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“Pay what you want” as a profitable pricing strategy: Theory and experimental
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 “Pay what you want” as a profitable pricing strategy:

Theory and experimental evidence

Vincent Mak

v.mak@jbs.cam.ac.uk, Judge Business School, University of Cambridge, Trumpington Street,

Cambridge CB2 1AG, United Kingdom

Rami Zwick

rami.zwick@ucr.edu, Department of Management and Marketing, A. Gary Anderson Graduate

School of Management, University of California, Riverside, Riverside CA 92521

Akshay R. Rao

arao@umn.edu, Department of Marketing & Logistics Management, Carlson School of

Management, University of Minnesota,

May 8, 2010

The authors would like to acknowledge the comments of Tony Cui, George John, Amnon
Rapoport, as well as seminar participants at the University of California, Berkeley, the
University of California, Riverside, and the University of Cambridge, on earlier versions of this
manuscript.
 “Pay what you want” as a profitable pricing strategy:

Theory and experimental evidence

Abstract

Prevailing wisdom in the literature suggests that the success of a “pay what you want” (PWYW)

pricing strategy depends on consumers’ altruistic inclinations, sense of fair play, or consumers’

willingness to reciprocate the firm’s generous offer. In this article, we consider whether PWYW

can be profitable when the consumer’s only motive is self-interest. Through analyzing an

infinitely repeated pricing game between a firm and a fixed consumer population, we find that

PWYW could be as profitable as a fixed price regime, if the firm’s strategy is to threaten to

switch to the fixed price regime over a length of time in the future, should PWYW not yield

enough profits. If consumers are forward looking and there exist a sufficient number of

consumers who find the firm’s fixed price regime to be more costly than other alternatives, then

such a threat could lead to a sustainable PWYW regime. We also examine coordination

mechanisms that may enhance the sustainability of this regime in practice, and present a

laboratory study that provides support for some of our conclusions.

Keywords: Pay what you want; pay as you wish; participative pricing; experimental economics;

game theory.
 1

1. Introduction

In late 2007, the British band Radiohead launched their new album In Rainbows with an unusual

strategy: customers could download the album from a specially created website and pay any

price they wanted. If they so desired, they could pay nothing. This “pay what you want”

(PWYW) campaign ran from October 10 to December 10, 2007. It generated considerable

commentary in the music industry, including skepticism regarding its financial viability1. For, if

consumers were allowed to download the new album for free, wouldn’t they all do just that?

Indeed, it was later estimated that about 62% of downloads of In Rainbows in October 2007 were

free downloads, but a remarkable 38% of downloads were accompanied by a payment that

averaged roughly $6.002 (Elberse and Bergsman 2008). Since there was no revenue sharing with

record companies and retailers, the entire revenue accrued to the band, leading one band member

to observe that in terms of digital income they “made more money out of this record than out of

all the other Radiohead albums put together” (Thom Yorke, quoted in Wired magazine, issue

16.01, January 2008).

More recently (October 2009), to celebrate their one year anniversary, the developers of the

indie video game “World of Goo” ran an experiment for one week, during which buyers could

pay what they wished for the game whose list price was $20. During the first week of the

experiment, about 57,000 people downloaded the game from the website and the average price

paid for the game was $2.03. The developers declared the results a “huge success” and extended

1
Fortune Magazine listed Radiohead’s PWYW strategy among the “101 Dumbest Moments in Business” in 2007
(http://money.cnn.com/galleries/2007/fortune/0712/gallery.101_dumbest.fortune/59.html).
2
The average payment is a misleading statistic in this case. Jane Dyball, Warner Chappell’s Head of Business
Affairs, the publishing company that licensed all digital rights on behalf of Radiohead, pointed out that the band and
their management never announced a timeline for their PWYW experiment and were watching the average price
daily with a view to potentially withdrawing it any moment should it drop too low. Dyball pointed out that the
average price went down after the download moved from uberfans to less committed fans, as expected
(http://musically.com/blog/2008/10/15/exclusive-warner-chappell-reveals-radioheads-in-rainbows-pot-of-gold/).
 2

the experiment for another week3. The success declaration should be evaluated with respect to

the reported 90% piracy rate for the game. Following the success of “World of Goo”, the

developer of Crayon Physics Deluxe allowed consumers to pay as they wished for the game for

one week (January 8-15, 2010). During this week 31,332 downloaded the game and paid on

average $1.90, leading the developer to announce that the experiment was “way more popular”

than he expected4.

Such PWYW pricing strategies are neither new nor rare, and are prevalent in a variety of

contexts. Public radio and television stations in the United States employ membership drives for

donations that contain all the essential features of a PWYW strategy. Many museums do not

charge admission fees, but suggest to patrons that they donate whatever they want, and

restaurants in the U.S., U.K., Australia and Spain have experimented with PWYW options on

their menus (Gregory 2009). As a consequence, PWYW has recently begun to attract thoughtful

academic scrutiny (e.g. Kim et al. 2009, Regner and Barria 2009, Gautier and van der Klaauw

2010, Gneezy et al. 2010, Chen et al. 2010). Many arguments for the successful employment of

a PWYW strategy can be proffered. One class of arguments relies on revenue generation

through consumers’ “social preferences”, which include their sense of altruism and fair play as

well as their willingness to reciprocate the firm’s generous offer. Another argument is based on

the notion of “loss leadership” and the generation of secondary income through an increased

customer base and through cross selling. Musicians, for example, can gain publicity by giving

away albums, which then leads to enhanced concert ticket sales and merchandizing; museums

may generate traffic through free admissions and subsequently earn revenues through sales at

their gift shops and cafeterias. However, such derivative income may not always be essential for

3
The developers, 2D Boy, posted the results of the experiment at http://2dboy.com/2009/10/26/pay-what-you-want-
birthday-sale-wrap-up/
4
We thank Petri Purho, the developer of Crayon Physics Deluxe, for sharing the sales data with us.
 3

PWYW to be successful. Consider Wikipedia’s attempts to generate donations at the end of 2008,

when a banner with a “Donate Now” button appeared at the top of every Wikipedia page; the

campaign eventually achieved its target of raising $6 million, and there was no secondary

income associated with the strategy (Hughes 2009).

Our study examines whether PWYW strategies can successfully be employed when

arguments based on social preferences and loss leadership are not operative. Specifically, if a

firm is faced with purely self-interested consumers, and there are no secondary benefits, can

PWYW still be a profitable pricing strategy relative to fixed pricing (FP)? We answer this

question through a game-theoretic model as well as laboratory experimentation, and identify

conditions under which PWYW is more beneficial than FP to both the firm and to consumers.

The principal intuition underlying our results is captured in Wikipedia’s 2008 fundraising

campaign. In that campaign, Wikipedia underscored the argument that user donations “will help

keep Wikipedia free”, and hinted that a failure to raise sufficient funds would lead to Wikipedia

users being charged a subscription fee, or Wikipedia being forced to carry advertisements

(Hughes 2009). In essence, sufficient donations would sustain Wikipedia’s PWYW model in the

future, but if donations did not reach sufficiency, Wikipedia might begin to charge users a

subscription fee that would potentially be higher than the donation solicited, or Wikipedia might

entertain advertisements, an action that could reduce users’ future benefits because Wikipedia

might no longer be truly neutral.5

In our model, we abstract the essential features of the strategy just described and investigate

when it is incentive compatible for consumers. Consumers may be willing to pay a positive

5
The indie music download site Marathon of Dope, which operates on a PWYW basis, voices a plea of a similar
nature in its web pages (e.g. http://marathonofdope.com/?p=634): “Whatever money you decide is reasonable to pay
for the music at Marathon Of Dope will go directly to the artists. That money will enable them to continue making
high caliber music and bring it directly to you.” The implicit threat to listeners is that insufficient current donations
will force the artists to compromise on quality and efficient distribution of their music in the future.
 4

amount under PWYW if the alternative they face is a relatively high fixed price. That is, if the

firm’s willingness to switch to a high fixed price for a pre-specified length of time (which we

call “punishment periods”) is a credible threat, then consumers have an incentive to pay a

positive amount in the current period. This argument stands if every individual consumer’s time-

discounted total expected utility gain under PWYW is at least as high as the corresponding total

utility gain that she would enjoy if she paid nothing in the current period under PWYW and then

paid fixed prices throughout the punishment periods. Our major theoretical results consist of a

statement of this intuition in quantitative terms. Formally, we examine a class of simple firm

strategies in the following form in the context of infinitely repeated firm-consumers interactions:

(1) the firm continues to implement PWYW if total payment from consumers is not lower than a

pre-announced threshold; (2) if the threshold is not reached in a particular period, the firm

implements FP for a pre-specified number of periods from the next period onwards, before

reverting to PWYW. Given this firm strategy, we find conditions under which a PWYW-

sustaining equilibrium exists on the consumers’ side, which generates higher profit than under

FP. In other words, we identify parametric conditions that admit a PWYW equilibrium which is

more profitable to the firm and more beneficial to consumers, than if the firm practices FP.

However, our equilibrium solutions are sensitive to coordination failures, because, given a

threshold profit and a punishment strategy that fulfill the theoretical conditions, there is typically

a great multitude of consumer-side equilibria, which makes it potentially difficult for consumers

to align their behavior with respect to one particular equilibrium. Thus, we suggest four

mechanisms that can be adopted by the firm to enhance consumer coordination. The functions of

two of these mechanisms – payment constraints and probabilistic punishment – can be

demonstrated purely through game theoretic considerations. The other two, namely that
 5

consumers are allowed to communicate with each other, and that consumers are provided

suggested payments, are behavioral strategies inspired by previous literature, and require

empirical verification. Therefore we report a laboratory experiment designed to understand: (a)

whether (i) consumer communication and (ii) suggested payment enable subjects to sustain a

theoretically admissible PWYW equilibrium; (b) as control conditions, whether (i) theoretically

admissible PWYW equilibria are sustainable without coordination mechanisms, and (ii) whether

PWYW is sustainable even when theory does not admit any PWYW equilibria. We conclude

our paper with a discussion of the theoretical insights we obtain and their relevance to

practitioners.

2. Literature and Model

In this section, we first offer a brief review of the literature that is relevant to the PWYW

phenomenon. We then present an analytical model that captures our core argument that self-

interested consumers might, under certain conditions, sustain a PWYW strategy that is profitable

for the firm.

2.1 Related Literature

While the literature on pricing strategies is voluminous, the literature that speaks to the PWYW

pricing strategy is relatively sparse. One approach examines the secondary benefits that might

accrue to the firm if PWYW strategies are employed. For instance, the viability of PWYW in the

context of museum admissions has been studied empirically by Steiner (1997) and Toepler

(2006). Steiner (1997) examines whether free admission can serve as a loss leader that increases

overall museum revenues through souvenir sales and cafeteria sales, but finds empirically that

this pricing strategy is not optimal. Toepler (2006) finds that visitors to a museum with free
 6

admission typically do not donate as much as the amount recommended by the museum

establishment. Seemingly, the recommended amount serves as a reference point, and consumers

discount from that reference point (Rao and Sieben 1992).

A number of recent field studies on PWYW, including Kim et al. (2009), Regner and Barria

(2009), Gautier and van der Klaauw (2010), and Gneezy et al. (2010) find that consumers often

pay positive amounts, and identify factors that affect their payments. Kim et al. (2009) observe

that social preferences such as altruism and a sense of fair play influence the amounts paid.

Regner and Barria (2009) suggest that consumers’ motivation to reciprocate the firm’s offer to

allow comprehensive pre-purchase sampling (if there is such an offer) influences their PWYW

payment positively. Gautier and van der Klaauw (2009), meanwhile, demonstrate that

consumers who were told they could pay what they wanted after committing to a purchase on

average paid more than those who were told they could pay what they wanted before committing

to a purchase.

Our paper complements this line of empirical research by examining PWYW when a firm’s

credible threat of a high future fixed price provides the sole motivation for self-interested

consumers to pay a positive amount under PWYW. The mechanism we propose involves the

continued offer of PWYW by the firm in the subsequent period, subject to the requirement that

the sum of consumer payments in the current period reaches a specific threshold. This

requirement makes our model similar to the provision point public goods game that has been

studied experimentally (e.g. van der Kragt et al. 1983, Rapoport 1988, Cadsby and Maynes 1998,

and Croson and Marks 2000). That is, our study points out how an infinitely repeated pricing

game involving PWYW can produce incentives for consumers to pay sufficiently high prices

under PWYW, through a mechanism that resembles a provision point public goods game.
 7

However, whereas our mechanism is about consumers paying to avoid the discontinuation of a

beneficial pricing regime, the provision point public goods game is about players contributing to

facilitate the provision of a beneficial public good. This variation in framing might make a

behavioral difference. Further, to tackle the issue of potential coordination failures in our model,

we also suggest additional coordination mechanisms, some of which are not discussed in the

provision point public goods literature.

PWYW can also be seen as a type of participative pricing mechanism (Chandran and

Morwitz 2005), in which consumers are involved in the price-setting process. But common

participative pricing mechanisms such as price negotiations, conventional auctions, and the

Name-Your-Own-Price (NYOP) mechanism (e.g. Kamins et al. 2004, Terwiesch et al. 2005,

Spann and Tellis 2006, Amaldoss and Jain 2008), are qualitatively different from PWYW

because, while a seller can reject a price bid in those other participative pricing mechanisms, he

cannot do so when practicing PWYW.

2.2 Model

Consider an infinitely repeated game6 in which a firm S launches and sells a perishable product

at zero marginal cost in every period to a fixed market environment (marginal cost is indeed

negligible with Internet businesses and with museums, among which there are many examples of

PWYW).7 The products have no intrinsic value to the firm, and, being perishable, a product sold

in a period has no utility to consumers once that period is over.

6
An “infinitely repeated” game can also be interpreted as a repeated game with indefinite termination. That is,
conditioned on the game being played now, there is always a positive probability that there will be a next period in
which the game is played again (see, e.g. Zwick et al. 1992). The time discount factors of players in an infinitely
repeated game partly capture this probability (and partly capture their intrinsic time preferences) in an expected
utility framework.
7
Adding a per period fixed cost does not alter the essence of our results, and hence we assume in this study that the
per period fixed cost is zero unless stated otherwise (but see Appendix B where we consider the implications of a
positive marginal cost).
 8

We assume that every consumer in any one period demands at most one unit of the available

alternatives.8 Firm S’s potential market consists of two principal consumer segments: (1) a

segment of dedicated fans (e.g., “Deadheads”) whose valuation of every one of S’s products is

always uF (> 0) and for whom there is no outside option that is a viable substitute, and (2) a

segment of casuals whose valuation of every one of S’s product is always uC (> 0) but for whom

there exists an outside option with the same valuation uC that is a perfect substitute, and this

outside option is sold at an exogenous, fixed price p0. Other than these two segments, there may

also exist some consumers who strictly prefer their best alternatives over S’s products even when

the latter are offered free, and therefore, they are not included in S’s potential market and can

safely be ignored. It is commonly known that the total number of fans and casuals is N, of which

a proportion q are fans and a proportion 1-q are casuals. Table 1 lists the valuations of the

different segments for the different available options in every period.

