Once a month I step into the shop of a Moroccan immigrant on the southwest side of Chicago to get my hair cut. He doesn’t have much formal schooling, but he is fluent in four languages and has created a successful business by defying conventional logic. How? By using a modified form of price discrimination, or charging a different price to different clients in order to maximize profits. Price discrimination, while having an ugly name, has made him an extremely successful man with more clients than time. It is also important to note that his customers are well aware they are all paying different prices, and are more than happy to do so.
The first time I walked into this barbershop was with a buddy of mine who had been going there for years. He assured me it would be the best haircut I had ever had. Going in I was hesitant. I had, after all, gone to the same barber every month for my entire life. My nerves were held back only because I trusted the recommendation of my friend, a man I had known my whole life.
Soon after sitting in the chair, I realized that this was a different kind of barbershop experience. The Chicago Bulls were on the flat screen above my head, he used a shaving cream machine and a straight razor to make the perfect lines, and wax was applied to my eyebrows (something I never knew I needed, but that my wife assures me I did). It was, indeed, the best haircut I had ever had. When it came time to pay, however, I was left confused.
When I handed the barber my credit card, he asked me, “How much would you like to pay?” I was taken aback. I had just been asked point-blank how much I valued the life’s work of the man standing across from me. I insisted on him giving me a price, and he insisted on the opposite. In the end I settled on a value, he swiped the card, thanked me, and I left. This interaction stayed with me, and I couldn’t shake how unique the whole experience was. I wasn’t sure why anyone would work without knowing what the value of each customer was going to be. I was wondering if he chooses which appointments or walk-ins to serve first based upon how much he thought he would make. I had to find out for myself.
I went back to that barber with the same friend the next month. When I sat in the chair I asked him “Why is it that you never give anyone a price?” His answer was simple yet profound. He said something to the effect of, “I have rich customers and I have poor customers. I have old customers and I have young customers. I do not tell them how much to pay because they will pay what they can afford. The rich offset the poor, the generous offset the cheap, and in the end, everyone gets a quality product at the price they are comfortable with.” This aspect of never turning away a client seemed like a great play on not only the economics of the situation, but the psychology of it as well.
As the single owner and sole employee of his business, nearly every cost associated with the running of the barbershop is fixed. Utilities and rent are nearly the same when serving 10 or 50 people in one day. Because of this, the marginal revenue gained by serving one more customer is always higher than the marginal cost associated with serving one more customer. This means that every customer, whether frugal or high-roller, contributes to the profit of his business.
This business model would lead many people to assume that customers would turn to a “free-rider” mentality, assuming that they can pay less because they believe that others will compensate their low revenue purchase with higher revenue purchases. This is not the case. It might be because people understand that their barber knows a lot about their personal life and level of success, and therefore feel disingenuous by stiffing a man who knows your situation. It could be because there is a feel good mechanism triggered by knowing your cash is going directly to the human being standing in front of you. It might be another answer altogether, of this I cannot be certain. What I do know, however, is that the business model is thriving.
This is not the only example of a ‘pay what you wish’ mechanism being more successful than a fixed amount. When the band Radiohead released their album “In Rainbows”, fans could choose the price they wished to pay. In this case, we also had a situation in which there was upfront, fixed, and sunk costs in the creation of the album and maintenance of the website, comparable to the building of a barbershop and maintenance of the store. The band bypassed a record label by self releasing the album via the internet, therefore every dollar spent on the album went directly to the creators of the music.
Nobody can deny the emotional connection that exists between a music artist and their fans or a barber and their customers. I would hypothesize that this same approach would not have worked for a corporate player in these industries, as there is no emotional connection to corporations like that which exists between people. The takeaway, on the other hand, is that when faced with a free-rider choice, where the rational thing to do would be to save your money, humans might not think so rationally. While I would not advise every small business owner to eliminate listed prices in favor of this “trust your neighbor” method, at this south-side barbershop, business is booming.