: 11 Ths result s also predcted n a theoretcal paper by Chen, Koengsberg, and Zhang (2010), who consder the compettve mplcatons of PWYW prcng n a horzontally dfferentated duopoly. They confrm the above ntuton by provng that when enough consumers care about dstrbutve farness, weaker horzontal dfferentaton results n more frms usng PWYW to soften prce competton. 10

12 Predcton P4: If a PWYW seller competes wth a posted-prce seller and both types of sellers stay n the market, then the PWYW seller wll get lower prces on average than f he s a monopolst. 12 In the experment, we can test predctons P3 and P4 rgorously. In a frst step, we mpose the market structure exogenously to test whether and under what condtons PWYW acheves full market penetraton and a PWYW seller drves a tradtonal seller out of the market. Then we endogenze the market structure to see whether sellers choose PWYW as a compettve strategy. In both treatments, we can compare the prces pad voluntarly to PWYW sellers to the prces pad n the treatment wth a monopolstc PWYW seller. A nce feature of the experments s that the unt of observaton s the entre market; that s, we not only observe the reacton of buyers to PWYW, but we also observe the nteracton of buyers and sellers and whether and under what condtons sellers choose to employ PWYW to market ther products. 3 Expermental Desgn 3.1 Base Treatment The Base Treatment of the experment consders one seller who faces three potental buyers, each of whom wants to buy one unt of the product to be produced by the seller. The seller s restrcted to sellng hs product by usng the PWYW mechansm; that s, each buyer can decde for hmself what prce to pay, ncludng a prce of zero. At the begnnng of each perod (stage 1), the seller has to decde whether to enter the market. If he stays out, the perod ends and the seller and the three buyers get a payoff of zero. If the seller enters he decdes on an nvestment I { 0,1} n the qualty of hs product at stage 2. The nvestment costs the seller two ponts and doubles the valuaton of the product for all buyers. At stage 3, all players learn the seller s margnal cost of producton and the buyers valuatons. The producton cost c { 0,1,2,3,4} s drawn randomly. Each buyer { 1, 2,3} b v { 2, 6,10} b s assgned a base valuaton that s also drawn randomly and ndependently for each buyer. If the seller nvested n a qualty mprovement at stage 2, the valuatons of all buyers are doubled. Thus the actual valuaton of each buyer b s { 2, 4,6,10,12, 20} p to b b v. At stage 4, each buyer decdes whether to buy the product and what prce 0 12 Ths predcton also follows from a model of outcome-based socal preferences (see Proposton 4 of Appendx 1). 11

13 pay. The seller s oblged to supply the product to every buyer who wants to buy t at the prce b p that buyer b pays voluntary. t = 1 t = 2 t = 3 t = 4 Seller decdes whether to enter the market Seller decdes whether to nvest nto the qualty of hs good Seller and buyers learn the seller s margnal cost and each buyer learns hs actual valuaton Buyers decde whether to buy and whch prce to pay. Payoffs are made. FIGURE 1. Sequence of Events n Each Perod: Base Treatment Fnally, payoffs are realzed. The seller s monetary payoff s M s = b s where B { 0,1} and { 0,1} 0 f he dd not enter the market 3 b b s, B ( p c) 2I f he dd enter the market b= 1 b s I are ndcator varables wth B = 1 f buyer b decded to buy and I = 1 f the seller decded to nvest. Note that the buyer ncurs the margnal cost c only f a buyer buys hs product, whereas the nvestment cost of 2 s sunk and ndependent of the number of buyers. The monetary payoff of buyer b s gven by M b 0 f the seller dd not enter or buyer b dd not buy = b. s b (1 + I ) v p f the seller entered and buyer b dd buy Ths game s repeated n a block of fve perods wth the same group of one seller and three buyers. Then sellers and buyers are randomly rematched and a new block of fve perods starts. Each sesson has 20 perods dvded nto four blocks. Each subject keeps hs role as a buyer or seller throughout the entre sesson, but valuatons and costs are randomly reassgned n each perod. Before the experment starts, the nstructons (see Appendx 2) are read aloud to all subjects. Note that the expermental desgn bases the results strongly aganst the PWYW mechansm. The nteracton s computerzed and completely anonymous. No scope exsts for communcaton or personal nteracton between the subjects. The product s fcttous and reduced to ts monetary value for the buyer. All of these factors make t easy for a buyer to take the product and pay nothng. The Base Treatment can tell us whether PWYW on a monopolstc market acheves full market penetraton and whether and how much buyers are payng voluntarly. However, on ts own the Base 12