---------------------------------------

Insert Table 1 about here

---------------------------------------

At the beginning of every period, S decides whether to allow PWYW or to implement FP for

the product sold in that period. It may choose one and only one pricing scheme from this set of

two alternatives. If it decides to implement FP, it decides the price p and announces p to

consumers. Each consumer then decides whether to buy the product from the firm at price p, to

buy the outside option at price p0, or to not buy. If, instead, S decides to allow PWYW, it

announces this decision to consumers at the beginning of the period. Each consumer then

8
This is not a crucial assumption. As long as we specify consumers’ preference structures correctly, we can derive
similar conditions for profitable PWYW even when allowing for multiunit per period demand. But no major
additional insights are obtained by relaxing this assumption. Therefore, for expository convenience, we adopt the
single-unit demand assumption.
 9

decides whether to buy the product from S (and if so, to pay a non-negative price of her choice),

to buy the outside option at price p0, or to not buy. Regardless of the pricing scheme employed,

every consumer’s purchase decisions are independent of the purchase decisions of other

consumers. Figure 1 is a schematic representation of the sequence of decisions in each period.

We assume that, at the end of every period, S knows the total profit it earns during that period.9

---------------------------------------

Insert Figure 1 about here

---------------------------------------

All consumers have the same per period time discount factor δ ∈ [0,1) for utility gains.10 For

any consumer, the net utility gain of a purchase t periods after the current period is δ t −1 (u − r ) ,

where u is the consumer’s valuation of the purchased product and r is the price paid for that

purchase. Assume without loss of generality that u C ≥ p 0 ; if this is not true, the casuals’

effective outside option becomes no purchase. Assume also that u F ≥ p 0 .11

In most of our discussion, we assume that N, q, uF , uC, δ, and p0 are the same in all periods,

so that consumer taste and the marketing environment are stable and fixed across periods.

(However, as we will show later, some of these assumptions can be relaxed if the firm imposes

payment constraints under PWYW.) Our assumptions approximate some naturally occurring

scenarios. For instance, a popular music band with a well-established style often faces a largely

stable market consisting of many “casual” consumers with generic taste plus a small segment of

9
For the equilibria to be discussed, we do not need to assume that S knows the breakdown of individual payments
under PWYW.
10
S may time-discount future profits too, but this turns out to be irrelevant for the equilibria we examine and hence,
in the interest of brevity, we omit discussion of this aspect of the model unless otherwise stated.
11
Relaxing this assumption introduces the possibility of uF < p0 ≤ uC, so that, under FP, S might like to sell to casuals
to the exclusion of its fans, whose valuations of S’s products are lower than the valuations of casuals towards S’s
products. Accommodating this possibility does not affect the basic insights that follow from Proposition 1, but we
adopt this assumption for expository convenience.
 10

dedicated “fans”. Such a band has almost zero marginal cost when it offers a downloadable

album every season. It is also fairly typical with pop music that an album has virtually no value

to many consumers once a season is over, and thus can be viewed as a perishable product. The

outside competitive environment can be the mainstream music industry, which, despite the

constant change in stars and albums, presents more or less the same fare (as far as consumption

utility and price are concerned) to both fans and casuals.

It is helpful to first consider a firm strategy with which S implements FP with the same price

every period. Define p̂ as the price that maximizes S’s per period profit. The value of p̂ is

obtained as follow, together with the corresponding consumer purchase behavior, which

constitutes a demand-side equilibrium given the firm’s strategy:

(a) If qu F > p 0 , then pˆ = u F ; only fans buy from S with zero net payoffs, so that S earns a

profit of Nqu F , while every casual buys the outside option with net utility gain u C − p 0 ;

(b) If qu F < p 0 , then pˆ = p 0 ; every consumer buys from S with net utility gain u − p 0 ,

where u is the consumer’s valuation of S’s product. S earns a profit of Np0 ;

(c) If qu F = p 0 , then either pˆ = u F and consumer behavior is like (a), or pˆ = p 0 and

consumer behavior is like (b). S earns a profit of Nqu F = Np0 in either case.

We have made the convenient assumption that, if a consumer is indifferent between buying from

S and either buying the outside option or not buying at all, she buys from S.12 S’s per period

profit under this equilibrium is π 0 = N max{qu F , p 0 } .

Next, define the following firm strategy, which we call a “PWYW strategy with threshold π

and m punishment periods”: S announces a threshold profit level, π , that it must earn in a period

12
This assumption is not crucial. Relaxing it leads to some adjustment in our results but the major insights are
unaltered.
 11

in which it allows PWYW, if it is to continue to allow PWYW in the next period. In other words,

if total payment to S in a period with PWYW falls below π , S implements FP with price p̂ for m

periods (m > 0) from the next period onwards.

We now examine consumer-side equilibria that are admitted by such a firm strategy. First, it

is straightforward to see that, as long as π ≥ u F (which must be true in the interesting case of

π ≥ π 0 = N max{qu F , p 0 } ), it is a consumer-side equilibrium that every consumer pays nothing

whenever S implements PWYW, thus triggering FP at price p̂ in the next m periods, during each

of which, fans buy from S while casuals buy from S if p̂ is lower than p 0 or buy the outside

option otherwise. Call this equilibrium the baseline equilibrium. The baseline equilibrium is

feasible under a PWYW strategy whenever π ≥ π 0 regardless of the number of punishment

periods. Note that S can earn more profit by implementing FP perpetually, if it foresees that

consumers would behave according to the baseline equilibrium under PWYW.

However, there may also exist consumer-side equilibria under a PWYW strategy in which

the punishment is never triggered and S implements PWYW in every period. We shall focus on

equilibria with stationary, pure strategies, so that consumer i always pays the same amount pi to

S in any period with PWYW; such consumer strategies can be represented by the set { pi } , which

we call a payment scheme. The total payment in a consumer-side equilibrium that sustains

PWYW cannot exceed π ;13 since it cannot be lower than π for S to continue to implement

PWYW, total payment must be exactly π . This implies that ∑p

i
i = π is a PWYW-sustaining

13
Total payment cannot be higher than the threshold in equilibrium. Suppose this is not true and there is a payment
scheme in equilibrium with a total payment that is higher than the threshold. But then there must exist an alternative
payment scheme that also adds up to the threshold but requires at least one consumer to pay less while all other
consumers pay the same. That consumer would then have an incentive to deviate unilaterally from the original
payment scheme, meaning that the original payment scheme cannot be part of the equilibrium.
 12

consumer-side equilibrium. Naturally, from the perspective of the firm, only strategies that yield

per period profits that are at least π 0 are of interest. The question that then emerges is: under

what conditions will a PWYW strategy with threshold π ≥ π 0 and m punishment periods admit

PWYW-sustaining consumer-side equilibria? Our answer is summarized as follows, which is

proved in Appendix A:

PROPOSITION 1. A PWYW strategy with threshold π ≥ π 0 and m punishment periods

admits consumer-side equilibria in which S always allows PWYW, iff:

(a) qu F ≥ p 0 , and

δ (1 − δ m )  (1 − q ) p 0 
(b) ⋅ 1 +  ≥ 1,
1 − δ m +1  qu F 

and π satisfies:

[δ (1 − δ m ) /(1 − δ m +1 )][qu F + (1 − q ) p0 ] ≥ π / N ≥ qu F .

Further, for every such π , any member of this set is characterized by a payment scheme { pi }

with which consumer i pays pi for S’s product in any period with PWYW, and which satisfies:

(i) 0 ≤ pi ≤ [δ (1 − δ m ) /(1 − δ m +1 )] u F for every i who is a fan,

(ii) 0 ≤ pi ≤ [δ (1 − δ m ) /(1 − δ m +1 )] p 0 for every i who is a casual, and

(iii) ∑pi
i = π ≥ Nqu F .

Conceptually, in a consumer-side equilibrium that sustains PWYW, consumers are willing to

pay positive amounts because they reckon that paying nothing in a period, only to have to suffer

from the FP punishment in the next m periods, does not yield as much time-discounted total

utility as adhering to the payment scheme { pi } every period. The conditions in Proposition 1
 13

describe when this can happen at a profit threshold that is attractive to the firm relative to

perpetual FP. Further, these equilibria are Pareto superior to perpetual FP for both the firm and

consumers. When condition (a) is fulfilled, pˆ = u F , π 0 = Nqu F , so that S earns no less than π 0

per period with a PWYW strategy that fully satisfies the proposition. This outcome occurs

because, when S implements FP every period with price pˆ = u F , only fans buy from S while

casuals buy the outside option, while under a PWYW equilibrium, all consumers buy from S and,

since S’s market size has now expanded from qN to N, S can still earn at least as much under

PWYW as under perpetual FP, even though every consumer pays less under PWYW. Individual

consumers who pay positive amounts in equilibrium are prevented from unilaterally deviating

and paying less than under equilibrium because of S’s threat that, if it earns a lower-than-

equilibrium profit in any period, the punishment of m periods of FP at price p̂ will be triggered.

The different upper bounds for payment under PWYW for the different types of consumers

indicate that the consumer-side equilibria bear some similarity to second-degree price

discrimination mechanisms, according to which consumers with different valuations of the target

product self-select the prices they pay.

Conditions (a) and (b) in Proposition 1 allow us to identify potential consumer markets that

can sustain a PWYW consumer-side equilibrium that provides more profit to the firm than under

perpetual FP. In Appendix A, we show that these conditions are in fact necessary for a PWYW

strategy with m punishment periods to admit any pure strategy PWYW-sustaining consumer-side

equilibria that generate at least as much per period profit as π 0 . Condition (a) implies that a

portion of consumers do not buy from S under perpetual FP. Condition (b) is satisfied when: (1)

consumers’ time discount factor is high ( δ is high); (2) the maximum profit that S may ever earn

from the casuals (which is realized when it charges a fixed price p 0 ), namely N (1 − q) p0 , is not
 14

too much below the maximum profit that it may ever earn from the fans i.e., Nqu F . Note that, if

condition (a) is fulfilled, we must have qu F > (1 − q ) p 0 and also q (u F − p 0 ) ≥ (1 − q ) p 0 , which

means that the loss of profit from fans under FP when the price is reduced from u F to p 0 cannot

be compensated for by the corresponding gain of profit from casuals. But condition (b) is

satisfied when this difference is small and δ is high. To sum up, a consumer market admits a

PWYW sustaining consumer-side equilibrium when consumers are very forward looking and a

portion of them are “priced out” under FP only because a fixed price at u F captures slightly

more profit than at p 0 (in Appendix B, we describe a generalization of our model that allows for

a high degree of heterogeneity among consumers and a positive marginal cost).

We now turn to a discussion of two major issues underlying our theoretical results, before

presenting the empirical portion of our research which is designed to examine the effectiveness

of the two behavioral coordination mechanisms that we shall introduce in the discussion.

2.3 Discussion

Two key issues merit discussion here: the credibility of the firm’s threat to revert to a fixed price

regime if the payments from PWYW are insufficient, and how coordination failures on the part

of consumers might be avoided.

Credibility of the Firm’s Threat. It is important to ask if the firm’s “commitment to punish”

is credible from the point of view of consumers; if not, no PWYW equilibria can be realized.

Indeed, one might question whether, after a period in which PWYW is allowed but total payment

fails to reach threshold, S would prefer to “let bygones be bygones” and re-establish a PWYW

equilibrium. The firm may have an incentive to do this because, if a PWYW equilibrium can

successfully be re-established with a threshold that is higher than π 0 , it can earn higher profits

by doing so, compared with the profits from implementing the punishment. Consumers could
 15

prefer to sustain a PWYW equilibrium anew over the FP punishment because they pay less under

the PWYW regime. In other words, both the firm and consumers may agree to re-establish a

PWYW regime since it is Pareto superior to the firm implementing the punishment. Demanding

“renegotiation-proofness” rules out many commonly known repeated game equilibria, such as

the infinite repetition of (defect, defect) or the trigger strategy (cooperate, cooperate) equilibria

in repeated prisoners’ dilemma (see e.g. Farrell and Maskin 1989, Abreu et al. 1993).

However, the lack of renegotiation-proofness is not always a valid theoretical reason to rule

out an equilibrium (e.g., Fudenberg and Tirole, 1996, p.174-176), nor is it a legitimate reason to

discard a mechanism as unworkable. First of all, firms may find it preferable to make decisions

about the future based on consumers’ behavior in the past, compared with letting “bygones be

bygones”. That is, firms may legitimately be concerned that they may develop a reputation for

being “soft” on executing punishment, and consumers may rationally anticipate that should

PWYW not yield sufficiently high revenues during the next iteration, the firm will once again let

bygones be bygones.

In our case, if the firm believes that, following a period in which consumers had failed to pay

sufficiently under PWYW, there is a sufficiently high probability that consumers would change

their behavior and collectively pay to sustain PWYW at the firm’s desired threshold π upon re-

establishment of PWYW, renegotiation is appropriate. But, such a belief is as open to challenge

as the opposite belief by the firm that consumers are likely to fail to sustain PWYW if the firm

does not commit to a punishment. Both beliefs are “rational” although only the latter is

consistent with the PWYW equilibrium we suggest. Further, if the firm carries out punishment

as promised, a PWYW equilibrium is indeed “re-established” after m periods when the

punishment is over. The firm has to earn per period profit at π 0 for m periods, but in exchange,
 16

it establishes credibility among consumers regarding its threat when PWYW is re-established at

a higher threshold profit than π 0 . That is, we suggest that renegotiation can at most be a transient

issue (if at all), and the credibility of the firm’s threat among consumers can be established at

least in the long run.

From a more empirical point of view, consumers in general believe in the credibility of firms’

announced commitment to various pricing policies. One example is the no-haggling policy

practiced by (among others) car retailer CarMax and the manufacturers of automobile models

Saturn and Scion. The retailer Filene’s Basement famously employ pre-announced pricing

schemes (Bell and Starr 1994) which consumers believe it will carry out. Such policies may not

survive a theoretical renegotiation-proofness scrutiny but are nevertheless perceived as credible

by consumers.

Coordination mechanisms. When PWYW-sustaining consumer-side equilibria with π ≥

π 0 and m punishment periods do exist, there is no unique equilibrium. Typically, a great

multitude of PWYW equilibria, each corresponding to a feasible payment scheme, can satisfy the

constraints in Proposition 1. In addition, the baseline equilibrium (in which everyone pays zero

whenever S allows PWYW, and FP is implemented subsequently) is always feasible whenever

π ≥ π 0 , even though it is not Pareto optimal when PWYW equilibria exist. The implication is

that consumers might fail to coordinate to sustain PWYW not because each consumer fails to

react “correctly”, but because either: (1) consumer assumptions and behavior are misaligned as

to which particular equilibrium to follow, which results in payments that do not add up to

threshold, or (2) one or more consumers make “irrational”, perhaps unintentional, errors (such as

simple calculation mistakes). Behaviorally, the issue of coordination failure is not unique to our

model but is shared with all other multiple equilibrium games (e.g., Zwick and Rapoport 2002).
 17

It can be envisioned that, given a PWYW firm strategy, over a time horizon that is much

longer than m, consumers can learn to reduce unintentional errors and can coordinate so as to

converge towards an equilibrium. Nevertheless, they may converge to the baseline equilibrium

rather than to any PWYW equilibrium. Therefore, it would be to the firm’s advantage to design

a mechanism that would help consumers align their behavior according to a particular PWYW

equilibrium in the very first place, and help them maintain such an alignment. We offer four

such possibilities:

1. Payment constraints. Suppose S only allows payments under PWYW to be one of three levels:

0, k, and l; moreover, S chooses k, l, and threshold profit π , such that

0 < k ≤ [δ (1 − δ m ) /(1 − δ m +1 )] p 0 < l ≤ [δ (1 − δ m ) /(1 − δ m +1 )] u F and π = Nql + N (1 − q )k .

