In October 2007, the British band Radiohead released their seventh album – In Rainbows – as a digital download that customers could pay whatever they liked for. The results of this risky venture are a guarded secret, but the album’s popularity was clear. It topped the charts and allegedly sold 1.2 million copies in the first day alone. Even though many fans paid nothing (the average contribution ranged from $2.26 to around $8 depending on the survey), the band still earned more money from In Rainbows than their previous album, Hail to the Thief. But according to a new study, Radiohead could have earned even more money by adding a slight twist to their plan – telling people that half their voluntary payments would go to charity.
Many businesses are trying out new strategies that appeal to the better nature of their customers. Some promote the fact that they donate a proportion of their profits to charity. Others, from Radiohead to restaurants, invite people to pay what they like for their products. People often get away without paying anything but in practice, they frequently cough up something. But according to Ayelet Gneezy from the University of California, San Diego, the best strategy is to fuse the two approaches.
At a theme park, Gneezy conducted a massive study of over 113,000 people who had to choose whether to buy a photo of themselves on a roller coaster. They were given one of four pricing plans. Under the basic one, when they were asked to pay a flat fee of $12.95 for the photo, only 0.5% of them did so.
When they could pay what they wanted, sales skyrocketed and 8.4% took a photo, almost 17 times more than before. But on average, the tight-fisted customers paid a measly $0.92 for the photo, which barely covered the cost of printing and actively selling one. That’s not the best business model – the company proves itself to be generous, it’s products sell like (free) hot-cakes, but its profit margins take a big hit. You could argue that Radiohead experienced the same thing – their album was a hit but customers paid relatively little for it.
When Gneezy told customers that half of the $12.95 price tag would go to charity, only 0.57% riders bought a photo – a pathetic increase over the standard price plan. This is akin to the practices of “corporate social responsibility” that many companies practice, where they try to demonstrate a sense of social consciousness. But financially, this approach had minimal benefits. It led to more sales, but once you take away the amount given to charity, the sound of hollow coffers came ringing out. You see the same thing on eBay. If people say that 10% of their earnings go to charity, their items only sell for around 2% more.
But when customers could pay what they wanted in the knowledge that half of that would go to charity, sales and profits went through the roof. Around 4.5% of the customers asked for a photo (up 9 times from the standard price plan), and on average, each one paid $5.33 for the privilege. Even after taking away the charitable donations, that still left Gneezy with a decent profit.
This is a substantial result, especially since it came from a real setting. The theme park that Gneezy used stands to make another $600,000 a year in profits if it takes up her sales strategy. And just to be sure, Gneezy confirmed that sales at a nearby souvenir shop didn’t fall on the days when she ran her study. These extra profits weren’t coming at a cost to retailers elsewhere in the park.
Gneezy describes the combination of charitable donations and paying what you like as “shared social responsibility”, where businesses and customers work together for the public good. It’s a slightly different idea to corporate social responsibility, where the act of charity is dictated by the company. And it’s very different from the classic view of the modern corporation as a profit-making machine, beholden only to its shareholders.
Corporate social responsibility is a mantra for many a modern firm, but it’s often done at a financial cost. Customers might assume that the company has ulterior motives for its practices beyond the call of ethics. Indeed, that’s often the case – acts of goodwill can do wonders for a company’s brand, and public interest in its products of services. But if people suspect that they’re somehow being manipulated, that can negate the positive effects of any act of charity.
Gneezy thinks that shared social responsibility is a better model because the company is clearly putting itself at financial risk, and people are less likely to smell a rat. Customers are also more likely to personally identify with the cause they are contributing to. Regardless of who sets the price, they are still contributing to charity, but it feels more like an active decision if they choose the price themselves.
There’s more evidence to back up this idea in the experiment – when Gneezy added a charitable donation to the pay-what-you-want scheme, fewer people bought the photo. The option to name your own price attracts a lot of cheapskate customers, who may not actually want the product very much, and who aren’t prepared to pay much, if anything, for it.
When the charity factor is introduced, these casual freeloaders balk at the idea of paying nothing, because it’s more likely to reflect badly on them. Rather than naming a higher price, their preference is to avoid buying altogether – for them, it isn’t worth it. Sales fall, but the actual profits go up because the remaining customers are motivated by their desire for the product and for the cause, will pay for both.
The experiment could be expanded in many interesting ways. For example, what about a discounted fixed price option with charitable donation, or a pay-what-you-want option with a minimum threshold? For now, it tells us that trying to tap into the ethical side of consumerism is very tricky, but possible without compromising profits. As Gneezy concludes, “Apparently, a company can best serve its community and its shareholders by sharing its social responsibility with its customers.”
Reference: Science http://dx.doi.org/10.1126/science.1186744
Image from alterna2
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