I Want to Break FREE: The Neuroeconomics of Discounts and Business Strategy

FREE

FREE. It's not just another discount.

As workers poured into the lobby of an office building one morning they encountered a candy sale of sorts. On the table were two kinds of chocolates for sale. One of the chocolates offered were Hershey Kisses. The price tag on the Hershey Kiss was $0.01 (one cent). The other chocolates offered were Lindt truffles – a high quality chocolate renowned for its flavor. The Lindt truffle was priced $0.15 (fifteen cents). Overwhelmingly, 75% of people purchased the Lindt truffle recognizing the value in the price for such a high quality chocolate. This chocolate sale was actually the experiment of MIT economist Dan Ariely and he wanted to find out how discounts affect our decisions.

The next time around Ariely decided to lower the price of both chocolates by one cent. This meant the Hershey Kisses were now $0.00 (FREE) and the Lindt truffles were now $0.14 (fourteen cents). So what happened? The preference for chocolate was actually reversed. The Hershey Kiss was now chosen 69% of the time. The price difference was exactly the same between both chocolates, but it seems the word FREE may have had something to do with the dramatic role reversal of chocolate preference.

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The Neuroeconomics of FREE

FREE isn’t just another discount. The word FREE when encountered in purchasing decisions is loaded with emotion, and surprisingly, emotions are responsible for more of our decisions than logic.  Economists have long thought that logic and logic alone is what guided our behaviors and decisions when in the purchasing process. However, Neuroeconomics teaches a more up-to-date approach of how we make our financial decisions, and as it turns out more often than not our emotions are what guide our behaviors. As humans, and as consumers, we make think logically but we act emotionally. So when you’re shopping and you encounter FREE it impacts you in a way that other discounts cannot . We all share the common belief that FREE is good (most of the time), and the added positive emotional boost that you get from FREE just can’t be achieved through any other numerical discount. I’m also willing to guess there is a physiological boost from just seeing FREE.

FREE is the Future of Business

We live in the digital age, and as a result FREE is becoming more and more common. This is possible because the falling costs of digital technology lets companies make as much stuff as they want for devastatingly low costs, and when you can make stuff for low costs that enables you to give it away for FREE. Chris Anderson, author of Free: The Future of Radical Price, made a great point in saying “Give a product away, and it can go viral. Charge even a single cent for it and you’re in an entirely different business…The truth is that zero is one market and any other price is another.”

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Companies can make a lot of money by giving stuff away. Businesses like Google have made large amounts of money by giving away FREE email services, however on the backside they’re increasing their revenue by selling advertising on that space. Amazon was able to boost online sales world wide by offering FREE shipping on orders over a certain amount, and because one item alone wouldn’t typically reach that required amount for FREE shipping consumers ended up adding another item to their shopping carts just to attain the benefits (both financial and emotional) of FREE.

Leveraging FREE in Marketing and Sales

Like anything there is a skill required in utilizing FREE in your business strategy to create success. Amazon leveraged FREE shipping to gain additional sales that otherwise would have not been there. Google used GMail to gain exposure to millions of users so they could sell advertising space to other companies. The strategic use of FREE allowed Google and Amazon to increase their revenue. These are just a few examples of how FREE is used in business everyday.

Apple was able to boost iPod sales initially by giving away the software program iTunes. This FREE program allowed Apple to gain familiarity with consumers and at the same time opened the door for them to easily purchase downloads and hardware to enhance their media experience. Taking it a step further the iTunes Store offers a FREE download each week and all you have to do to get the FREE song is sign up for an iTunes account. Free used properly is brilliant.

FREE can be good for businesses but it can also be bad. YouTube for example has failed to make Google any money thus far. In fact it’s draining money from Google. YouTube lets people upload and download videos as much as they want for FREE, and that is the problem. An estimated 75 billion videos will be served up by YouTube this year. Even though technology costs are almost near zero for YouTube, any fractional number multiplied by 75 billion is going to be a lot. In fact a recent report by Credit Suisse estimates that YouTube’s bandwidth costs in 2009 will be $360,000,000. [Gladwell, New York Times July 2009] YouTube’s continual FREE transactions are costing Google dearly because the user has no restrictions on FREE. For YouTube to turn a profit they need to find a solution that properly leverages FREE in their business plan and strategy.

Purchasing FREE: Buyer Beware

Hopefully after reading this post you will be more attuned to how businesses utilize FREE to influence your purchasing decisions. People love FREE. However, FREE sometimes is not the best option because we can emotionally overreact to FREE leading us to make poor decisions. Dan Ariely talks about purchasing a car a few years back. Because he has two children he thought logically and came to the conclusion that he should buy a minivan. Given his situation it was the most sensible option, but when he got to the dealership he was distracted by this beautiful Audi coupe that advertised FREE oil changes for the first 30,000 miles. Mislead by his heightened emotions to regain his youth and the FREE oil change offer he abandoned his logic and paid more for the Audi. Although the Audi is a nice car, Ariely regrets his decision because he knows the minivan would have been the best choice. In addition to practicality, Dan estimated his FREE oil change expenditures to be near $150 hardly worth his initial response to FREE the first time around.

Some FREE Advice

As I am finishing writing this post I just noticed that I am sipping a calorie FREE can of Diet Squirt. Over my shoulder my television is playing and I just heard a commercial for a fast food chain that is advertising Zero (FREE) Trans Fats in their food. It would appear that FREE is all around us urging us to purchase. Next time you set out to make a major purchase keep FREE in the back of your mind and make sure it’s truly the best decision for you in the long run.

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One thought on “I Want to Break FREE: The Neuroeconomics of Discounts and Business Strategy

  1. After I read this article I went to one of my usual video game websites and watched a video on Nintendo’s Wii Shop Channel for the Wii. In it the narrator is saying the prices for the downloadable games in terms of “Wii Points” and I kept thinking to myself “That’s not a bad price.” But as soon as the narrator converted the points back to dollars I immediately became hesitant as to why I had ever wanted to download the game. It seems that instead of being free, if something costs, say, beans instead of dollars, people are more happy to part with beans.

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