Then the unique PWYW equilibrium (other than the baseline equilibrium) has every fan (casual)

paying l (k). This occurs because a fan (casual) will pay at most l (k) in any PWYW equilibrium

according to the upper bounds presented in the latter part of Proposition 1 (which still apply

when there are payment constraints), so that total payment reaches π under payment constraints

only when every fan (casual) pays l (k). Payment constraints can therefore trim down the

number of PWYW equilibria to one, which greatly facilitates coordination. Moreover, if the

firm or consumers have uncertainty over the current and/or future values of δ , u F , or p 0 , but it is

commonly known that:

(a) [δ (1 − δ m ) /(1 − δ m +1 )] u F and [δ (1 − δ m ) /(1 − δ m +1 )] p 0 will never be below l and k

respectively, and
 18

(b) π = Nql + N (1 − q )k will never be less than the optimal time-discounted average profit for S

under perpetual FP starting from any period,14 then the firm will maintain a threshold π during

every period while every fan (casual) paying l (k) remains an PWYW equilibrium payment

scheme, irrespective of the uncertainties.

It is arguable that payment constraints compromise the spirit of PWYW by allowing

consumers to pay only at certain levels, but notice that paying zero remains a real option, and, in

principle, every consumer still has a choice to decide how much to pay for S’s product. By

allowing zero payment, however, the baseline equilibrium (in which everyone pays zero

whenever S allows PWYW) remains feasible. The firm can remove this possibility by further

constraining payments to be either k or l. Indeed, PWYW strategies in the field often require a

minimum price (e.g. Regner and Barria 2009), which is a FP-PWYW hybrid.

2. Probabilistic punishment. Consider the following modification to S’s punishment strategy,

which we call probabilistic punishment with upper threshold π , lower threshold π , and m

punishment periods: S announces π and π , with 0 < π < π , such that, if S allows PWYW in

period t and total payment turns out to be Λ t in that period:

(a) If Λ t < π , S switches to FP with posted price p̂ for m periods from t+1 onwards and reverts

to PWYW in period t+m+1;

(b) If Λ t ≥ π , S continues PWYW in t+1;

(c) If π ≤ Λ t < π , S continues PWYW in t+1 with probability (Λ t − π ) /(π − π ) but implements

punishment as in (a) otherwise (i.e. with probability (π − Λ t ) /(π − π ) ).

14
For a firm S with time discount factor, δS, the time-discounted average of a temporal stream of (expected) incomes
∞
x1, x2, … xt, … is defined as (1 − δ S ) ∑δ
t =1
t −1
S x .
t
 19

In Appendix C, we show that PWYW-sustaining consumer-side equilibria under probabilistic

punishment, if they exist, generate per period profit π ; we also present conditions under which

there exist PWYW equilibria with at least as much profit as under perpetual FP.

Probabilistic punishment is a coordination mechanism in the sense that it can be used to

protect an established PWYW equilibrium from crumbling due to some consumers paying less

than what they should. This function is important because, once total payment under PWYW in

a PWYW equilibrium with non-probabilistic punishment falls below threshold, all consumers

may be less inclined to sustain PWYW after the punishment periods are over, thus leading to a

convergence towards the baseline equilibrium. Under probabilistic punishment, even if total

payment falls slightly below the upper threshold, there is still a high probability that PWYW will

continue into the next period. Moreover, as we point out at the end of Appendix C, given that i’s

equilibrium payment is strictly less than an upper bound, as long as the sum of other consumers’

payments under PWYW never falls too far short of that under equilibrium, i still finds following

the PWYW equilibrium to be always preferable to paying zero. This observation that does not

apply to the “step-function” punishment discussed elsewhere in this paper. Thus probabilistic

punishment provides additional robustness for PWYW equilibria over “step-function”

punishment.

3. Consumer communication. In our model, the game that consumers play has the same

flavor as the provision point public goods game. In that literature, van der Kragt et al. (1983)

observe empirically that allowing subjects to communicate before making decisions yields a

much higher success rate of provision relative to when subjects are not allowed to communicate.

We thus surmise that communication will have a similar effect in coordinating consumers to pay

according to a particular PWYW equilibrium. This is by no means a foregone conclusion. In his

 20

survey chapter on public goods experiments, Ledyard (1995, p.158) points out that the evidence

on group gains from communication in environments with thresholds (as in our study) is mixed.

Van der Kragt et al. (1983) report that communication increases efficiency and contribution,

while Chamberlin (1978) and Palfrey and Rosenthal (1991) report no discernible effect. Ledyard

concludes that the effect of communication in environments with thresholds “needs more study.”

4. Suggested payments. If, in addition to the threshold and the number of punishment periods,

the firm recommends a suggested payment scheme to consumers which constitutes a PWYW

equilibrium, the suggested scheme may become a “focal point” (Schelling 1960) and thus

function as a coordination mechanism. This is especially likely when the suggested payment

scheme is perceived as a fair and natural choice of equilibrium, such as when every consumer

(regardless of type) has the same per period utility gain with the scheme. The “equi-earnings”

equilibrium that we use in our experiment provides one such numerical example.

To sum up, we have suggested four mechanisms that firms can adopt to enhance consumer

coordination. The functions of payment constraints and probabilistic punishment have been

demonstrated theoretically. However, communication and suggested payments are behavioral

strategies, the effectiveness of which can only be studied empirically. In the next section we

describe an experiment designed to assess whether these elements of coordination are needed for

the sustainability of PWYW15.

15
Although payment constraints and probabilistic punishment should be effective in enhancing coordination based
on theoretical reasoning, this does not eliminate the need to verify these predictions experimentally. However, we
have elected to experimentally test the effectiveness of the behavioral strategies only, because: (1) they cannot be
justified on theoretical grounds alone, (2) they are the simplest to implement, and (3) they maintain the spirit of
PWYW to the fullest. Clearly, experimentation with payment constraints and probabilistic punishment are
warranted for future studies.
 21

3. An Empirical Examination

3.1 Overview of Our Approach

Our model is intended to be prescriptive for the firm. We do not claim that our model describes

the behavior of firms that offer PWYW, nor is it possible to demonstrate that our model is

isomorphic with the various illustrations we provided earlier, to motivate our study. We do,

however, propose that the PWYW strategy can be profitable for firms if the firm interacts

repeatedly with its customer base, and if that customer base displays certain properties that are

specified in our model. Our theoretical results indicate that under certain specific conditions,

self-interested consumers will find a PWYW pricing scheme with pre-specified threshold and

punishment periods attractive, and will sustain it indefinitely to the benefit of both the firm and

the consumers. For our model to be practically valuable, we need to verify that consumers are

likely to behave according to at least one of the PWYW equilibria that are admitted by the model

given the firm’s strategy. In this respect, to be prescriptive for the firm, the PWYW equilibria

must be descriptive of actual consumer behavior.

The goal of the laboratory experiment reported in this section is to assess: (a) whether

consumer communication and suggested payments, the two behavioral coordination mechanisms

proposed in the previous section, can help consumers align their behavior with a particular

PWYW equilibrium and sustain it indefinitely; and (b) as control conditions, whether (i)

theoretically admissible PWYW equilibria are sustainable without coordination mechanisms, and

(ii) whether PWYW is sustainable even when theory does not admit any PWYW equilibria, such

as when the threshold profit is too high and when there is no punishment. To accomplish these

goals, we study the demand side of our model through an experiment in which subjects, who

play the role of consumers, are exposed to simulated firm strategies. Subjects know that the
 22

firm’s strategy is pre-determined and is not being played by other subjects. This approach likely

removes any altruistic, non-economic motivation on the part of the subjects to sustain a PWYW

just to allow other subjects playing the role of the firm to earn their “fair share”, had the firm

been played by other subjects. If the proposed PWYW strategy is shown to be a sustainable in

the lab when such non-economic considerations have been removed, the strategy might be even

more successful in the field, where non-economic factors including fairness and reciprocity may

play a role in consumers’ payments (e.g., Kahneman et al. 1986).

We now turn to a discussion of several conceptual factors that influenced the design of our

experiment.

3.2 Design

Our design incorporated several elements. First, across all conditions, we controlled for the

demand profile of the consumer market, and kept the punishment scheme simple for subjects to

understand by simulating a “grim trigger” strategy, according to which the firm would switch to

fixed pricing forever, if total PWYW payment failed to reach threshold in a period. This

corresponds to the case when m tends to infinity in our model. Second, we varied the threshold

π , the other parameter of the PWYW strategies that we examine, across conditions. Third, we

examined whether communication among consumers and suggested payment amounts could be

effective coordination mechanisms. Finally, we considered whether descriptive features of the

experimental stimulus might influence subjects’ ability to generate and sustain a PWYW

equilibrium, by varying the richness of the description of the purchase context embedded in the

experiment.16

16
As we describe shortly, our experimental settings incorporated the context of independent music bands. To
eliminate concerns that the “rich” context of indie bands might have primed subjects to employ considerations in
their payment behavior that were specific to that particular context, we performed additional empirical work that
employed “neutral” stimuli.
 23

Model-based factors. We tested three pricing strategies to verify that consumers react to the

threshold and the threat in the predicted manner. Specifically, in Strategy 1, we implemented the

basic model with parameters that satisfy conditions (a) and (b) in Proposition 1, with a threshold

that was set to theoretically admit a PWYW-sustaining consumer-side equilibrium. Strategy 2

was similar to Strategy 1, except that the threshold was set at a high level that theoretically did

not admit PWYW equilibria. In Strategy 3, the threshold was set to zero, which corresponds to a

firm adopting an unconditional PWYW strategy. Of these three pricing strategies, only Strategy

1 theoretically admits PWYW-sustaining consumer-side equilibria.

Note that, if strategic considerations drove subjects to pay non-zero sums under Strategy 1,

then strategic considerations ought to drive subjects to pay zero under Strategies 2 and 3. If, on

the other hand, subjects were motivated by non-strategic considerations such as altruism and

fairness, and therefore paid positive amounts under Strategy 1, then those non-strategic

considerations ought to drive them to pay a positive amount under all three strategies.

Behavioral coordination mechanisms. As discussed above, we manipulated two factors that

may enhance coordination: communication (players were allowed to chat on-line, or not) and

suggested payments (provided, or not provided). Note that, although communication and

suggested payments under Strategy 1 were expected to enhance subjects’ ability to coordinate

and hence sustain PWYW, we expected that, when there was no self-interest based reason to

sustain PWYW (under Strategies 2 and 3), communication and suggested payment should not,

by themselves, be sufficient to generate a sustainable PWYW. That is, communication and

suggested payments can facilitate coordination when PWYW is feasible, not otherwise. If this

expectation turns out to be the case, it strengthens our claim that strategic (rather than non-

economic) drivers are necessary to sustain PWYW under Strategy 1.

 24

Context. We manipulated descriptive elements of the experimental context. While the

subject’s task was to purchase online music in one set of conditions, we provided a relatively

sterile or neutral purchase context in another. Subjects exposed to a “rich” context may

potentially be influenced by the context per se rather than by the strategic nature of the situation

(e.g. Chou et al. 2009). Conversely, subjects exposed to a relatively neutral stimulus might focus

more on the strategic elements of the task. This manipulation, therefore, allows for the

identification of a boundary condition for the model, if the sustainability of PWYW is dependent

on the richness of the purchase context.

Figure 2 summarizes our design. Under Strategy 1, two levels of context (rich versus neutral)

were crossed with three levels of coordination, resulting in conditions labeled “No

Chat/Suggestion,” “Chat/No Suggestion,” and “No Chat/No Suggestion”, where “Suggestion”

indicates the provision of a suggested payment scheme 17. Under strategy 2, two levels of context

(rich versus neutral) were combined with the Chat/No Suggestion condition. Six groups of

subjects in each of the above combinations participated under the rich context manipulation and

two groups participated under the neutral context manipulation. In addition, two groups of

subjects participated under Strategy 3, which employed the rich context with the

Chat/Suggestion manipulation.18

17
A “Chat/Suggestion” condition would have made the design a complete factorial design, but this cell was not
included because any information from that cell would have been redundant, in light of the information we would
obtain from the chat condition.
18
A complete factorial design incorporating all three factors would have been prohibitively complex. Further,
Strategy 1 is the option that represents our principal strategy of interest, whereas Strategies 2 and 3 serve as controls.
We selected the environment for Strategies 2 and 3 that was most likely to sustain PWYW. Therefore, they likely
would provide a strong test for our claim that strategic considerations are necessary to drive payments under
Strategy 1, if indeed, subjects reverted to zero payment under Strategies 2 and 3.
 25

---------------------------------------

Insert Figure 2 about here

---------------------------------------

3.3 Experimental Procedures

Subjects were divided into groups of eight, and every subject interacted with the same group of

seven other subjects throughout the session. During the experiment, all decisions were made via

networked computers using the z-Tree software (Fischbacher 2007). Two hundred seventy-two

undergraduate subjects from a university in Hong Kong participated in the experiment. All the

subjects volunteered to participate in the study, which was billed as a decision-making

experiment with payoff contingent on performance.

Each session consisted of a practice game followed by 20 games. Each game consisted of an

indefinite number of rounds such that, after every round, there was a 90% probability that the

game would continue to the next round and a 10% probability that the game would end

immediately. This procedure thus created an effective per period time discount factor of δ = .9

for the subjects. This is a common procedure employed in laboratory experiments designed to

mimic infinitely repeated games with time discounting (Zwick et al. 1992). In every condition,

after all the games were concluded in a session, 5 games were chosen at random from the 20

games played and each subject was paid his/her earnings from all the rounds in those games after

converting tokens (the experimental currency) to Hong Kong dollars (US$1 = HK$7.8).19 In

addition, every subject was paid a show-up fee of HK$40. Average subject payment across all

conditions, including the show-up fee, was HK$171.7.

19
The conversion rate is 1 token = HK$0.1 for the three conditions with threshold = 400 tokens, and 1 token =
HK$0.4 for the condition with threshold = 680 tokens. These rates make the expected payoff of the Pareto optimal
equilibria in all main conditions approximately the same. The conversion rate is 1 token = HK$0.1 for the no
threshold condition.
 26

For expository convenience, we first describe the experimental context.

Context. Recall that context was manipulated by providing subjects rich information or

neutral information. The actual instructions used in both contexts are included in Appendix D.

Rich context. Subjects were told that two (fictitious) bands, “Playa” and “Quello”, each

uploaded a new song to their site during every round of the game, to allow people to listen to it

online. During each round, a player could either listen to a Playa song or to a Quello song, or to

none. At the beginning of each game, each player was assigned to one of two types: “Fan of

Playa” or “Casual Listener”. These categories corresponded to the “fan” and “casual” segments

in our model, with Playa representing the firm S, and Quello representing the outside option.

