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The Price of FREE!

  It is a cliché that nothing in this world comes for free. That doesn’t make it any less true. So when we deal with freebies, what is it that we’re giving up? What is the cost attached to the freebie, whether monetary or otherwise? This Special Report is an introduction of sorts to the fascinating world of consumer behaviour.

Soumen Dutta
Mentor, Program Director, PG India

When was the last time you downed that extra beer to get the ‘Happy Hours’ free beer for your friend? When was the last time you bought an extra shirt to get the FREE voucher at Shoppers Stop? When was the last time you bought an item on Amazon only when it had free shipping to your house? If your answer to all three questions is ‘NEVER’, you are one of those rare individuals who have not been bitten by the FREE bug. For the rest of us, we are deeply infected with “FREElaria” – the non-terminal disease of being irrationally in love with things given to us for free.

Most of our actions are usually predictable when we have a price tag to our purchase. We have this thing about the glory of bargaining and an obscure economic concept called ‘cost-benefit analysis’ that our mental faculties churn out in seconds. But why is it that our actions change completely when we hear the word FREE? Almost like a zombie we toe the line the marketer has laid for us. What is it in the 4 letter word that turns our world upside down?

Origins of ‘Cost-Benefit Analysis’

Basically, Cost-Benefit Analysis (CBA) is when you’re faced with a situation where you have to take a decision, and you draw up the advantages and disadvantages of taking that decision. At its simplest, if the advantages outweigh disadvantages, go ahead with the decision.
Even though the origins of the economic concept of CBA can be traced to the works of Jules Dupuit, a French engineer and Alfred Marshall, a British economist, the true credit of the practical development of CBA goes to the Federal Navigation Act of 1936 that mandated the US Corps of Engineers to carry out projects for the improvement of the waterway system only when the total benefits of a project exceeded the costs of that project.
According to the US Corps of Engineers, CBA estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile.
By the 1950s, economists developed a rigorous, consistent set of methods for measuring benefits and costs of projects. According to investopedia, CBA is defined as a process by which business decisions are analysed. The benefits of a given situation or business-related action are summed up, and then the costs associated with taking that action are subtracted.


Zero Price Effect
“When people are offered something for free, they have this extreme positive reaction that clouds their judgement. They are ready to forgo options that are, rationally speaking, better for them.”

This is the ‘Zero Price Effect’1. This esoteric term was coined as a result of a series of experiments that Dan Ariely, Kristina Shampanier and Nina Mazar conducted at the Massachusetts Institute of Technology (MIT). These experiments about “free” with the fun-loving lads of MIT led to the publication of an article on the true value of free things in the journal Marketing Science. And suddenly, free no longer appeared free.

So, why does getting something for free make us act so differently than when we pay? What changes when the price of something is lowered to zero? To understand the effect of zero, we first have to delve into the normal maze of common decision making with things that have a price. Everything that has a price must go through the cost-benefit analysis, whether it is as significant a decision to solve the Kashmir issue by declaring war on Pakistan (the cost of this is really high), or as minor a decision to buy the ticket to the matinee show of Avengers: Infinity War. While the stakes involved in both these decisions are dramatically different, the route for arriving at the decision is roughly the same:

How much are you losing
How much are you gaining
Subtract the first from the second to see what have you got.
If you have a positive number, go for it!
If not, look for the next best alternative.
The real dilemma begins when the concept of free  enters the fray. According to Juan Nicolau, Economics Professor at the University of Alicante, “It only implies benefits and no costs, while another offer with a positive price, no matter how small it is, always conveys both benefits and costs.” Dan Ariely in his book Predictably Irrational theorizes, “’FREE!’ gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is. Why? I think it’s because humans are intrinsically afraid of loss. There’s no visible possibility of loss when we choose a FREE! item.”

An alternative thought is that our love for FREE stems from our laziness. Can it be that we prefer FREE, because we it is easier to grab a free object than make the effort of reaching for the wallet or purse, taking the money out and paying up? Kristina Shampanier tried to ascertain the reason, through her experiments at a cafeteria checkout line where people were already prepared to reach into their wallets. She proved that “it’s not about having to reach out for the money, it is this affective reaction that people have.” So, more than laziness, it is our irrational love for FREE that makes us act the way we do. But how does it really work?

