Tuesday, July 21, 2009

Zero as a special price

The main thesis of Chris Anderson's Free: The Future of a Radical Price is that "free" is a special price. Reducing a price from two cents to one cent is not the same as reducing it from one cent to free.

That much, at least, doesn't seem implausible (though much of the rest does). Behavioral responses in general are often non-linear, and in any case people are not rational. Better yet, there is some evidence for it. In Zero as a Special Price: The True Value of Free Products, Kristina Shampanier, Nina Mazar and Dan Ariely describe a series of experiments exploring people's reactions to free stuff vs. merely cheap stuff.

In the experiment that seems to get the most press, Shampanier et. al. offered subjects (MIT students, to be precise) the choice of Hershey's kisses at one cent or Lindt truffles at fifteen cents. The students chose Hershey's 14% of the time, Lindt 36% of the time and nothing the other 50%.

The choice was then changed to free Hershey's* kisses vs. Lindt at fourteen cents. The ratios changed from 14:36:50 to 42:39:19. That is, many more people went for the free Hershey's, many fewer went for the fourteen-cent Lindt and somewhat fewer opted for nothing.

One thing to note here: The experiment was conducted in a booth at MIT's student center as people came and went. In such a setup it's hard to tell to what extent you're getting the same people before and after the change. The experimenters imposed a 30 minute break between changes in an attempt to minimize the overlap, since if you can't do a direct comparison with the same subject being presented each choice, it's best not to muddy the waters and instead try to make the samples as independent as possible.

This little distinction seems worth noting, since you're not measuring the response of the same person seeing the same price difference but with different prices. The people who saw the fourteen-cent Lindt would generally not have had the impression that Lindt was "supposed to" cost fourteen cents more than Hershey's. One might plausibly argue that the comparison in both cases was between Lindt at some random price and Hershey's either free or at one cent.

However, when the choice was given between free Hershey's and Lindt at a dime, the ratios were 40:48:12. Effectively (assuming the effect is statistically significant, and I'll take their word on that), lowering the price of Lindt caused people who would have paid more to instead do nothing.

Did I mention that people aren't rational?

The authors argue that the results are best explained by the theory that people see free Hershey's as being worth more than one-cent Hershey's, and that generally people assign a premium to free goods purely on account of their being free, as when people spend hours of their time standing in line for a free coffee promotion.

The authors go to some lengths to eliminate other possibilities. For example, they compare prices of two cents and 27 cents vs one cent and 26 cents vs free and 25 cents. The first two give basically the same results. The second is dramatically different, suggesting that whatever non-linearity there is lies close to the zero price.

They also conducted an experiment on Halloween in which the kiddies were given the opportunity to switch chocolate bars in various ways. Frankly, I didn't take the time to grok that one completely, but it seemed to support the general hypothesis.

The discrepancy between Lindt at a dime and Lindt at fifteen cents is an example of the more thoroughly studied tendency, well exploited by clothing designers and others, of people to perceive higher-priced goods as being worth more.

They also mention research suggesting that when the price becomes free, social norms take over from economic concerns. For example, students would take an average of four Starburst candies for a penny, but would only take one if they were offered for free.

So ...

Lots of interesting stuff here. Clearly "free" is a different price from others. This has been known to marketers forever, but the authors provide interesting data and insights.

The next obvious question is what effect a negative price would have. Would more people have gone for a free Hershey's vs. a fourteen-cent truffle, or for a Hershey's and a penny vs. a thirteen-cent truffle?

Meanwhile, back at the web, does this mean that giving stuff away online is the way of the future and previous business models are obsolete? Looking at the specific results from the candy-pricing experiments, that seems like a bit of a leap.

* All trademarks are property of their owners. Please don't sue me for leaving off the "TM" or whatever I was supposed to include.

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