The assignment of types was such that, of the eight players in each group, two were Fans of

Playa and six were Casual Listeners, yielding q = 1/4. Every player’s role stayed the same in all

rounds of the same game, but was re-assigned randomly from game to game, with the constraint

that each player had to be a Fan of Playa in 5 games and a Casual Listener in 15 games. The

valuations of the different types of players towards the different bands’ music follow the model

with u F = 201 tokens and u C = 49 tokens. The price of the outside option, i.e. Quello, was

p 0 = 48 tokens. Subjects were told that, in the first round of every game, Playa allowed every

listener to pay as s/he wished, i.e., Playa’s first-round strategy was always PWYW. Moreover, if,

in a round with PWYW, the total payment that Playa received from its listener(s) reached a

threshold number of tokens (400 under Strategy 1 and 680 under Strategy 2), Playa would

continue to allow every listener to pay as s/he wished in the next round (if the game continued

into the next round), but if Playa received less than the threshold amount in a round, it would

change its pricing scheme and would charge every listener a fixed price of 200 tokens per round

in all future rounds (if any) of the same game. In every round of the game, a player needed to
 27

choose one from the following set of options: listen to a song by Playa, listen to a song by Quello,

or listen to neither. If Playa employed FP in that round and if Quello or Playa were chosen, the

player earned a net payoff that was equal to her valuation of the song of her choice minus its

(fixed) price. If Playa allowed PWYW in that round and the player decided to listen to a Playa

song, she entered the price she decided to pay for the song and she earned a net payoff that was

equal to her valuation of the Playa song minus the price she decided to pay for it (see Appendix

E for sample screenshots of the decision screens). After a round in which Playa allowed PWYW,

all players were informed about the decisions of all other players, though players were not

identifiable and so the decision history of individual players could not be traced by others.

Players were also informed about whether total payment reached the threshold and whether

Playa would continue to allow PWYW in the next round. A randomization process then took

place to determine if the game proceeded to the next round or was terminated.

Neutral context. The instructions were structurally similar to those provided in the “rich”

condition, except that no specific context was provided. For example, subjects were given

options named “S”, “N”, and “R” to choose from, instead of “Playa”, “Neither”, and “Quello”.

Their experimental task was described plainly as a choice between three options rather than a

choice between listening to a song from Playa, Quello, or neither. At the beginning of each

game, subjects were assigned to be of either “Type Y” or “Type Z”, instead of “Fan of Playa”

and “Casual Listener”. The threshold was described in neutral terms: PWYW continued in the

next round with option S iff (1) the payment scheme for S was PWYW in the current round and

(2) total payment to S reached a pre-announced threshold in the current round. However, context

description apart, the experimental treatment was identical between groups playing within every

condition.
 28

Strategies. The three strategies were operationalized as follows.

Strategy 1. In this condition the game’s parameters satisfied conditions (a) and (b) in

Proposition 1 and the threshold was set to allow a theoretically sustainable PWYW. The

parameters were: N = 8, δ = .9, q = 1/4, u F = 201 tokens, u C = 49 tokens, and p 0 = 48 tokens.

Since qu F = 50.25 tokens > p0 , and δ {1 + [(1 − q ) p 0 / qu F ]} = 1.545 > 1 , conditions (a) and (b) in

Proposition 1 were satisfied. Subjects were told that, in the first round of every game, they could

pay as much as they wished for the offering from firm S. Moreover, if, in a round with PWYW,

the total payment to S reached 400 tokens ( π =400 tokens), PWYW would continue in the next

round (if the game continued into the next round), but if the total payment turned out to be less

than 400 tokens in a round, S would change its pricing scheme and would charge a fixed fee of

200 tokens per round in all future rounds (if any) of the same game ( p̂ =200 tokens). From

Proposition 1, we know that PWYW-sustaining consumer-side equilibria with theoretical

threshold profit (after accounting for the total number of consumers) is between 402 (= 8quF )

and 621 (= 8 δ [quF + (1 − q ) p0 ] ) tokens; however, for practical reasons, we used a threshold profit

of 400 tokens.20

Strategy 2. The purpose of this condition was to eliminate the possibility that non-strategic

considerations might drive a sustainable PWYW outcome. Such an outcome might occur if

subjects adhere to a payment scheme that is in fact not incentive compatible in terms of their

own monetary payoffs, but which allows them to derive extra utility due to the sheer ability to

20
According to theory, the per period optimal price for S should indeed be 201 tokens, and thus, once S turns to FP,
it should charge 201 tokens rather than 200 tokens, and earn a per period profit of 402 tokens. However, in the
experiment, to make sure that there was no tie between any two alternatives under FP, we used 200 tokens as S’s FP
(which means that its per period profit under FP was 400 tokens) so that Fans were expected to strictly prefer S to no
purchase (and the outside option) when S switched to FP. This does not alter our conclusions based on Proposition 1.
What it amounts to is simply changing the effective uF to 200 tokens for ease of calculation.
 29

sustain PWYW through cooperation. In such an event, a high threshold would also yield

PWYW outcomes.

Recall that per period profit under any PWYW equilibria must be no more than 621 tokens, if

we apply Proposition 1 to our parameters. In this condition, we raised the threshold profit

requirement to 680 tokens ( π =680 tokens). Thus PWYW should be unsustainable unless non-

strategic considerations play a role in consumers’ decisions.

Strategy 3. This strategy was similar to Strategies 1 and 2 except that the threshold was set to

zero ( π =0 token). That is, S implemented PWYW unconditionally whatever payments (if any)

it received from the players. Although the threshold was effectively set at zero, subjects were

told that the focal firm’s management hoped to receive at least 400 tokens every round from their

customers. This experimental condition is important because our proposed PWYW strategies are

crucially dependent on consumers’ reaction to the firm’s use of the threat to switch to fixed

pricing in all future periods if the threshold is not met. Since there is no such threat in this

condition, if we find that consumers pay positive prices under Strategies 1 and 3, our premise

that subjects reacted to the firm’s threat of employing a fixed price in the future would be

questionable. If, on the other hand, PWYW was sustainable under Strategy 1 but consumers

reverted to paying zero under Strategy 3, we can infer that consumers did respond to the firm’s

threat to switch to fixed price in the future (i.e., strategy 1).

Coordination mechanisms. The two coordination mechanisms were operationalized as

follows.

Communication. In the no-communication condition (no chat condition) subjects made their

decisions without communicating with each other. In the communication condition (chat
 30

condition) subjects in the same group were allowed to engage in an online chat in a “chat forum”

before the first period of every game for a limited duration.21

Suggested payments. In conditions with suggested payments, all subjects were provided a

suggested payment scheme for sustaining PWYW. The suggested scheme appeared on every

decision screen and was also mentioned in the instructions. For example, under the rich frame

manipulation, subjects read the following instructions:

Suggested payments under the “pay as you wish” scheme

Although Playa allows players to pay as much as they wish for listening to their song in a
round when the “pay as you wish” scheme is implemented, they nevertheless provide
suggested payment amounts. In particular, they suggest that Fans of Playa pay 164
tokens and hence earn (201-164=) 37 tokens in such a round. Causal Listeners are
suggested to pay 12 tokens and hence earn (49-12=) 37 tokens in such a round. If all
players pay their suggested amount in such a round, the total payment to Playa will be
(2x164+6x12=) 400, exactly the amount needed to keep the “pay as you wish” scheme
going to the next round (if there is a next round).

3.4 Analysis and Results

All analyses and results reported here exclude data from the practice game, since subject

behavior in the practice game was not incentivized. Our dependent variables of interest are the

mean payment for the focal firm’s product in a PWYW round, and the number of rounds with

sustained PWYW (a round with sustained PWYW is one in which PWYW is allowed and total

payment to the focal firm reaches the threshold). We first describe our statistical analyses and

then provide some insights that emerge from an examination of the chat log.

Statistical analyses. We first test for the effect of context. We conducted an ANOVA

employing a 2 (context: rich or neutral) x 3 (communication and suggested payment

21
We ran a pilot session with unlimited chat allowed throughout the experiment; the results were similar to the chat
condition reported here, but it took subjects almost three hours to finish the session. Therefore, for practical reasons,
we chose a limited duration structure for our main experiment. The allowed duration for chat before each game was:
(1) Practice Game to Game 6: 3 minutes per game; (2) Game 7 to Game 13: 2 minutes per game; (3) Game 14 to
Game 20: 1 minute per game.
 31

combinations: No Chat/No Suggestion; Chat/No Suggestion; No Chat/Suggestion) design under

Strategy 1, on the two dependent variables. We find that there is no significant main effect of

context (F(1,18) = 1.02, p > .3 and F(1,18) = 1.82, p > .1), nor is there a significant interaction

(F(2,18) = 0.79, p > .4 and F(2,18) = 1.45, p > .2) under Strategy 1 for both the overall mean

payment and number of sustainable PWYW rounds, respectively. We also analyzed a simple

effect of context under Strategy 2 and found no significant main effect (F(1,6) = 3.28, p > .1 and

F(1,6) = 1.27, p > .3), for both variables. Thus we conclude that context has no effect on the

dependent variables, and therefore, for the remaining analyses, the data from the two contexts is

combined.

Table 2 presents the main results (aggregated over context). A preliminary inspection of

Table 2 reveals that mean payments in a PWYW round (average over consumer type: 49.40

tokens) and sustainability (167.50 rounds) is much higher under Strategy 1 Chat/No Suggestion

condition than under any other condition, except, of course, for sustainability under Strategy 3.

In that condition, because of the zero threshold, any payment (including zero) yields a

sustainable outcome.

------------------------------------------

Insert Table 2 about here

------------------------------------------

The importance of coordination is confirmed by further statistical analysis on the mean

payment in PWYW rounds and the number of rounds with sustained PWYW. A 1-factor

(coordination type) MANOVA on both dependent variables reveals significant main effects

across the three coordination conditions under Strategy 1 (Wilks’ λ = .087, F(4,40) = 23.81, p

<.0001). This is confirmed by a univariate ANOVA for both variables (F(2,21)=5.19, p = .015
 32

for mean payments in PWYW rounds, and F(2,21)=91.01, p < .0001 for sustainability,

respectively). Pair-wise comparisons using MANOVA confirm that both variables are indeed

significantly higher in the Chat/No Suggestion condition than in any of the other two conditions

(Chat/No Suggestion vs. No Chat/No Suggestion: Wilks’ λ = .027, F(2,13) = 234.24, p <.0001;

Chat/No Suggestion Vs No Chat/Suggestion: Wilks’ λ = .12, F(2,13) = 45.99, p <.0001). These

results are confirmed by corresponding univariate pair-wise comparisons with each dependent

variable (p< .05 in all comparisons). A pair-wise comparison between the Chat/No Suggestion

conditions under Strategies 1 and 2 also shows a significant effect (Wilks’ λ = .028, F(2,13) =

221.70, p <.0001) that is confirmed by univariate pair-wise comparisons of both dependent

variables (p<.01 in all comparisons).

Further pair-wise comparisons using MANOVA reveal no other significant effects between

conditions in Strategies 1 and 2 at p < .1. But univariate comparisons involving only the number

of rounds with sustained PWYW show that No Chat/Suggestion in Strategy 1 yielded higher

sustainability of PWYW than the No Chat/No Suggestion condition in Strategy 1 and the

Chat/No Suggestion condition in Strategy 2, with marginal significance (F(1,14)=3.35, p = .089

and F(1,14)=3.49, p = .083 respectively). The first result implies that a suggested payment has

some positive impact on PWYW sustainability compared with no suggestion or when the

threshold is too high (even if consumers can communicate with each other in the latter case). No

other pair-wise comparisons of either of the two major dependent variables among conditions in

Strategies 1 and 2 yield effects at the p < .1 level.

It is also clear from Table 2 that unconditional PWYW (Strategy 3) yielded much lower

payments than conditional PWYW that allows for theoretically sustainable PWYW (Strategy 1).

A pair-wise comparison between the conditions in Strategy 1 and Strategy 3 shows that mean
 33

payments in PWYW rounds are significantly higher in any of the former than in the latter (No

Chat/No Suggestion: F(1,8)= 8.71, p = .018, Chat/No Suggestion: F(1,8)= 4021.05, p < .0001,

No Chat/Suggestion: F(1,8)= 19.27, p = .0023). But there is no significant difference in mean

payments between the conditions in Strategies 2 and 3 (F(1,8)= 1.47, p > .2).

Figure 3 presents the mean number of rounds with sustained PWYW classified by the game’s

length (in rounds). For purposes of reference, under perfect sustainability, a line representing

y=x is also provided. Under Strategy 1 Chat/No Suggestion condition, the plot is much closer to

the perfect sustainability line than the plots associated with the other conditions, providing a

visual illustration of the importance of both the threat of a fixed price and the availability of chat

in sustaining PWYW.22

------------------------------------------

Insert Figure 3 about here

------------------------------------------

Based on these analyses, we conclude that the experimental data demonstrates the feasibility

of the proposed PWYW policy. That is, within the context of our experiment, a PWYW strategy

with a pre-announced profit threshold induces highly sustainable PWYW iff: (1) there exists an

individually incentive compatible payment scheme that sustains PWYW (i.e. PWYW-sustaining

consumer-side equilibria are theoretically sustainable given the strategy), and (2) subjects can

communicate with each other to coordinate among themselves to sustain PWYW.

How does communication function as a coordination mechanism? Based on van der Kragt et

al. (1983), we suggest that, first of all, communication allows subjects to align their strategies

along one payment scheme; secondly, communication helps subjects to make a commitment to

each other on adhering to an agreed upon payment scheme. To further examine these proposed
22
Strategy 3 is not included in the figure since sustainability is not a valid indicator.
 34

functions and the nature of communication that occurred during the chat periods, we next turn to

an analysis of the chat log.

Thick Description. The following qualitative insights emerge from an examination of the

raw data and the chat log:

(1) Under fixed pricing, subjects paid according to predictions (i.e. Fans of Playa chose Playa

and Casual Listeners chose Quello) in at least 96% of the observations in any condition;

(2) In Strategy 1 Chat/No Suggestion condition, six groups played according to the equi-earnings

equilibrium. The remaining two groups played according to almost equi-earnings equilibria,

with the per round payments of Fans of Playa/Casual Listeners being 170 tokens/10 tokens

for one group and 162 tokens/13 tokens (which make up a total payment of 402 tokens) for

another group;

(3) It appears that many subjects intuited from early on that they should cooperate to sustain

PWYW under Strategy 1 ( π =400). This is most directly reflected in the chat log in the Chat

condition in which there was hardly any challenge to the notion that subjects should

cooperate. Subjects were instead occupied from early on with arriving at a commonly agreed

upon payment scheme through chat. Here are some suggestive quotes:

a. “ …[if] anyone cheat (sic) all of us get the least ... including the cheater,”

b. “ If we know when [the game ends] we can simply pay zero [in the last round] ...

but [since we do not, it is] not worth taking the risk,”

c. “… please think of the benefit of the whole team,”

d. “… if you break our relationship ... you will earn less,”

e. “PLEASE DON'T TRY TO CHEAT!!!!!!!!!!!!!!!!!”

f. “…the more the number of round[s] the more we gain.”

