Tuesday, December 14, 2010

More Thoughts about Pay-What-You-Want

Our paper on Pay-What-You-Like (Pay-What-You-Want is becoming the popular term now) has been reviewed and rejected by two journals. Each time it received one excited review, one critical review, and one editor that didn't want to take the chance. The critical reviews anchored on the notion that PWYW was infeasible because it is donations-based. Their reasoning is straightforward: people would free-ride to the point that businesses would not be able to cover costs. Indeed, that has happened in the past with other PWYW businesses. However, success has also happened.

Here was an update 8 weeks after the original Panera Cares location was opened (http://blogs.reuters.com/shop-talk/2010/07/28/paneras-pick-what-you-pay-cafe-holds-its-own/). It's success has opened the door for more locations. In addition to their location in Clayton, MO Panera Cares has recently opened another location in Dearborn, MI (http://www.freep.com/article/20101123/BUSINESS06/11230328/Panera-Cares-Cafe-in-Dearborn-aims-to-help-everyone-afford-a-meal-or-a-treat ) and will be opening a location in Portland, OR (http://www.panerabread.com/pdf/pr-20101122.pdf).

Interestingly, each of the these locations have a lower median income than Clayton and they are more heterogeneous along other dimensions.For example, Dearborn is the capital of the Islamic Center for America and has a large Arabic population. Portland, Oregon is not racially diverse however they are more secular than Clayton or Dearborn. The notion of heterogeneity and secular matter because they have shown to correspond to less trusting or charitable behavior. The lower income levels of these cities also make them a very interesting experiment compared to Clayton, MO (they are homogenous and wealthy as written in an earlier post).

In our model we rely heavily on a notion called "warm glow". That is, people receive some positive utility in addition to the actual consumption of the good. We state there are three channels by which this warm glow may be activated. These arguments were not given creedence by some of our reviewers, but, each of them is intuitive and I think is receiving more support as new ideas and a renaissance of old ideas are being forged in economics.

1. Existence Support - Armen Alchian talks about how firms are not necessarily profit maximizing but motivated by a survivorship principle. If customers also realize that firms must at least be able to proceed to the next period in order to continue production is it too much of a leap to say that patrons also could operate on survivorship principles? Do you ever find yourself saying, "We should really go to that restaurant. Their food is good and I don't want them to go out of business."?

2. Charity - The evidence that PWYW is improved by charity is found in a Gneezy et al field experiment that shows revenues as Disney Land were improved by the announcement that 50% of proceeds went to charity. Additionally, Panera cares may be successful because people view part of their mission as charitable (http://yourlife.usatoday.com/mind-soul/doing-good/kindness/post/2010/11/panera-opens-doors-to-their-second-cares-cafe-charity-store/132353/1).

3. Identity - Akerlof and Kranton's book Identity Economics is making the rounds big time. Their article which the book is partially based on has already been cited 1,400+ times. Basically what they're saying is that people make decisions out of who they perceive themselves to be. Considerations of identity would yield dramatically different predictions than typical economic models.

It's good to see that the PWYW model is working for Panera as it has worked for many other stores. Recently we had a guest speaker, Paul Zak, at FSU who works in a new area called Neuroeconomics. From his research he finds that when we place trust in another person the recipient of our trust also receives a spike in Oxytocin. This Oxytocin chemical tends to improve reciprocity and other-regarding behavior. It is neat that there is a biological foundation to this notion. 

I guess the question still remains. Giving to charity seems easy, but, difficult when your stream of revenue from donations is uncertain. If warm glow can work through identity or existence value how do you generate that in your customer base?

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