14 Treatment cannot tell us the causal factors that drve the observed behavor. In order to dentfy these factors we conducted the followng control treatment. 3.2 Exogenous Entry and Investment Treatment (EX E&I) In the Base Treatment the PWYW seller decdes n every perod whether to enter the market and whether to nvest. We compare the Base Treatment to a control treatment n whch entry and nvestment s mposed exogenously as follows: For two sessons of the Base Treatment, we conducted two new sessons wth exogenous entry and nvestment that exactly matched the seller s entry and nvestment decsons n the Base Treatment. Thus, for each perod and each group of one seller and three buyers, we exogenously mposed the entry decson and the nvestment level that was chosen endogenously n the Base Treatment. Therefore, the valuatons of the buyers are exactly the same n the two treatments. However, n the Base Treatment they have been determned by the voluntary entry and nvestment decsons of the sellers whle they have been assgned by the expermenter n the Exogenous Entry and Investment Treatment (EX E&I). Furthermore, f a seller ncurred the nvestment cost voluntarly n the Base Treatment, then the correspondng seller n the Exogenous Entry and Investment Treatment was forced to ncur the same nvestment cost. Thus the two treatments are dentcal except for whether the entry and nvestment decsons were taken voluntarly or mposed exogenously. The Exogenous Entry and Investment Treatment turns off two of the three motvatons for voluntary payments summarzed n Predcton 1. If entry and nvestment are mposed exogenously, then buyers do not have to pay postve prces n order to nduce the seller to stay n the market and to nvest. Furthermore, because sellers don t take any decsons n ths treatment, buyers cannot be motvated by ntenton-based recprocty. If there are no decsons, then there are no ntentons to be nferred. Thus, f buyers pay postve prces n the Exogenous Entry and Investment Treatment, and f prces are ncreasng n the buyer s valuaton and the seller s costs then ths s strong evdence for outcome-based socal preferences. By comparng the Exogenous Entry and Investment Treatment to the Base Treatment we can also fnd causal evdence for the exstence of the other two motvatons for payng postve prces. If we observe that buyers pay hgher prces n the Base Treatment than n the Exogenous Entry and Investment Treatment, then ths cannot be due to outcome-based socal preferences. The hgher prces could be due ether to ntenton-based recprocty or to the strategc concern to nduce the seller to stay n the market and to nvest n future perods. Note that n the last perod of each block there s no future. Thus, strategc concerns are swtched off both n the Base Treatment and n the Exogenous Entry and Investment Treatment, whle ntenton-based recprocty can stll be a motvatonal force n the last perod of the Base Treatment (where the seller decded to enter and to nvest), but not n the Exogenous Entry and Investment Treatment. Hence, f 13

15 we observe hgher prces n the last perod of the Base Treatment than n the last perod of the Exogenous Entry and Investment Treatment, then ths s causal evdence for ntenton-based recprocty. Furthermore, f buyers are payng lower prces n the last perod of the Base Treatment than n the other perods of the Base Treatment, ths last perod effect s causal evdence that some buyers pay postve prces for strategc reasons. 3.3 Competton: Fxed and Flexble Roles The treatments descrbed so far consder a monopolstc seller. We also conducted two competton treatments. In these treatments, we had two sellers and sx buyers n one group. At the begnnng of each perod, each of the sellers decdes whether to enter the market. In the Competton Treatment wth Fxed Roles (COMP_FIX), one of the two sellers had to use PWYW and the other seller had to post a prce. In the Competton Treatment wth Flexble Roles (COMP_FLEX), each seller chooses whether to use the PWYW mechansm or to post a prce. In both treatments, buyers observe whch seller uses whch prcng mechansm, whether a seller nvested n the qualty of hs product, and what prce (f any) s posted. If a buyer bought from the PWYW seller, he determned whch prce to pay. If he chose the seller wth the posted prce, he had to pay the posted prce. Both sellers are randomly assgned the same margnal cost c { 0,1,2,3,4}. t = 1 t = 2 t = 3 t = 4 Seller decdes whether to enter the market [& whch prcng mechansm] Seller learns f compettor Seller and buyers learn the entered [& hs prcng mech.] seller s margnal cost c, sellers decdes whether to nvest nto learn f compettor nvested the qualty of hs good Posted-prce seller sets prce & buyers learn actual valuaton v Buyers decde whether and where to buy and whch prce p to pay f buys at PWYW seller. Payoffs are made. FIGURE 2. Sequence of Events n Each Perod: Competton Treatments The competton treatments are desgned to test the effect of competton on behavor n PWYW markets. Frst, f a competng seller s present, buyers have to be less concerned about keepng the PWYW seller n busness. Thus f we observe lower prces n the competton treatments than n the Base Treatment ths s addtonal ndependent evdence that strategc concerns are mportant. Second, we can test whether predcton P2, sayng that PWYW acheves maxmum market penetraton, also holds f another seller offers the same product at a posted prce. Ths s closely related to predcton P3 whch clams that a PWYW seller wll drve a seller usng posted prces out of the market. If the PWYW seller does not corner the market, then some other forces, such as concerns for self-mage or altrusm, must be affectng behavor. 14