 35

(4) Although our experiment was not designed to explore how chat enhances the sustainability of

PWYW, nevertheless, a causal inspection of the chat log in the Chat condition of Strategy 1

seems to support the assertion provided by van der Kragt et al. (1983) that chat enhances

cooperation in two major ways:

(a) Subjects can align their strategies by working out a PWYW-sustaining payment scheme

that just sums up to the threshold and which everyone agrees upon. Such a payment

scheme is essentially what van der Kragt et al. call a “minimally contributing set”, as no

subject has an incentive to deviate by paying less than specified in the scheme. In the

experiment, this was usually achieved by one player suggesting the payment scheme and

then discussing with/explaining to other players why they should follow it;

(b) Subjects can make commitments to each other that they will adhere to the payment

scheme that is agreed upon. In other words, chat allows for the establishment of an

obligation or a “social contract”, even though chat is essentially “cheap talk” and, if

individual deviations in a game occur, it was impossible to identify renegades who might

have violated their commitment to pay their share. It was typical that, following the

suggestion and discussion of a particular payment scheme, every player would send out a

single-line message as a confirmation to others of his/her agreement with the scheme,

before the chat session was concluded for the upcoming game. Also, since the No

Chat/Suggestion condition under Strategy 1 did not lead to highly sustainable PWYW, a

“social contract” is apparently essential for PWYW sustainability in the chat condition;23

(5) In the No Chat/No Suggestion condition under Strategy 1, subjects appeared to have serious

coordination problems. Attempts to sustain PWYW by individual subjects were very often

23
Since no “social contract” can be established if there is no agreed upon payment scheme to start with, an agreed
upon payment scheme is therefore necessary for the manifestation of a social contract.
 36

undermined by other subjects’ low or zero payments. Even in the No Chat/Suggestion

condition under Strategy 1, initial enthusiasm to sustain PWYW could have been dampened

because certain subjects tried to take a little advantage by paying slightly less than what was

suggested for their role, despite the very clear realization that everyone’s payment was

critical to sustaining PWYW. However, attempts to establish sustained PWYW were

observed throughout the session in both No Chat conditions of Strategy 1;

(6) Under Strategy 2 (Chat/No Suggestion), the data show that subjects in general quickly

arrived at the understanding that it was best for them not to sustain PWYW and pay zero

tokens for Playa’s song in every game’s first round; and

(7) Subjects under Strategy 3 always took advantage of Playa and paid close to zero for their

song. The mean (standard deviation) individual payment was 1.85 (2.14) tokens (average

over both types). Although subjects were told that Playa’s management hoped to receive at

least 400 tokens every round, the mean total payment was always far lower than that.

Subjects paid zero tokens to Playa in 69.97% of the observations. There are only 46

observations (i.e. 1.51% of all observations under Strategy 3) of a subject paying according

to the suggested equi-earnings scheme. We conclude that, when there was no threat to

switch to fixed price if total payment did not reach the threshold, subjects almost never

collectively paid under PWYW to reach 400 tokens, despite Playa’s plea for a payment of

400 tokens every round. Seemingly, non-economic factors such as altruism and fairness

were not the main considerations among our subjects.

4. Concluding Remarks

4. 1 Summary
 37

In this paper, we first develop a simple economic model to investigate whether and how a firm

can continuously earn a profit by allowing self-interested consumers to pay whatever they want

for its products. Our model incorporates an infinitely repeated pricing game with (effectively) a

two-segment market, in which the firm could use a switch from “pay what you want” to fixed

pricing over a pre-specified number of “punishment periods” as a threat to incentivize consumers

to pay a sufficiently high price even under PWYW. Our model predicts that a market of

consumers admits a PWYW sustaining consumer-side equilibrium when the consumers are very

forward looking and a portion of them are “priced out” under a fixed price only regime, because

the firm earns a slightly higher profit by setting a high price relative to when it prices sufficiently

low to capture all consumers.

We then offer four coordination mechanisms that are aimed to avoid coordination failures in

sustaining PWYW. Two of these are justifiable on theoretical grounds while the other two,

namely that consumers are allowed to communicate before making payment decisions and that

consumers are provided suggested payments, are behavioral strategies inspired by previous

literature and require empirical verification. We therefore experimented on the latter two

strategies, and concluded that, while suggested payments did not lead to a sustainable PWYW

equilibrium, consumer communication proved to be an effective coordination mechanism.

Overall, within our experimental conditions, a PWYW strategy induced highly sustainable

PWYW among consumers iff: (1) the strategy theoretically admits PWYW-sustaining consumer-

side equilibria, and (2) subjects were allowed to communicate with each other.

4.2 Implications

Theoretical issues. According to our model, it is sufficient that the firm sets a PWYW

“target” or “threshold” that it estimates is at least as much as the amount it would earn under
 38

other pricing schemes, announce this threshold to consumers, and alerts them to actions that it

will take in the future that would adversely affect consumers if the threshold was not reached.

This is a purely self-interest based argument. However, in light of the extant literature that

suggests a role for non-economic factors, we wished to assess whether PWYW can be a

profitable strategy even when consumers are not motivated by altruism or their innate sense of

fair play. Consequently, in our experiment, we attempted to eliminate the potential impact of

non-economic factors by having subjects play against a simulated firm rather than another

subject.

Whether non-strategic factors are sufficient to behaviorally sustain a common, unconditional,

PWYW scheme (such as under Strategy 3) is an open question. Our speculation, based on our

results (recall that Strategy 3 failed to sustain PWYW outcomes) is that non-economic factors

such as altruism, a fairness motive, and the like, are insufficient to sustain PWYW as a long term

pricing policy.

However, if the conditions specified in our model are fulfilled, the likelihood of PWYW

being a sustainable profit-generating pricing strategy is likely to be enhanced when consumers

are altruistic as well. That is, non-economic factors that foster the norm of reciprocity and fair

play will likely improve the firm’s profits under a PWYW pricing environment.

Managerial issues. Our results suggest that for PWYW to succeed, the firm must clearly

announce its intention to switch from PWYW to a fixed price over a pre-specified duration24

should a pre-specified revenue threshold not be achieved, and this explicit threat must be

perceived to be credible by consumers. Furthermore, the PWYW strategy does not have to be a

loss leader strategy that needs to be subsidized by derivative, secondary revenue. In markets in

24
It suffices if this pre-specified duration is understood by the consumers to be the minimum (as opposed to precise)
duration of fixed price punishment. It is straightforward to deduce that a PWYW equilibrium satisfying Proposition
1 with threshold π and m punishment periods remains admissible when m is longer, controlling for π.
 39

which there is a segment of “die-hard” consumers, who can potentially influence casual

consumers, PWYW is a feasible pricing strategy, so long as there is repeated interaction between

the firm and consumers, and our other modeling assumptions are not violated.

These theoretical conditions are likely to be observed in the case of independent music bands,

particularly when their fans communicate with each other and with casual listeners, since such

communication can serve as an effective coordination mechanism. A small group of lovers of

non-mainstream music likely constitute the band’s core customers, who form a closely knit

social network with frequent communication through blogs, social network sites, tweets, and the

like. Further, fans probably have the ability to influence a “casual” segment (comprising friends

and relatives) to patronize the band and pay sufficiently high prices, so that fans may avoid

paying a high fixed price in the future.25 Similarly, a neighborhood restaurant serving a local

community might meet the criteria as well. The restaurant could build a brand reputation for

being sensitive to social welfare-issues, and thus attract a “fan base” who then influence their

social network to patronize the restaurant and pay sufficiently high prices to avoid the prospect

of a higher fixed price. In addition, the firms in these examples can restrict the range of

acceptable payments, a regime that is relatively easy to implement especially in online

transactions, and probabilistic punishment, to help consumers sustain PWYW. Note that, in

practice, in a probabilistic punishment world, consumers need only infer that the firm would

continue PWYW with some likelihood even if total payment does not reach threshold, but this

likelihood will decrease as the gap between the total payment and the threshold increases.

4.3 Limitations and Future Research

25
For example, the website Kroogi.com, which is a content community where musician, artists, writers and
photographers post copyrighted materials, allows consumers to self select themselves to ever expanding “social
circles” of fans and to download the materials based on the traditional PWYW model. Online chat forums for
various circles of fans are provided by the site developer.
 40

Although the roles of constraints on payment amounts and probabilistic punishment as

coordination mechanisms are theoretically justifiable, it would be valuable to verify them

empirically. Meanwhile, our experiment employed only eight consumers in each market.

Laboratory conditions do not allow for the conduct of experiments with group sizes that

approximate naturally occurring markets, so our results may immediately apply only to relatively

niche markets with a small number of potential consumers. Clearly, it would be useful to

conduct field experiments to see if the insights we gain from our experiment generalize to larger

markets.26 More crucially, our idea of increasing consumers’ incentive to pay (in fact,

incentivizing even the most “selfish” consumers to pay) by communicating a credible threat has

not been tested empirically in the field.

In face-to-face interactions, consumers might develop “reputations” which ought to limit

free-riding and thus reduce coordination problems. Consumers may also derive utility from

PWYW pricing schemes and may wish to encourage the firm to continue using this mechanism,

and therefore may choose to pay sufficiently high prices to sustain a PWYW outcome. For

example, 27% of the consumers (out of 12,643) who responded to a survey after paying what

they wished while downloading the “World of Goo” game selected the option “I like the pay-

what-you-want model and wanted to support it” in answer to the question “Why did you choose

that amount?”27. Future modeling work might take these factors into account to add richness to

the theoretical argument and practical applicability of PWYW strategies.

26
The fan base need not be very large for profitable application of our proposed pricing scheme. For example,
musician Matthew Ebel said that he makes 26.3% of his net income from just 40 hard-core fans
(http://www.musicthinktank.com/blog/in-defense-of-1000-true-fans-part-ii-matthew-ebel.html) which relates to
Kevin Kelly's theory that to be a success as a content creator, you just need 1,000 "true fans."
(http://www.kk.org/thetechnium/archives/2008/03/1000_true_fans.php).
27
We thank Ron Carmel and Kyle Gabler, the 2D Boy team, for sharing the survey data with us.
 41

In our model, the firm’s threat is the institution of an unpalatable fixed price regime, should a

threshold level of profit not be achieved. An alternative and viable threat in some instances (e.g.,

non-governmental organizations) is the prospect of the firm closing its shutters. This scenario

can be formulated as a game similar to our model. Exiting from the market can be used as a

threat to induce consumer-side equilibria that sustain PWYW. A simple adaptation to our

standard model would be: (1) maintain the setup of a potential market of “fans” and “casuals”

with different valuations u F and u C respectively, towards the organization’s offering ( u F > u C );

(2) however, no consumer in the potential market has any outside option, the organization’s

offering being considered unique (competition between organizations can also be modeled); (3)

the threshold is then taken as the per period fixed cost of operation, T; (4) for expository

purposes, simply assume that once the organization exits from the market, it exits forever, so that

all consumers in the potential market earn zero utility in all subsequent periods. Then, a

calculation similar to that employed to prove Proposition 1 shows that, if δ [q u F + (1 − q )u C ] ≥ T ,

a PWYW strategy with threshold π such that δ [q u F + (1 − q )u C ] ≥ π ≥ T admits PWYW-

sustaining consumer-side equilibria while generating sufficient revenue for the organization to

survive.28

28
A related tactic was used in 2000 by Stephen King when he started publishing The Plant as an electronic serial.
On his website he promised to unconditionally publish the first two installments (by July 24 and August 21, 2000).
He asked that readers pay at least $1 for each download under an honor-system payment model. That is, payment
was not enforced and readers could have chosen to pay nothing and have still downloaded the first two installments.
King further promised that if pay-through equaled or exceeded 75%, Installment Three would go up in September.
As long as pay-through equaled or exceeded 75%, King promised to carry The Plant through to its conclusion.
However, if pay-through fell below the set threshold, King committed to pull the plug on the story. In his words "If
you pay, the story rolls. If you don't, the story folds." The pay-through rates for installments 1 and 2 were 75% and
70%, respectively. For the third installment the rate rose back to 75% but for the fourth installment the pay-through
rate dropped to 46% and King pulled the plug on the book. The book has yet to be completed. Other authors have
used similar online publishing methods with varying degrees of success (e.g., Lawrence Watt-Evans’ The Spriggan
Mirror and Diane Duane's The Big Meow.) Note, however, that in this model the value of an installment may be
higher for those who have already invested in earlier ones.
 42

Finally, model extensions could incorporate competition, and each of the competing firms

can decide between PWYW and FP for its product in every period of an infinitely repeated

pricing game. The model might also consider a highly stochastic market environment in which

consumer tastes and outside options change from period to period. In these scenarios, we still

expect that equilibria with profitable PWYW could exist over some parameter ranges, as long as

sufficient numbers of repeated interaction occur and FP can be used as a credible threat.

However, coordination issues remain, and experiments on these extended models could yield

insights on how PWYW could be sustained in such highly complex business environments.
 43

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 47

Table 1

Consumer valuations in the standard model

S’s product The outside option

Fan uF 0

Casual uC uC

Table 2

The mean payment in a PWYW round and mean number of rounds with sustained PWYW

Mean payment in
Mean no. of
a PWYW round
rounds (s.d.)
(s.d.)

with
Strategy Fans Casuals played sustained
PWYW

No Chat 75.96 18.41 191.50 10.50

No Suggestion (39.84) (14.50) (4.87) (9.96)
Chat 160.76 12.28 193.00 167.50
1
No Suggestion (4.96) (1.01) (5.15) (18.24)
No Chat 117.61 11.36 191.88 35.88
Suggestion (41.01) (4.31) (4.67) (37.95)

Chat 48.06 14.25 192.75 9.25

2
No Suggestion (57.01) (12.93) (4.50) (13.65)

Chat 3.87 1.17 190.00 190.00

3
Suggestion (3.84) (1.58) (0.00) (0.00)
 48

Figure 1

The PWYW pricing game: sequence of decisions in each period.

Firm S
Announces pricing decision

FP: price p PWYW

Each consumer decides whether to Each consumer decides whether to

Buy Buy from S Buy

Buy from S Make No Make No
outside at price of outside
at price p purchase purchase
option choice option
 49

Figure 2

The Experimental Design

Strategic Factors Non-Strategic Factors

Pricing Strategy Communication and Suggested Payments Context

No Chat / No Suggestion
Rich
Strategy 1 Chat / No Suggestion
No
No Chat / Suggestion

Rich
Strategy 2 Chat / No Suggestion
Neutral

Strategy 3 Chat / Suggestion Rich

The common parameters in all conditions are δ = .9, q = 1/4, u F = 201 , u C = 49 , p 0 = 48 and
p̂ =200 (except in Strategy 3).

The Pricing Strategies:

Strategy 1 In the first round of every game, subjects can pay as much as they wish for firm
S’s offering. Moreover, if, in a round with PWYW, the total payment to S reaches
400 tokens ( π =400), PWYW will continue to the next round (if the game
continues into the next round), but if the total payment is less than 400 tokens in a
round, S would change its pricing scheme and would charge a fixed fee of 200
tokens per round in all future rounds (if any) of the same game ( p̂ =200).

