Living Economics

Radiohead, an established British alternative rock band, released its 2007 album "In Rainbows" under a pay-what-you-want download pricing model from their own website.

Millions of copies were downloaded with a global average payment of £2.90, compared to the average cost of £5.80 for an album downloaded on iTunes. Three out of five people downloading the album paid nothing (ft.com).

At its inception, the pay-what-you-want download model was hailed as path-breaking. But that model left too much money on the table and was not sustainable as a business model. Specifically, it benefited the would-be pirates who otherwise would have to pirate the album through illegal file-sharing. And it deprived those with higher reservation prices to express them by buying more expensive versions. The only silver lining was the proof that established bands could self-release their music without the record labels and iTunes as middlemen.

It seemed that Radiohead has learned its pricing lessons.

In 2011, Radiohead abandoned its pay-what-you-want pricing model and released its "King of Limbs" album as a fixed-price (£6.00) paid-for download. This fixed-price download was followed by the release of a more expensive CD and an even more expensive deluxe package (pcmag.com). Releasing a product at different price points (tiered pricing) is, of course, a classic way to higher profit through price discrimination.

A recent study shows that the pay-what-you-want pricing model tends to reduce sale of non-digital products because of the ambiguity about fairness. Those who are concerned about damaging their self-image by offering too little may just as soon not buy any (Economist). But they might be willing to pay more than their reservation price if they think the fixed price is a good deal because of a big price discount.

The pay-what-you-want model makes economic sense when it is used as a limited-time promotion and as a loss-leader to increase sale of higher profit-margin related products. The cost of such marketing promotion is reduced if its marginal cost is close to zero as in digital downloads (getelastic.com).