The Free-work
As rational human beings, we use “heuristics”— efficient rules and mental shortcuts — to help us in making judgments and taking decisions. Depending on the importance of our decisions, our brains select a pathway for our actions. While buying a car, we take utmost care to go through every step of the complex cost-benefit analysis, as we believe it to be of high importance with a lot at stake. However, while deciding on which paratha to eat, we mostly rely on our gut feeling to save ourselves the effort of the complex decision making process. It is like cajoling yourself, saying, “There’s not much to lose in this decision, so why bother so much!” This is our “affect heuristic” — a short cut based on gut feelings or instinct. More pronouncedly, when FREE becomes a part of the transaction, we no longer do a cost-benefit analysis at all before taking a decision. Rather, we start relying solely on gut feelings and a positive emotion.

Let’s explore this with another common example. Two different hotel rooms are listed on the same website, one without breakfast, the other with FREE breakfast. While comparing the rooms, you might have first liked the room without the breakfast. However, the moment you saw FREE breakfast in the second room, you suddenly start liking the second one more. “Benefits and costs are always present, as opting for the alternative with a free component does imply paying for the other component of the product,” Nicolau says. “Nonetheless, a positive affection is generated toward the component and, in turn, toward the whole product itself.” So, even though we know we are paying for the free item through the other part of the bundle, we are just happy to feel better about the FREE option!

5 FREE things which aren’t really FREE
1. Free Search
While Google’s free searches have actually given the Internet the shape that it is today, it is in reality an extremely costly proposition. While you do not physically shell out a single rupee for your searches, you’re actually selling yourself! Google it records your behavioural, attitudinal and usage patterns, and makes these patterns available to the various sellers to show you their ads. In effect, Google is selling your patterns to various third parties. This leads to a wide variety of impulse purchases and unwanted expenditure.

Imagine yourself pining for the latest PS4 video game console for a while, but just not being able to buy it because you want to take the GMAT. However, not being able to buy doesn’t mean you can’t take a peek at all the good things and features of the PS4. So, once in a while, you end up searching for the various technical specifications of the PS4 and the new games being released for it. Suddenly, an ad pops up while you are reading an article about Permutation and Combination. The simple ad says, “Buy PS4 at 32% discount on www.amazon.com with special cashback from Paytm and financing from Bajaj Finance.” Now, this seems too good to be true, and you end up closing the deal! So, while you wind up with a cracking deal for the PS4, you end up spending money on something you could have done without.

Advice: Google tracks your every activity in order to improve your search recommendations and serve ads suitable for you. You can be untraceable by deleting items from your history, turning tracking off on your browser or using the incognito mode while browsing. On the other hand, you can just focus on what’s important and let go of the rest.

2.Free Shipping
Free Shipping is an extremely popular way for e-retailers to sell higher priced items. A classic example is when you find a t-shirt worth `1250 to be a better bargain than a t-shirt worth `800 with `200 shipping charges, just because the former comes with FREE shipping. While the latter is a better deal, you may, like most other online shoppers, get put off by any additional charges like shipping added to your purchase!
Advice: While buying online, it is always better to compare identical products with shopping charges or free shipping, as on numerous occasions, products work out cheaper when you actually opt to pay separate shipping charges.

3. Free Prizes
Free prizes come at a large cost, be it the smaller prizes or the bigger ones.
In case of the former, like a movie ticket or even an iPhone, you feel obligated to behave the way the seller wants you to. So, at a very low cost, you become a believable brand ambassador for the company. By accepting the “Free Gift” from the company, you lose your negotiation power by being forced by your conscience.
In case you are lucky enough to win the bigger gifts like a car, a flat or air tickets for an international vacation, be prepared for the additional costs that accompany them. While the marketer gifts you the car, he doesn’t pay the road taxes, the registration fees or the maintenance costs for your car. Similarly, a flat comes with its whole bouquet of taxes and fees. And the vacation doesn’t end with the flights – the costs of stay, travel, sightseeing and food, all add up to be an additional expenditure.
Advice: Before you start celebrating a Free Gift, make sure you can afford the additional costs that come with it.