Strategy 2 Similar to Strategy 1 except that the threshold is raised to 680 ( π =680).

Strategy 3 S implements PWYW unconditionally in every round.

 50

Figure 3

Mean number of rounds with sustained PWYW in games with different total number of rounds

15
14
13
12
Mean no. of rounds with

11
10
sustained PWYW

9
8
7
6
5
4
3
2
1
0
4-5 6 7 8 9 10 11 12 13 14 15
Total no. of rounds

Strategy 1, No Chat / No Suggestion Strategy 1, Chat / No Suggestion

Strategy 1, No Chat / Suggestion Strategy 2, Chat / No Suggestion

Perfectly sustained PWYW

 APPENDICES (to be published online as Electronic Companion)

APPENDIX A: Proof of Proposition 1

The aim of the proposition is to outline conditions under which a PWYW strategy with

threshold π ≥ π 0 and m punishment periods admits consumer-side equilibria that sustain PWYW.

So, consider a PWYW strategy with threshold π = π 0 + ∆ , where ∆ ≥ 0 . Consider payment

schemes according to which consumer i pays the same pi for S’s product in every period with

PWYW. Any one such payment scheme can be represented by the set { pi } . We shall examine

the necessary and sufficient conditions for the existence of an incentive compatible { pi } that

sustains PWYW given the threshold π = π 0 + ∆ .

We start with the necessary conditions, which will make up the “only if” part of Proposition

1. Suppose an incentive compatible and PWYW-sustaining { pi } exists. Then, as detailed in

footnote 12 in the main text, the sum of the pi s must add up to exactly the threshold π 0 + ∆ :

(1) ∑pi
i = π0 + ∆ .

Moreover, every consumer must find that paying pi every period for S’s products is at least

as good as paying zero for S’s product in a period and then buying S’s products or the outside

option for m periods afterwards under FP. That is:

1 − δ m +1 δ (1 − δ m )(u F − pˆ ) δ (1 − δ m )
(2a) If i is a fan, ⋅ (u F − pi ) ≥ u F + , or pi ≤ pˆ ;
1−δ 1−δ 1 − δ m +1

1 − δ m +1 u C − pi δ (1 − δ m )(u C − min{ pˆ , p 0 })
(2b) If i is a casual, ⋅ ≥ uC + , or
1−δ 1−δ 1−δ

δ (1 − δ m )
pi ≤ min{ pˆ , p 0 } ,
1 − δ m +1
where p̂ is the one-period optimal selling price for S, which is also the price it will post under

perpetual FP with constant price. Note that, strictly speaking, we should also write out the

constraints ∀i pi ≥ 0 at this point, but the above conditions certainly satisfy these constraints,

and the following deductions are unaffected as well.

Now, if there exists a payment scheme that satisfies conditions (1), (2a), and (2b), we must

have:

δ (1 − δ m )
⋅ N [q ⋅ pˆ + (1 − q ) ⋅ min{ pˆ , p 0 }] ≥ π 0 + ∆ .
1 − δ m +1

It is easy to see that, when qu F < p 0 , so that pˆ = p 0 = π 0 / N , the above inequality is impossible

to fulfill, given δ < 1 and ∆ ≥ 0 . Therefore we must have qu F ≥ p 0 so that pˆ = u F and

π 0 = Nqu F , and the above condition becomes:

δ (1 − δ m )
⋅ N [qu F + (1 − q ) p 0 ] ≥ Nqu F + ∆ , or
1 − δ m +1

δ (1 − δ m )
⋅ [qu F + (1 − q ) p 0 ] − qu F ≥ ∆ / N .
1 − δ m +1

Thus, if ∆ ≥ 0 , we must have:

qu F ≥ p 0 , and

δ (1 − δ m ) δ (1 − δ m )  (1 − q ) p 0 
⋅ [ qu + (1 − q ) p ] − qu ≥ 0 , i.e. ⋅ 1 +  ≥ 1.
1 − δ m +1 1 − δ m +1 
F 0 F
qu F 

These make up the necessary conditions pertaining to Proposition 1. The upper bounds for

per period payment, i.e., (i) and (ii) in Proposition 1, are simply the results in (2a) and (2b) in

conjunction with the condition qu F ≥ p 0 . Constraint (iii) in Proposition 1 is simply the

condition (1) stated earlier in this proof.

 For the “if” part of Proposition 1, suppose conditions (a) and (b) are fulfilled. Then, by (b), it

is possible to choose π such that [δ (1 − δ m ) /(1 − δ m +1 )] ⋅ [qu F + (1 − q ) p 0 ] ≥ π / N ≥ qu F . With

such a π , consider the following payment scheme:

pi = ε [δ (1 − δ m ) /(1 − δ m +1 )] u F if i is a fan, and

pi = ε [δ (1 − δ m ) /(1 − δ m +1 )] p 0 if i is a casual, where

π
ε= .
N [δ (1 − δ ) /(1 − δ
m m +1
)][qu F + (1 − q ) p 0 ]

Then (2a) and (2b) are fulfilled if qu F ≥ p 0 , which is condition (a), and 1 ≥ ε > 0 , which is

immediately satisfied by our choice of π . Therefore, if (a) and (b) of Proposition 1 are fulfilled,

then there exists π satisfying [δ (1 − δ m ) /(1 − δ m +1 )][qu F + (1 − q ) p 0 ] ≥ π / N ≥ qu F , and, for

every such π , a PWYW strategy with threshold π admits a set of consumer-side equilibria

(with at least one member as in the one example we just discussed) according to which S always

allows PWYW and makes profit π every period. The payment scheme associated with the

discussed example, moreover, certainly satisfies the constraints (i) to (iii) in Proposition 1.

As an end note to this section, we establish that the conditions (a) and (b) in Proposition 1 are

in fact necessary for a PWYW strategy with m punishment periods to admit any pure strategy

consumer-side equilibria that sustain PWYW and generate at least as much per period profit as

π 0 . In effect, we need to consider cases when consumers could pay temporally varying prices

under PWYW. Thus far we have only considered equilibria in which each consumer pays the

same amount under PWYW in every period (although payments across consumers can be

different; in fact, since the upper bound for a casual’s payment, [δ (1 − δ m ) /(1 − δ m +1 )] p 0 , is
lower than qu F given qu F ≥ p 0 , there must be fans who pay more than any casual under

equilibrium to assure that the total payment is not lower than qu F ).

Based on any arbitrary reference period, index the periods by the variable t. Consider a

generalized payment scheme under PWYW with which consumer i pays pit for S’s product in

period t. Then conditions (2a and b) need to be modified as follows:

(1 − δ m +1 )u F t + m t '− t δ (1 − δ m )(u F − pˆ )
(2a) If i is a fan, − ∑ δ pit ' ≥ u F + for all t, or
1−δ t '=t 1−δ

t +m
(1 − δ )∑ δ t '− t pit ' ≤ δ (1 − δ m ) pˆ for all t.
t '=t

t +m
(2b) If i is a casual, (1 − δ )∑ δ t '− t pit ' ≤ δ (1 − δ m ) min{ pˆ , p 0 } for all t.
t '= t

Adding up these inequalities across all consumers, we have:

t +m
(1 − δ )∑ δ t '− t (π 0 + ∆) ≤ δ (1 − δ m ) N [qpˆ + (1 − q ) min{ pˆ , p 0 }] , or
t '=t

δ (1 − δ m )
⋅ N [q ⋅ pˆ + (1 − q ) ⋅ min{ pˆ , p 0 }] ≥ π 0 + ∆ .
1 − δ m +1

From these results, we can derive the same conditions as in Proposition 1.

 APPENDIX B: The General Model

We now offer a generalization of Proposition 1, which results in Proposition 2 below. We

maintain the assumption of a fixed, stable market environment, but now allow for a high degree

of heterogeneity among consumers and a positive marginal cost. It turns out that we only need to

characterize the following parameters for each individual consumer i:

δ i = i’s time discount factor,

vi = i’s valuation of S’s product less i’s net utility gain (before considering time discount)

from her most preferred outside option,

where no purchase (zero utility) is counted as an available outside option. For example, in our

standard model, for a fan, vi = u F − 0 = u F , since a fan’s most preferred outside option is no

purchase; for a casual, vi = u C − (u C − p 0 ) = p 0 . S is effectively a monopoly when consumer

valuations are defined according to vi ; moreover, S’s potential market is defined by the set of

consumers with vi ≥ 0 . Denote as G (v, δ ) the cumulative distribution function of vi and δ i

among the consumers, so that, given a randomly chosen consumer i, G (v, δ ) = the probability

that vi ≤ v and δ i ≤ δ . The total number of consumers is N.

Suppose that each product sold incurs a marginal cost c for S, and S’s optimal per period

profit maximizing price under FP is p̂ , so that its optimal per period profit under FP with

constant price is:

 
π 0 = N ( pˆ − c) ∫ dG (v, δ ) = N max ( p − c) ∫ dG (v, δ ) .
v ≥ pˆ
p
 v≥ p 
Assume that c is not so high that S would prefer to exit the market if it operates under FP. Also,

as with other parameters, assume that c is constant across periods, so that p̂ must also be

constant across periods. Then, we have the following:

PROPOSITION 2. A PWYW strategy with threshold π ≥ π 0 and m punishment periods

admits consumer-side equilibria in which S always allows PWYW, iff:

∫ {[δ (1 − δ ) /(1 − δ m +1 )]v − c}dG (v, δ ) ≥ pˆ ∫ {1 − [δ (1 − δ m ) /(1 − δ m +1 )]}dG (v, δ ) ,

m

pˆ > v ≥ 0 v ≥ pˆ

and π satisfies:

N ∫ {[δ (1 − δ m ) /(1 − δ m +1 )] ⋅ min{v, pˆ } − c}dG (v, δ ) ≥ π ≥ π 0 .

v≥0

Further, for every such π , any member of this set is characterized by a payment scheme { pi }

with which consumer i pays pi for S’s product in any period with PWYW, and which satisfies:

(i) 0 ≤ pi ≤ [δ i (1 − δ im ) /(1 − δ im +1 )] min{vi , pˆ } for all i, and

(ii) ∑p i
i = π ≥ π0.

Proof of Proposition 2. The proof is very similar to that of Proposition 1 but requires more

general terminology. We shall only focus on PWYW equilibria with stationary payments, i.e.,

each consumer pays the same amount under PWYW across periods (although payments across

consumers can be different). Extension into non-stationary payments is very similar to previous

discussions in the context of the standard model too, and will not be repeated here, in the interest

of brevity.

First of all, as noted in the main text, consumer i would never buy from S, even under

PWYW (when she could pay nothing for S’s product), if vi < 0 . This is because vi is the

difference between i’s valuation of S’s product ( i.e. the maximum net utility gain she can earn
from S’s product) and the net utility gain she can earn from purchasing her most preferred

outside option. Thus, if vi < 0 , she still prefers to purchase her most preferred outside option

even when she can obtain S’s product for free. Conversely, if vi ≥ 0 , i buys from S under

PWYW. Thus, overall, under PWYW, a consumer buys from S iff vi ≥ 0 .

Consider a candidate PWYW equilibrium with specified per period profit π = π 0 + ∆

( ∆ ≥ 0 ), which is also the threshold that S uses for its credible threat. Consider a possible

payment scheme for this equilibrium under which consumer i always pays pi for S’s product in

a period; only a consumer i with vi ≥ 0 would ever join this scheme. The payment scheme can

be represented by the set { pi } . Similar to the corresponding portion of the proof in Proposition

1, we must have (with marginal cost c):

(1) ∑(p
{i:vi ≥ 0}
i − c) = π 0 + ∆ ,

where we explicitly state in the equation the domain of consumers over which the summation

applies.

Now, for consumer i, let her valuation of S’s product be u i ≥ 0 .1 Then, once S switches to

FP with posted price p̂ , i buys S’s product according to whether ( u i − pˆ ) (the net utility gain

from purchasing S’s product) is not less than ( u i − vi ) (the net utility gain from purchasing the

outside option). Hence once S switches to FP, i’s per period net utility gain must be

ui − min{ pˆ , vi } . Thus the incentive compatibility condition for i to adhere to the payment

scheme { pi } when punishment lasts m periods is:

1
Since i’s net utility gain from her most preferred outside option must be non-negative, so that we effectively only
need to consider consumers with vi ≥ 0 we can assume that ui ≥ 0 for all i without loss of generality; consumers with
negative u i would definitely not buy from S and need not be considered as part of the market.
 1 − δ im +1 δ i (1 − δ im )(u i − min{ pˆ , vi }) δ i (1 − δ im )
(2) ⋅ (u i − pi ) ≥ u i + , or pi ≤ min{ pˆ , vi } .
1− δi 1− δi 1 − δ im +1

Combining (1) and (2), we have (noting that π 0 = N ( pˆ − c) ∫ dG (v, δ ) ):

v ≥ pˆ

∫ {[δ (1 − δ ) /(1 − δ m +1 )]v − c}dG (v, δ ) ≥ pˆ ∫ {1 − [δ (1 − δ m ) /(1 − δ m +1 )]}dG (v, δ ) .

m

pˆ > v ≥ 0 v ≥ pˆ

These make up the necessary condition pertaining to Proposition 2. The upper bound for per

period payment, i.e., (i) in Proposition 2, is simply the results in (2). Constraint (ii) in

Proposition 2 is simply the condition (1) stated earlier in this proof.

For the “if” part of Proposition 2, suppose the condition

∫ {[δ (1 − δ ) /(1 − δ m +1 )]v − c}dG (v, δ ) ≥ pˆ ∫ {1 − [δ (1 − δ m ) /(1 − δ m +1 )]}dG (v, δ )

m

pˆ > v ≥ 0 v ≥ pˆ

is fulfilled. Then, it is possible to choose π such that

N ∫ {[δ (1 − δ m ) /(1 − δ m +1 )] ⋅ min{v, pˆ } − c}dG (v, δ ) ≥ π ≥ π 0 ,

v≥0

as π 0 = N ( pˆ − c) ∫ dG (v, δ ) . With such a π , consider the following payment scheme:

v ≥ pˆ

pi = ε [δ i (1 − δ im ) /(1 − δ im +1 )] min{vi , pˆ } for every consumer i, where

π
ε= .
N ∫ {[δ (1 − δ m ) /(1 − δ m +1 )] ⋅ min{v, pˆ } − c}dG (v, δ )
v≥0

We must have 1 ≥ ε > 0 given our choice of π . Therefore, if the first condition in

Proposition 2 is fulfilled, then there exists π satisfying:

N ∫ {[δ (1 − δ m ) /(1 − δ m +1 )] ⋅ min{v, pˆ } − c}dG (v, δ ) ≥ π ≥ π 0 ,

v≥0

and for every such π , a PWYW strategy with threshold π and m punishment periods admits a

set of consumer-side equilibria (with at least one member as in the one example we just
discussed) according to which S always allows PWYW and makes profit π every period. The

payment scheme associated with the discussed example, moreover, certainly satisfies the

constraints (i) and (ii) in Proposition 2.