16 Thrd, the competton treatments allow us to test P4 whch predcts that the prce charged by a tradtonal seller acts as a reference pont that lmts the prces pad voluntarly. Fnally, the Competton Treatment wth Flexble Roles allows us to see whether sellers prefer PWYW or posted prces and whch form of competton wll arse n equlbrum. In COMP_FLEX, sellers could choose whether to use the PWYW mechansm or to post prces (PP). Accordng to predcton P3, f one PWYW seller faces one PP seller, then the PWYW seller wll get all consumers and the PP seller makes a proft of zero or a loss (f he nvested). If both sellers offer posted prces, Bertrand competton wll drve down prces to margnal costs, and profts are also (close to) zero or negatve due to the sunk nvestment cost. Thus, offerng posted prces does not seem to be attractve. Offerng PWYW, on the other hand, elmnates prce competton and appeals to consumers farness and recprocty. If ntenton-based recprocty drves consumers, they may behave even more recprocally f the seller has chosen PWYW rather than been forced to use ths prcng strategy as n COMP_FIX. These arguments suggest optng for PWYW may be proftable. On the other hand, f consumers are motvated by outcome-based socal preferences, they may also buy from a seller offerng posted prces. 13 In ths case, PWYW need not push a PP seller out of the market. If the PP seller survves, predcton P4 suggests hs prce lmts what buyers are wllng to pay the PWYW seller voluntarly, whch reduces PWYW profts. Furthermore, f most consumers are selfsh and pay postve prces only for strategc reasons (to keep the PWYW seller n busness), they have a much lower ncentve to pay f they can rely on a second seller to supply the product. Agan, ths argument works aganst the proftablty of PWYW. Because the unt of observaton s an entre market, we can see how the nteracton of buyers and sellers affects the proftablty and vablty of PWYW as a compettve strategy and how the market structure s formed endogenously. We conducted the experments at MELESSA of the Unversty of Munch n 2010/11. We had four sessons for the Base Treatment and the COMP_FIX 14 Treatment, and two sessons of the Exogenous Entry and Investment Treatment and the COMP_FLEX Treatment, wth 24 partcpants n each sesson, for a total of 288 subjects partcpatng n the experments. Each sesson had two matchng groups wth 12 subjects each and no nteracton between subjects across matchng groups. Subjects were undergraduate students from the Unversty of Munch and the Techncal Unversty of Munch studyng a broad range of majors. Experments were computerzed usng the software z-tree (Fschbacher 2007) and ORSEE (Grener 2004). Sessons lasted about two hours (ncludng the completon of a questonnare). Subjects were pad ther earnng of all perods. 13 See Proposton 3 n Appendx In the sessons of the COMP_FIX Treatment, we had the subjects play two blocks of COMP_FIX followed by two of COMP_FLEX, whch s why we have only two blocks n the COMP_FIX Treatment. The observatons of the COMP_FLEX Treatment n blocks 3 and 4 are thus not drectly comparable to the observatons n the sessons wth four blocks of COMP_FLEX. To be on the safe sde, we use only the COMP_FLEX data of the sessons wth four blocks of the COMP_FLEX Treatment. 15