4.Free Food and Beverages
About a month ago, a strange sight welcomed me when I entered the usually sparsely crowded Inorbit Mall in Vashi. A serpentine queue about a mile long slithered at a snail’s pace towards the newly opened Starbucks, while the rest of the mall wore a dejected look. While I was trying to figure out what was wrong, two super busy teens shoved a piece of glossy pamphlet while tracking down their next target. Starbucks was giving away a FREE drink on their nth store opening.
While I have nothing against Starbucks’s policy, what I found strange was how much time one wasted in the queue waiting for that free drink. While the free drink had no price, there were so many other valuable tasks that could have been accomplished in the time wasted for the drink. So, while your downside for the drink in price is really Zero, your opportunity cost for the time wasted is really high.
Advice: The next time you plan to stand in that long queue for a free thing, ask yourself if there’s anything better that you can do with your time. If there is, then that drink isn’t free for you.

5.Free Hotel Breakfasts
Very often when I go on vacation, my family is excited about the FREE breakfast at the hotel. On one of my official trips, I actually did a cost-benefit analysis of this free breakfast. The hotel was charging `7,500 per night on one of the travel sites, while it was charging me `9,000 per night, which included the FREE breakfast. And frankly, I don’t remember the last time I had breakfast worth `1,500!
Advice: Actually, “Free Breakfast” means you’ve already paid for it. Doling out “Free” food and beverages worth thousands of rupees every single day would ensure a speedy demise for any hotel. So, book the hotel after a thorough price comparison on websites like Hotels.com, trivago, agoda.com.

Why give something for free?
Most cost accountants would agree with me that a free gift or a free sample is a sure shot money loser. But the truth is that consumers love freebies. And any marketer worth his salt would agree that if done properly, freebies are the bait that guarantees a nitro-boost to sales. A positive takeaway from this is that consciously or unconsciously, consumers respond in a host of surprising and conducive ways when they get something for nothing.  This leads to generous rewards for the companies in return for their ‘generosity’. Here are a few of the surprising ways consumers are affected by freebies.

Give the customers a feel
Free samples ensure that your product reaches the hands of your customers. And every person who is trying out your product has the potential to become a lifelong customer. This eliminates the choices and options that were in the mind of the customer and hooks him to your product. Imagine yourself walking down the aisle of beverages at your local supermarket. While you are confused between Red Label and Society Tea, a Sales Rep from Lipton walks up to you and offers a free sip of their latest Darjeeling Tea. While you are unsure about how the other brands will taste, you now know for sure how Lipton tastes. And if you like what you tasted, you’ll want to keep the headache of choosing and justifying your choice by simply picking up the pack that the smiling Sales Rep hands you!

Free comes with an obligation
There’s a saying among marketers that giving out freebies can mean either you are desperate or you are going out of business. And both these things lower the brand value of any company. Over and above this, there’s an actual cost for the freebies. So, in all it would mean a losing proposition.
Contrary to this belief, Fast Moving Consumer Goods or FMCG companies have stuck to using the technique of FREE sampling. Free samples at supermarkets help boost sales (at least partially), because customers who’ve been given a taste tend to feel obliged to buy the food they’ve been given for free. The reason for this is what marketers call the Reciprocity Principle. But there’s more to reciprocity than the simple giving back. According to Randy Garner, a professor of behavioural science at Sam Houston State University, feeling obliged to reciprocate a favour “can occur despite the fact that we may never have requested the favor in the first place. (sic)”2

The reciprocity principle is one of the basic laws of social psychology that states that in many social situations, we pay back what we received from others.

So, while you had no interest in buying Cheddar Cheese when you entered Star Bazaar, the small bite of Free Cheddar that your son just loved made you feel obligated to buy at least one pack of it.