It is straightforward to verify that Proposition 2, when applied to the model in the main text,

yields Proposition 1. The insights and discussion after Proposition 1 also apply here.

As an end note to this section, we examine the impact of a change in c on the existence of

PWYW equilibria with higher profit than under perpetual FP. Intuitively, one might expect that

a higher marginal cost creates more loss with each low-payment transaction under PWYW, thus

making PWYW equilibria less profitable. But the optimal perpetual FP profit changes at the

same time, rendering comparison between equilibrium PWYW and perpetual FP profits less

straightforward. In more detail, first define the function:

K (c ) ≡ ∫ {[δ (1 − δ ) /(1 − δ m +1 )]v − c}dG (v, δ ) − pˆ ∫ {1 − [δ (1 − δ m ) /(1 − δ m +1 )]}dG (v, δ ) .

m

pˆ > v ≥ 0 v ≥ pˆ

By Proposition 2, PWYW equilibria exist with higher profit than under perpetual FP iff

K (c) ≥ 0 . Note that p̂ is non-decreasing in c (Tirole 1988, p. 66-67), so that we can divide our

discussion into two cases: ∂pˆ / ∂c = 0 and ∂pˆ / ∂c > 0 .

For the case ∂pˆ / ∂c = 0 , it is obvious that ∂K / ∂c < 0 , and so increasing marginal cost could

lead to PWYW equilibria with higher profit than under perpetual FP becoming non-existent.

For the case ∂pˆ / ∂c > 0 , it is more convenient to calculate the derivative of K w.r.t. p̂ rather

than c, from which we obtain:

∂K ∂c
= pˆ δ ( pˆ ) − cg ( pˆ ) − ∫ dG(v, δ ) − ∫ {1 − [δ (1 − δ ) /(1 − δ m +1 )]}dG (v, δ ) + pˆ g ( pˆ ) − pˆ δ ( pˆ ),
m

∂pˆ ∂pˆ pˆ > v ≥ 0 v ≥ pˆ

where g ( pˆ ) = ∫δ dG( pˆ , δ ) and δ ( pˆ ) = ∫δ [δ (1 − δ ) /(1 − δ m +1 )] dG ( pˆ , δ ) .

m

0≤ <1 0≤ <1
Thus:

∂K ∂c
= ( pˆ − c) g ( pˆ ) − ∫ dG(v, δ ) − ∫ {1 − [δ (1 − δ ) /(1 − δ m +1 )]}dG (v, δ ) .
m

∂pˆ ∂pˆ pˆ > v ≥ 0 v ≥ pˆ

Hence an increase in c, which leads to an increase in p̂ , could lead to an increase in K if: (1)

g ( pˆ ) is large, i.e., many more consumers are priced out with the increase in p̂ ; (2) ∂c / ∂pˆ is

small, i.e. ∂pˆ / ∂c is large, or p̂ increases sharply with c ; (3)

∫ {1 − [δ (1 − δ ) /(1 − δ m +1 )]}dG (v, δ ) is small, i.e., demand is not high at price p̂ , and those who
m

v ≥ pˆ

buy from S at p̂ have high time discount factors. Then, counter-intuitively, an increase in

marginal cost could bring about the existence of PWYW equilibria with higher profit than under

perpetual FP.
 APPENDIX C: PWYW Strategy with Probabilistic Punishment

We first prove a set of equilibrium results analogous to Proposition 1. As before, we shall

only focus on pure-strategy, stationary equilibria. Because of the increased complexity of the

model, break them down into one proposition and two corollaries:

PROPOSITION 3. Consider a PWYW strategy with probabilistic punishment with upper

threshold π , lower threshold π , and m punishment periods. If this strategy admits a consumer-

side equilibrium with which total payment is positive under PWYW, then S makes profit π every

period and continuously allows PWYW with certainty. Moreover, any such equilibrium is

characterized by a payment scheme { pi } with which consumer i pays pi for S’s product in any

period with PWYW, and which satisfies:

(i) 0 ≤ pi ≤ [δ (1 − δ m ) /(1 − δ m +1 )] vi if π − π ≤ [δ (1 − δ m ) /(1 − δ m +1 )] vi ,

(ii) 0 ≤ pi ≤ vi − [(1 − δ ) / δ (1 − δ m )] (π − π ) if π − π ≥ [δ (1 − δ m ) /(1 − δ m +1 )] vi , and

(iii) ∑p
i
i =π ,

where vi = pˆ when i is a fan and vi = p 0 when i is a casual.

Proof of Proposition 3. Consider a (pure-strategy, stationary) equilibrium payment scheme { pi } .

By definition, every pi must be a best response to all other consumers’ payments, given the

firm’s punishment strategy. Let λ −i = ∑ pi . Denote as ρ (Λ t ) the probability that S continues

j ≠i

PWYW in period t+1 given that it allows PWYW in period t and the sum of payments turns out

to be Λ t in that period. As described in the main text, ρ (Λ t ) = 0 when Λ t < π , ρ (Λ t ) = 1

when Λ t ≥ π , and ρ (Λ t ) = (Λ t − π ) /(π − π ) when π ≤ Λ t < π . Denote as U ( pi ' ) the total

time-discounted utility of i if i pays pi ' whenever PWYW is allowed, given other consumers’

strategies. Suppose i is a fan. Then:

  (u − pˆ )(1 − δ m )  
U ( pi ' ) = (u F − pi ' ) + δ  ρ ( pi '+λ −i )U ( pi ' ) + [1 − ρ ( pi '+λ −i )] ⋅  F + δ mU ( pi ' )  ,
  (1 − δ )  

δ (1 − δ m )(u F − pˆ )[1 − ρ ( pi '+λ −i )]

u F − pi '+
and so U ( pi ' ) = 1−δ , which can be rewritten as:
(1 − δ m +1 ) − δ (1 − δ m ) ρ ( pi '+λ −i )

1 (u F − p i ' )(1 − δ ) + δ (1 − δ m )(u F − pˆ )[1 − ρ ( p i '+λ −i )]

U ( pi ' ) =
1−δ (1 − δ m +1 ) − δ (1 − δ m ) ρ ( p i '+λ −i )
1 (u F − p i ' )(1 − δ ) + (u F − pˆ )[δ (1 − δ m ) − (1 − δ m +1 )] + (u F − pˆ )[(1 − δ m +1 ) − δ (1 − δ m ) ρ ( p i '+λ −i )]
=
1−δ (1 − δ m +1 ) − δ (1 − δ m ) ρ ( p i '+λ −i )
u F − pˆ pˆ − p i '
= + .
1−δ (1 − δ ) − δ (1 − δ m ) ρ ( p i '+λ −i )
m +1

When i is a casual, it can be similarly shown that:

uC − p0 p0 − pi '
U ( pi ' ) = + .
1−δ (1 − δ ) − δ (1 − δ m ) ρ ( pi '+λ −i )
m +1

Therefore, if we define vi such that vi = pˆ when i is a fan and vi = p 0 when i is a casual,

maximization of U ( pi ' ) is equivalent to maximizing:

vi − pi '
V ( pi ' ) = .
(1 − δ m +1
) − δ (1 − δ m ) ρ ( pi '+λ −i )

If λ −i ≥ π , ρ ( pi '+λ −i ) = 1 for any non-negative pi ' , and i’s best response is to pay zero.

Therefore, the best response is positive only if λ −i < π and we shall focus on this case in the rest

of this proof. We need first to consider a number of different regimes of pi ' , find out the

optimal strategy in each regime, and then find out which of those is the overall best response. If

π − λ −i ≥ 0 , then there exists a regime 0 ≤ pi ' ≤ π − λ −i over which ρ ( pi '+λ −i ) = 0 , and i’s

optimal strategy over that regime is zero payment. Next, over the regime π − λ −i ≤ pi ' ,
ρ ( pi '+λ −i ) = 1 and the optimal strategy over that regime is to pay π − λ−i . Lastly, over the

regime max{0, π − λ −i } < pi ' < π − λ −i , ρ ( pi '+λ −i ) = ( pi '+λ −i − π ) /(π − π ) , and so:

∂V ( pi ' ) − (1 − δ m +1 ) + [δ (1 − δ m )( pi '+ λ −i − π ) /(π − π )] + [(vi − pi ' )δ (1 − δ m ) /(π − π )]

=
∂pi ' {(1 − δ m +1 ) − [δ (1 − δ m )( pi '+ λ −i − π ) /(π − π )]}2
− (1 − δ m +1 )(π − π ) + δ (1 − δ m )(vi + λ −i − π )
= .
(π − π ){(1 − δ m +1 ) − [δ (1 − δ m )( pi '+λ −i − π ) /(π − π )]}2

The sign of the above does not depend on pi ' , and so V ( pi ' ) is monotonic over

max{0, π − λ −i } < pi ' < π − λ −i . Thus the optimal strategy over this regime must be a limiting

corner solution, i.e. either max{0, π − λ −i } or π − λ −i . Combining this with previous

observations, the overall optimal strategy is either to pay π − λ −i or zero. This implies that, if an

equilibrium with total positive payment under PWYW exists, i.e. if some of { pi } is positive,

then the total payment must be π . This confirms the condition (iii) ∑p
i
i = π in Proposition 3.

To find out the upper bounds in (i) and (ii) of Proposition 3, observe that the best response is

positive only if V (π − λ −i ) ≥ V (0) , i.e.

vi − (π − λ −i ) vi
≥ , or
(1 − δ ) − δ (1 − δ ) (1 − δ ) − δ (1 − δ m ) ρ (λ −i )
m +1 m m +1

δ (1 − δ m )[1 − ρ (λ−i )]vi ≥ (π − λ−i )[(1 − δ m +1 ) − δ (1 − δ m ) ρ (λ −i )] .

Recalling that the best response is positive only if λ −i < π , we only need to tackle two cases:

(1) λ −i ≤ π so that ρ (λ −i ) = 0 . Then the above inequality becomes:

δ (1 − δ m )
p i = π − λ −i ≤ vi ;
(1 − δ m +1 )

(2) π ≤ λ −i < π so that ρ (λ −i ) = (λ −i − π ) /(π − π ) . Then the above inequality becomes:

 (1 − δ )(π − π )
pi = π − λ−i ≤ vi − .
δ (1 − δ m )

Observe that:

δ (1 − δ m ) δ (1 − δ m )
π− v ≤ π when π − π ≤ vi , while
(1 − δ m +1 ) (1 − δ m +1 )
i

 (1 − δ )(π − π )  δ (1 − δ m )
π − v i − ≥ π π − π ≥
δ (1 − δ m ) 
when vi .
 (1 − δ m +1 )

This means that only one of either (1) or (2) applies to any consumer i. From these results, we

have the upper bounds (i) and (ii) in Proposition 3.

For the following two corollaries, recall that π 0 = N max{qu F , p 0 } is the optimal per period

profit under perpetual FP with constant price.

COROLLARY 1. Given a probabilistic punishment strategy with which π ≥ π 0 , PWYW-

sustaining equilibria exist iff qu F ≥ p 0 and one of the following is satisfied:

δ (1 − δ m ) π δ (1 − δ m )
(1) π − π ≤ p and ≤ [qu F + (1 − q ) p 0 ] ;
1 − δ m +1 1 − δ m +1
0
N

δ (1 − δ m ) δ (1 − δ m )
(2) p ≤ π − π ≤ u F and
(1 − δ m +1 ) (1 − δ m +1 )
0

π (1 − δ )(1 − q ) δ (1 − δ m )
+ (π − π ) ≤ qu F + (1 − q ) p 0 ; or
N δ (1 − δ m ) (1 − δ m +1 )

δ (1 − δ m ) π (1 − δ )
(3) u F ≤ π − π and + (π − π ) ≤ qu F + (1 − q ) p 0 .
1−δ m +1
N δ (1 − δ m )

Proof of Corollary 1. First consider qu F ≥ p 0 . Then vi = u F for fans. The “only if” direction

for (1) to (3) follow immediately from summing up the payment upper bounds (i) and (ii) in

Proposition 3 across consumers under different conditions, and noting that the total payment
must be π by (iii). The “if” direction can be proved by construction in a similar way as with

Proposition 1, and is omitted here. Next, consider qu F < p 0 . Then vi = p 0 for all consumers,

and summing up the upper bounds give the necessary conditions:

δ (1 − δ m ) π δ (1 − δ m )
(1a) π − π ≤ p 0 and ≤ p0 ;
1 − δ m +1 N 1 − δ m +1

δ (1 − δ m ) π (1 − δ )
(2a) p 0 ≤ π − π and + (π − π ) ≤ p 0 .
1−δ m +1
N δ (1 − δ m )

Both imply that π < Np 0 = π 0 , leading to a contradiction.

COROLLARY 2. There exists a probabilistic punishment strategy with m punishment

periods with which (a) π − π ≤ [δ (1 − δ m ) /(1 − δ m +1 )] u F , (b) π ≥ π 0 , and (c) there exist PWYW-

sustaining equilibria, iff:

(1) qu F ≥ p 0 and

δ (1 − δ m )  (1 − q ) p 0 
(2a) 1 +  ≥ 1.
1 − δ m +1  qu F 

There exists a probabilistic punishment strategy with m punishment periods with which (a)

π − π ≥ [δ (1 − δ m ) /(1 − δ m +1 )] u F ,(b) π ≥ π 0 , and (c) there exist PWYW-sustaining equilibria, iff:

(1) qu F ≥ p 0 and

1 − δ m +1 (1 − q ) p 0
(2b) ⋅ ≥1 .
1−δ uF

Proof of Corollary 2. The condition (1) qu F ≥ p 0 is reproduced from Corollary 1. Conditions

(2a) and (2b) are proved with similar approaches and we shall only present that for (2b). Since:

π − π ≥ [δ (1 − δ m ) /(1 − δ m +1 )] u F ,
we know that (3) of Corollary 1 applies. Note that π ≥ u F > [δ (1 − δ m ) /(1 − δ m +1 )]u F if

π ≥ π 0 = Nqu F . Therefore, given an upper threshold π , a choice of lower threshold exists that

satisfies the above constraint as well as the second inequality of (3), iff:

π (1 − δ ) δ (1 − δ m ) π 1−δ
+ ⋅ uF = + u F ≤ qu F + (1 − q ) p 0 .
N δ (1 − δ ) (1 − δ )
m m +1
N 1 − δ m +1

Incorporating the additional requirement that π ≥ π 0 = Nqu F produces (2b).