17 On average, subjects earned about 18.8 (US$26.40 at the tme of the experments), whch ncludes a showup fee of 4 (US$5.60). 4 Expermental Results We organze the presentaton and dscusson of our expermental results accordng to the three man reasons for usng PWYW: prce dscrmnaton, market penetraton, and competton. 4.1 Prce Dscrmnaton Our frst predcton s that PWYW s a means of endogenous prce dscrmnaton because dfferent consumers voluntarly pay dfferent prces for the same product. Thus we frst need to test whether buyers make postve voluntary payments even n our settng that nvolves full anonymty and no personal nteracton. Result 1: In all treatments, a large fracton of buyers who buy from a PWYW seller make substantal voluntary payments. Mean PWYW prces are sgnfcantly above zero and above producton costs n all treatments. However, PWYW prces are sgnfcantly lower n the competton than n the monopoly treatments. In all treatments payments are suffcent to cover the seller s cost and to generate postve profts f sellers nvest n qualty. If they do not nvest, profts are close to zero or negatve. There s a lot of heterogenety n buyers behavor. In partcular, a sgnfcant mnorty of buyers pays zero. Support for Result 1 s provded n Table 1. Comparng the Base Treatment to the two competton treatments we fnd that buyers pay on average a prce of 3.1 to the PWYW seller n the Base Treatment, but only 2.3 and 1.7 n the COMP_FIX and COMP_FLEX Treatment, respectvely. A Wlcoxon-Mann-Whtney test comparng the average prces n each matchng group of the BASE Treatment and n each sesson of COMP_FIX Treatment shows that ths dfference s hghly sgnfcant (p=.0174), whle the dfference between average prces n COMP_FIX and COMP_FLEX sessons s not (p=.1649). There s a lot of heterogenety n buyers behavor. Although many buyers pay farly generous prces, 19.3% of them pay zero n the Base Treatment. Wth competton, ths fracton ncreases to more than one thrd of all buyers. In the Base Treatment more than 60 percent of the buyers pay a voluntary prce that s strctly greater than the producton cost of the seller. Ths fracton s reduced to about 40 percent n the competton treatments. In all treatments, nvestng pays off and sellers who nvested make postve profts on average, but competton reduces profts. 16

18 Treatment BASE BASE Match EX. E&I COMP_FIX COMP_FLEX PWYW buy a) 96.7% 97.3% 96.3% 73.9% 89.7% PWYW prce b) PWYW prce nvest b) PWYW prce no nvest b) Percent zero payment b) 19.3% 20.0% 28.2% 34.8% 43.0% Percent prce > prod. cost b) 62.3% 64.7% 56.7% 49.8% 39.1% PWYW Seller entry 85.6% 82.9% 82.9% 92.5% 14.6% c) PWYW Seller nvest 83.5% 89.9% 89.9% 86.5% 77.1% PWYW Seller proft a) PWYW Seller proft nvest a) PWYW Seller proft no nvest a) Notes: BASE Match : only those sessons of the Base Treatment that are matched n the Exogenous Entry and Investment Treatment, a) Gven seller entry, b) Gven seller entry and buyer buyng, c) Percent of sellers choosng PWYW TABLE 1. Summary Statstcs What determnes how much buyers pay? Outcome-based theores of socal preferences (P1a) predct that buyers pay more f ther own valuaton and the seller s cost ncrease. Intenton-based models of recprocty predct that buyers pay more to recprocate the seller for hs nvestment n qualty, whereas exogenous changes n valuatons or costs have no effect (P1b). Predcton P1c suggests that buyers are drven by the strategc concern to keep the seller n the market, so ther payments should declne over tme and drop to zero n the last perod of each block. By comparng the Base Treatment to the Exogenous Entry and Investment Treatment (and the competton treatments) we can dscrmnate between these predctons. Recall that the EX E&I Treatment s based on the entry and nvestment decsons of the sellers n the frst two sessons of the Base Treatment. The results for these two sessons are summarzed n BASE Match. Note frst, that ntenton based recprocty and strategc concerns cannot play a role n the Exogenous Entry and Investment Treatment. Nevertheless we observe that n the EX E&I Treatment more than 70 percent of the buyers pay postve prces and 56.7 percent pay strctly more than the producton cost of the seller. Ths s strong evdence for outcome-based socal preferences (P1a). Comparng the EX E&I and the Base Match Treatment we fnd that prces are sgnfcantly hgher n the Base Match Treatment. 15 Thus, outcome-based socal preferences cannot be the whole story. Buyers may pay hgher prces n the Base Match Treatment ether because they are motvated by ntenton-based recprocty or for strategc reasons because they want to keep the seller n the market and to nduce hm to nvest n the future. However, n the last perod of each block there s no future, so the strategc concern 15 A Wlcoxon sgned rank test matchng the behavor of each buyer n the Ex E&I Treatment to the correspondng behavor of each buyer n the Base Match Treatment shows that the dfferences between the prces pad n the two treatments s hghly sgnfcant (p<0.0000). Ths s confrmed by a two sample t test (p=0.002). 17