Free is not cheap
We, as rational human beings, have this irrational tendency to associate quality with price. So, anything cheap is deemed to be of lower quality in relation to a comparable product. However, how do you measure the quality of something that is given for FREE with an expensive item? Imagine the free parking sensors that come with your latest auto-transmission car. We would imagine it to be of good quality as well, right?
Isn’t it surprising that while we associate lower quality with something that has been discounted, we suddenly look at a similar thing with high regard the moment it is FREE. You can think of this as a derivative of the common man’s Theory of Relativity, which says ‘Everything is relative’. We place a price value to an item that already has a price; researchers call it a ‘natural anchor’. But without a price as a cue, we tend to get confused, and our brain starts looking for other signs to indicate value. So, when the primary purchase item is a non-discounted high value one, you automatically associate its quality perception to the freebie as well.

Free gives you extra
Haipeng (Allan) Chen, Howard Marmorstein, Michael Tsiros, & Akshay R. Rao in an article in Journal of Marketing Study3 talk about an experiment in which participants had a choice of getting 33% more coffee or 33% off the regular price of coffee. More people picked the former, even though the discount is a better deal in terms of how much the coffee costs per ounce. Refer to Table 1. Assume the original weight of the coffee to be 100, and the original price to be 200, which means the cost per weight will be 200/100, i.e., 2. In Scenario A, participants got 33% more coffee, so the weight increases to 133 with the price the same as earlier, i.e., 200. In Scenario B, participants got a 33% discount, so the weight remains 100 while the discounted price is 134 instead of 200. And the new cost per weight shows the actual story!

ALL ABOUT COFFEE Scenario A Scenario B
Old Weight 100 100
Old Price 200 200
Cost per weight 2 2
New Weight 133 100
New Price 200 134
New Cost per weight 1.50 1.34

Apparently, we’re really bad at math when it comes to calculating percentages! The researchers found that people thought a 33% increase in quantity and a 33% percent discount were equivalent; in fact, the discount is equal to getting 50% more in terms of unit price.
Once shoppers get confused with the numbers, they’re left with only the emotional factors to guide their decision-making. People perceive getting something free or extra as a gain, while a discount is viewed as just reducing the amount paid out of pocket. We’d rather gain than lose, even when it’s not in our best interest economically!

People talk when they are happy
Who doesn’t love freebies? And what better way to make your customers praise you than to give freebies! Given our current closely interconnected world which is dominated by social media, the elusive good word that the brand is after is easily spread through social networks.
In fact, multiple researches have proven that customers converted into brand advocates can garner a brand more sales than a brand ambassador can through traditional advertising. And, of course, it’s a lot cheaper! Procter & Gamble figured out that one of the easiest and best ways to get people using and talking about their products is simply to give them out for free. In their article titled, What Drives immediate and ongoing word of mouth?, Jonah Berger and Eric M. Schwartz found that people who got a product for free talked about it 20% more.
So what do we do now?
Now that we are aware of our own small little shortcomings and fallacies, can we really do something about it? Is there a way to get our own decision making system back to work? The answer comes from Kristina Shampanier. According to her, the solution lies in making the decision after changing the equation, by increasing the price of the FREE item so that it is no longer free. Let’s break it down.
Add 10 rupees to the free price and add the same amount to the other alternative you were considering, and see how you would react to these new choices. Now that you have price tags for both the options, it will help you understand if you’re truly overvaluing the free product or not.
And of course, even after you’ve added 10 rupees, you may still want to take the FREE item, and that’s a completely personal choice! I’m pretty price sensitive (read, thrifty) and don’t mind spending the extra time or marginally extra expense once in a while for a FREE bargain that is acceptable to me. But only when my cost-benefit analysis comes out to be positive.
Always remember: There are no free lunches in this world. 

The author is an alumnus of IEM, Kolkata and IIFT, and has had extensive experience across multiple industries in India, Europe and Africa. After an illustrious career with TATA, his love for mentoring students brought him to IMS. He is the Program Director of the PG India vertical and a regular mentor.