It is generally achievable that, in a PWYW equilibrium, every consumer finds paying

according to equilibrium to be strictly preferable to paying zero, i.e. for all i:

vi − (π − λ −i ) vi
> .
(1 − δ m +1 ) − δ (1 − δ m ) (1 − δ m +1 ) − δ (1 − δ m ) ρ (λ −i )

This is true whenever the equilibrium payment is strictly lower than the applicable upper bound

for each consumer i as laid out in Proposition 3. Given this and the fact that ρ (⋅) is a continuous

function when π > π , even if the sum of all other consumers’ payments consistently fall below

λ−i , as long as the difference is always sufficiently small, paying zero (i.e. following the baseline

equilibrium) is strictly dominated by maintaining equilibrium payment for i. Formally, define

λ −i ' as the smallest possible sum of payments of all consumers except i in any period. Then the

above intuition can be captured by the following: there exists ε > 0 such that, for all i,

vi − (π − λ −i ) vi
ε > λ −i − λ −i ' > 0 ⇒ > .
(1 − δ m +1
) − δ (1 − δ ) ρ (π − λ −i + λ −i ' ) (1 − δ ) − δ (1 − δ m ) ρ (λ −i ' )
m m +1

The same cannot be said with the “step function” punishment, which is effectively the limit

π → π , and with which ρ (π − λ−i + λ−i ' ) drops from one to zero whenever λ−i − λ−i ' increases

from zero to an arbitrarily small positive amount. Thus probabilistic punishment provides

additional stability to PWYW equilibria over the “step function” punishment.

APPENDIX D: Experimental Instructions for Strategy 1, Chat/No Suggestion Condition

Neutral Context Rich Context

THE ONLINE MUSIC GAME

INSTRUCTIONS
INSTRUCTIONS

In this study you will make many decisions. Your payment at the end of the study will depend
on your own decisions as well as the decisions of others you play with.

During this study you will play the same game 20 times, and each game will consist of a
number of rounds.

Description of the Game

The game is played by 8 players. The game is played by 8 players. Two bands,
the Playa band and the Quello band, upload a
new song to their site every round of the game
and allow people to listen to it online.

In each round, a player can choose one of In each round, a player can either listen to a
three options: option S or option R or option Playa song or to a Quello song or to none.
N.

Types of Players

There are two types of players, who differ in There are two types of players, who differ in
how much they value each option. how much they like each band.

1. Type Y players – To these players, option 1. Fans of Playa – these people love Playa’s
S is equivalent to gaining 201 tokens (the music but not Quello’s. To them, listening
experimental currency used in this study to a Playa song is equivalent to gaining
that will be later converted to real money); 201 tokens (the experimental currency
but options R and N are equivalent to used in this study that will be later
gaining nothing i.e. 0 token. converted to real money); but listening to a
Quello song is worth nothing to them, and
is in fact equivalent to gaining 0 token.
2. Type Z players – To these players,
options S and R are equivalent to gaining 2. Casual Listeners – these people like
49 tokens, but option N is equivalent to listening to music in general but do not
gaining nothing i.e. 0 token. prefer one band over the other. Listening
to any song – be it Playa or Quello –
 means the same to them, and is always
equivalent to gaining 49 tokens.
To sum up:
To sum up:
Gain from selecting one
Type of
option Gain from listening to
player Type of
S R N a song of
player
201 0 Playa Quello
Y 0 token
tokens token Fan of 201
0 token
49 49 0 Playa tokens
Z
tokens tokens token Casual
49 tokens 49 tokens
Listener
Of the 8 players in the game, two are of Type
Y and six are of Type Z Of the 8 players in the game, two are Fans of
Playa and six are Casual Listeners.

We will assign these roles to you and the other players before each game begins. Every
player’s role will be fixed in all the rounds of the same game, but will be re-assigned from game
to game.

Each player will be of Type Y in 5 games and Each player will be a Fan of Playa in 5 games
Type Z in 15 games. and a Casual Listener in 15 games.

Payment

To choose an option, you may need to pay. To listen to a song, you may need to pay. The
Different options have different payment two bands have different payment schemes:
schemes: • Playa payment scheme. In the first round
• The payment scheme for option S. In the of every game, Playa allows every listener
first round of every game, anyone who to pay as he/she wishes. In other words, if
chooses S can pay as he/she wishes. In you listen to a Playa song you may pay
other words, if you choose S you may pay nothing (0 token), or you may pay any
nothing (0 token), or you may pay any number of tokens you wish; it is entirely
number of tokens you wish; it is entirely up to you how much you pay Playa for its
up to you how much you pay for S. song.
However, this scheme of “pay as you However, Playa will continue to carry out
wish” for S will continue to the next round this “pay as you wish” scheme only if it
only if the total payment for S from all receives at least 400 tokens from all those
those who have chosen S in this round is at who have listened to the Playa song in this
least 400 tokens; otherwise, S will cost round; otherwise, it will charge a fixed fee
200 tokens in all future rounds of the of 200 tokens per song in all future rounds
game. of the game.
In general, as long as the total payment In general, Playa’s management decides
 for S is at least 400 tokens in a round,
the payment for selecting S will continue
to be “pay as you wish”; but once the
total payment for S in a round is less
than 400 tokens, the payment scheme
for S will change and S will cost 200
tokens per round in all future rounds of
the game.
that, as long as the total payment that
Playa receives from its listener(s) is at
least 400 tokens in a round, Playa will
continue to allow every listener to pay as
he/she wishes; but once Playa receives
less than 400 tokens in a round, it will
change its payment scheme and will
charge every listener a fixed fee of 200
tokens per round in all future rounds of
the game.

• The payment scheme for option R. You • Quello payment scheme. Quello always
pay 48 tokens to choose R in a round, and charges a fixed fee of 48 tokens per song
this is the same in all rounds. per round.

• The payment scheme for option N. You

pay nothing i.e. 0 token to choose N in a
round, and this is the same in all rounds.

How much does a player earn from choosing How much does a player earn from listening
an option in a round? to a song in a round?

Your (and every other player’s) earnings from Your (and every other player’s) earnings from
choosing an option in a round are calculated as listening to a song in a round are calculated as
follows: follows:

Earnings from choosing an option Earnings from listening to a song

= Gain from choosing the option – payment = Gain from listening to the song – payment

Choosing R Listening to a Quello song

If a Type Z player chooses R in a round, If a Casual Listener listens to a Quello song in

he/she gains 49 tokens, but has to pay 48 a round, he/she gains 49 tokens from listening
tokens. Thus his/her earnings in that round are to the song, but has to pay 48 tokens for the
equal to: song. Thus his/her earnings in that round are
equal to:

Earnings = 49 tokens – 48 tokens = 1 token. Earnings = 49 tokens – 48 tokens = 1 token.

So a Type Z player earns 1 token for choosing So a Casual Listener earns 1 token for
R in a round. listening to a Quello song in a round.

If a Type Y player chooses R in a round, If a Fan of Playa listens to a Quello song in a

he/she gains 0 token, but has to pay 48 tokens. round, he/she gains 0 token from listening to
Thus his/her earnings in that round are equal the song, but has to pay 48 tokens for the
to: song. Thus his/her earnings in that round are
 equal to:

Earnings = 0 token – 48 tokens = -48 tokens. Earnings = 0 token – 48 tokens = -48 tokens.

So a Type Y player loses 48 tokens for So a Fan of Playa loses 48 tokens for listening
choosing R in a round. to a Quello song in a round.

To sum up: To sum up:

Type of player Earnings from choosing R Earnings from listening to

a Quello song
Y -48 tokens
Fan of Playa -48 tokens
1 token Casual
Z 1 token
Listener

Choosing S Listening to a Playa song

If a player chooses S in a round, and if S has a
fixed cost of 200 tokens in that round, the
calculation of earnings is similar to that for
choosing R, but with a cost of 200 tokens
instead of 48 tokens. But if the payment
scheme for S is “pay as you wish” in that
round, the payment and thus earnings of a
player may vary from player to player
depending on how much (if at all) each player
pays. To sum up:
If a player listens to a Playa song in a round,
and if Playa charges a fixed fee of 200 tokens
in that round, the calculation of earnings is
similar to that for listening to a Quello song,
but with a payment of 200 tokens instead of 48
tokens. But if Playa allows every listener to
pay as he/she wishes in that round, the
payment and thus earnings of a player may
vary from player to player depending on how
much (if at all) each player pays. To sum up:

Earnings
Earnings Earnings Earnings
from
from from from
listening to
choosing S in choosing S listening to a
a Playa
a round in a round Playa song
Type of song in a
under “pay as under fixed in a round
player round
you wish” cost under “pay
under
(supposing (of 200 as you wish”
fixed fee
player pays m tokens per (supposing
(of 200
tokens) round) player pays
tokens per
(201 – m) (201-200) = m tokens)
round)
Y
tokens 1 token Fan of (201 – m) (201-200)
(49 – m) (49-200) = - Playa tokens = 1 token
Z
tokens 151 tokens (49-200) =
Casual (49 – m)
-151
Listener tokens
tokens

If a player chooses option N in a round, If a player does not listen to any song in a
his/her earnings in that round is 0 token. round, his/her earnings in that round is 0
token.
How does the game continue after a round is finished?

A round is finished when all players have made their decisions for that round. After that, the
computer will randomly select whether the game will end or whether it will proceed to the next
round. After each round, there is a 90% chance that the game will continue to the next round
and a 10% chance that the game will end immediately.

The chat forum

Before each game, there is a chat forum with limited duration through which players in the
same group can send messages to each other. You are allowed to:
1. chat 3 minutes before each game in Games 1 to 6,
2. chat 2 minutes before each game in Games 7 to 13, and
3. chat 1 minute before each game in Games 14 to 20.
1.
Procedures

You will enter all your decisions via the You will enter all your decisions via the
computer terminal in front of you. computer terminal in front of you.

As each game begins, you will see on the
computer screen whether you have been
randomly assigned to be a Type Y or a Type Z
player. Remember that: (1) there are two
Type Y players and six Type Z players in
every game; (2) every player’s role (Type
Y/Type Z) will be fixed in all the rounds of
the same game, but will be re-assigned from
game to game; and (3) each player will be of
Type Y in 5 games and Type Z in 15 games.
As each game begins, you will see on the
computer screen whether you have been
randomly assigned to be a Fan of Playa or a
Casual Listener. Remember that: (1) there are
two Fans of Playa and six Casual Listeners in
every game; (2) every player’s role (Fan of
Playa/Casual Listener) will be fixed in all the
rounds of the same game, but will be re-
assigned from game to game; and (3) each
player will be a Fan of Playa in 5 games and a
Casual Listener in 15 games.

At the beginning of each round, you will see a At the beginning of each round, you will see a
Decision Screen such as Decision Screens (1) Decision Screen such as Decision Screens (1)
to (4) (Please refer to the handout on your to (4) (Please refer to the handout on your
desk labeled “Decision Screens”.) desk labeled “Decision Screens”.)

A Decision Screen lists the following from top
to bottom:
• Whether you are a Type Y or a Type Z
player.
• The number of the current game and
A Decision Screen lists the following from top
to bottom:
• Whether you are a Fan of Playa or a
Casual Listener.
• The number of the current game and
 current round.
• The payment scheme of S, R and N in the •
current round.
• Three buttons that correspond to the •
decisions you can make in that round, i.e.
(from left to right) (1) choose S; (2)
choose N; (3) choose R.
• Under each button, you will see a column
of numbers that include:
(i) Your gain in tokens if you choose the
option labeled on the button;
(ii) The cost you would have to pay for
your decision, except if your decision
is to choose S under “pay as you
wish” (see (iv));
(iii) Your earnings as a result of your
decision, except if your decision is to
choose S under “pay as you wish”
(see (iv));
(iv) If the payment scheme for S is of
“pay as you wish” in the current
round, then, in the space under the
“S” button where the cost would be
stated for other decisions, there is a
blank. You may enter in the blank
any potential payment that you are
considering. After that, you may
click the “Calculate” button to
calculate your earnings from
choosing S with that payment. You
may repeat this process for as many
potential payments as you like.
To make a decision, click the button labeled
with your choice – except that if the payment
scheme for S is “pay as you wish” in the
current round, and you decide to choose S,
you will need to: (1) enter your payment in the
blank space under the “S” button, (2) click the
“Calculate” button to see what your earnings
will be, and (3) click the “S” button.
Players choose options simultaneously. After Players make listening decisions
current round.
The payment scheme of Playa and Quello
in the current round.
Three buttons that correspond to the
decisions you can make in that round, i.e.
(from left to right) (1) listen to a Playa
song; (2) listen to no song; (3) listen to a
Quello song.
• Under each button, you will see a column
of numbers that include:
(v) Your gain in tokens if your decision
is as labeled on the button;
(vi) The fee that you would have to pay
for your decision, except if your
decision is to listen to a Playa song
under “pay as you wish” (see (iv));
(vii) Your earnings as a result of your
decision, except if your decision is to
listen to a Playa song under “pay as
you wish” (see (iv));
(viii) If Playa allows every listener to pay
as he/she wishes in the current round,
then, in the space under the “Playa”
button where the fee would be stated
for other decisions, there is a blank.
You may enter in the blank any
potential payment that you are
considering. After that, you may
click the “Calculate” button to
calculate your earnings from
listening to a Playa song with that
payment. You may repeat this
process for as many potential
payments as you like.
To make a decision, click the button labeled
with your choice – except that, if Playa allows
every listener to pay as he/she wishes in the
current round, and you decide to listen to a
Playa song, you will need to: (1) enter your
payment in the blank space under the “Playa”
button, (2) click the “Calculate” button to see
what your earnings will be, and (3) click the
“Playa” button.
all players have made decisions in a round, a
feedback screen will appear that shows: (1)
every player’s decision (S/R/N), payment, and
earnings in that round; (2) the total payment
for each option in that round. If the payment
scheme for S is “pay as you wish” in the
current round, the feedback screen will also
show: (a) whether the total payment for S
reaches 400 tokens; and (b) whether the “pay
as you wish” payment scheme for S will
continue in the next round of the game, or will
change to a fixed cost in all future rounds of
the game.
simultaneously and without communication
with each other. After all players have made
decisions in a round, a feedback screen will
appear that shows: (1) every player’s decision
(Playa/Quello/Neither), payment, and earnings
in that round; (2) the total payment received
by each band in that round. If Playa allows
every listener to pay as he/she wishes in the
current round, the feedback screen will also
show: (a) whether the total payment received
by Playa reaches 400 tokens; and (b) whether
Playa will continue to allow every listener to
pay as he/she wishes in the next round of the
game, or will charge a fixed fee in all future
rounds of the game.

Afterwards, the computer will select whether the game will proceed to the next round or will
end. Remember that there is a 90% chance that the game will proceed to the next round, and a
10% chance that it will end.

Once a game is ended, the next game will begin – unless you have already come to the last
(20th) game, after which the study will be finished.

You will play 20 games with the same group of 8 players (including yourself).

Payment

After all 20 games are finished, we will choose 5 games at random and pay you your total
earnings from all the rounds in those games at a rate of HK$1 = 10 tokens. If you have any
questions, please raise your hand and the study coordinator will come to speak to you.

If you wish to participate in this study, please sign the consent form. Afterwards, when you are
ready to start, please click the “START” button on the screen. You will then begin to play 1
practice game to familiarize yourself with the study; the practice game will not be chosen for
calculation of your final payment. After the practice game is finished, you will play the 20
games of the study.

Please wait patiently until all other players are ready to start.
 APPENDIX E: Decision Screens (Rich Context)

(1) A Fan of Playa’s Decision Screen when Playa carries out “pay as you wish”

(2) A Fan of Playa’s Decision Screen when Playa charges a fixed fee
 (3) A Casual Listener’s Decision Screen when Playa carries out “pay as you wish”

(4) A Casual Listener’s Decision Screen when Playa charges a fixed fee

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