Carlson School building exterior

A Profitable Approach for Charging Nothing

Monday, November 30, 2015

Is it possible to make money on an item by offering it for free? New research from Marketing Professor Akshay Rao not only shows it can work, it develops a model for doing so.

The prevailing wisdom on “pay what you want” (PWYW) pricing strategies has been that they work either because of altruism (people go to the museum and contribute $5) or because it is a loss leader (an artist offers his or her music for free to entice consumers to buy concert tickets or merchandise).

In a recent paper published in Organizational Behavior and Human Decision Processes, Rao and colleagues instead showed that PWYW schemes can effectively be used with self-interested consumers and with firms that want to make money off of that transaction, not a future one.

Rao says the band Radiohead’s 2007 release of In Rainbows provides an example of the necessary conditions. For starters, some consumers have to value the product (in this case Radiohead’s music) enough that they are more focused on a relationship than a single transaction.

“Radiohead couldn’t have done this with their first album,” says Rao, the Carlson School’s General Mills Chair in Marketing. “But by the time they released In Rainbows, they had built a fan base that loved their music and cared about future records.”

Next, vendors have to announce that they will switch to a higher fixed fee in the future unless enough revenue is generated through the PWYW offering. This motivates the sellers’ die-hard fans to become, in effect, their marketing arm and recruit new customers.

“They know that they can’t do it themselves, so they go to their friends and family and say, ‘This is pretty good, download it, and give them a couple bucks if you like it,’” says Rao. “Collectively, this small segment with a high willingness to pay influences a large segment with a low willingness to pay to create enough revenue for Radiohead to be happy and maintain this arrangement that makes its customers happy.”