Tip: goodwill can lead to profit

Here's my column in this weekend's Financial Review:

Jack Frost nipping at your nose and bells ringing on Fifth Avenue mark the time of year: ’tis the annual tipping season in New York. That’s when all the doormen, supers, nannies, housekeepers, mail carriers, newspaper deliverers, garbage men and the like get a year-end bonus from their clients.The individual amounts can range from a few dollars up into the thousands. In total, seasonal tips will add up to a substantial chunk of a service person’s annual income.

But deciding whether and exactly how much to tip is entirely up to each New Yorker. For some it’s a matter of conscience. For others it’s a more self-interested calculation, a spreadsheet exercise.

The amazing thing about the peculiar American culture of tipping is that it actually works quite smoothly. There’s absolutely no recourse if an anticipated tip never materialises. Nevertheless, the tips arrive like clockwork. And in New York, it’s been perfected to a high degree.

Perhaps that’s only natural in a city that runs on voluntary payments. The waitress at the lowliest hamburger joint depends on tips for survival. And at the other end of the spectrum, a discretionary bonus is likely to make or break the year for New York’s loftiest banker.

The principle of letting the client decide how much an intangible service is worth, in some cases after it is rendered, has lots of interesting implications for business. As the global service economy continues to grow, entrepreneurs have been testing new business models that reflect the usefulness of voluntary payment schemes.

This month, comedian Louis C.K. became the latest entertainer to experiment with a version of pay-what-you-decide business model on the web.

For $5, fans of Louis C.K. could download a video of his comedy show recorded live at the Beacon Theatre in New York. Or they could watch it without paying anything since he didn’t even try to prevent pirating. Louis C.K. says he chose the low $5 price because it was nearly free. And he wanted downloading to be easy, almost like hitting a link and streaming.

In the first week 175,000 people paid the $5 to download his show. The comedian expects that to top out about 200,000. Assuming that pans out, Louis C.K. will have grossed $1 million. After production costs of $250,000, he estimates making $750,000 in profits from his experiment.

Other entertainers who have tried similar pay-what-you-decide business models include Radiohead, hip-hop singer Niggy Tardust, and comedian Steve Hofstetter.

And it’s not just limited to entertainers. The sandwich chain Panera Bread opened a pay-what-you-decide cafe in St Louis, Missouri, about a year ago. The company found it generated valuable goodwill towards its brand. Perhaps just as important, it turned a profit. Since then, Panera has opened a further two pay-what-you-decide cafes.

From its initial experiment, Panera gleaned an important insight into the behaviour of its customers. The sandwich chain found that roughly 60 per cent pay the suggested price and 20 per cent pay more. Only about 20 per cent underpay for their food.

For some time, small software operators on the web have been experimenting with the pay-what-you-decide model.

The potential for this approach is very large. After all,the entire charitable sector is based on a pay-what-you-decide model. Last year Americans paid almost $US300 billion to charitable organisations. That is the biggest sector by far of the pay-what-you-decide economy.

It could be a lesson for other sectors. Some that are in trouble, such as music and publishing, have struggled to adapt old business models to the ubiquitous online world. So far, much of their effort has gone into devising schemes to protect content from unauthorised, meaning unpaid, use.

This month in a lower Manhattan court, Sony Music and Warner Music joined Universal Music Group’s suit against Grooveshark.

Grooveshark isn’t selling the other companies’ content. Instead, they are streaming it without requiring payment to listeners who (presumably) don’t keep a copy.

There’s just one little problem. Given the state of technology, there’s no way to keep a lid on content. And worse, if you actually happen to succeed in your efforts to discourage somebody from listening to a song, or reading a story, you lose a potential supporter. Illicit users could turn out to be an important source of “word of mouth” advertising. And if the product is good, what’s to say they won’t become paying customers one day.

After all, if nobody pays for the waitress, or the musician, or the corporate executive’s bonus, why should anyone expect them to keep doing their thing?

In the end it all boils down to a matter of trust. And the thing is, people actually like it when you trust them. Letting the customer know that you are confident in the value of what you do, and then trusting the customer to pay fairly for that can build a strong relationship. There’s no better way to communicate your worth or to build a business.

The Australian Financial Review