Mr. Malcolm Gladwell reviewed  Mr. Chris Anderson’s new book, “Free: The Future of a Radical Price”. It is a very well written review and very methodically breaks down Mr.Anderson’s claims.  From Mr.Gladwell’s review I found that Mr.Anderson quoted Professor Dan Ariely’s work and using it to support his case for free.

Anderson describes an experiment conducted by the M.I.T. behavioral economist Dan Ariely, the author of “Predictably Irrational.” Ariely offered a group of subjects a choice between two kinds of chocolate—Hershey’s Kisses, for one cent, and Lindt truffles, for fifteen cents. Three-quarters of the subjects chose the truffles. Then he redid the experiment, reducing the price of both chocolates by one cent. The Kisses were now free. What happened? The order of preference was reversed. Sixty-nine per cent of the subjects chose the Kisses. The price difference between the two chocolates was exactly the same, but that magic word “free” has the power to create a consumer stampede.

This experiment is very well explained in Professor Ariely’s book. But the problem is Mr.Anderson seem to have only read part of Professor Ariely’s work on free and ignore that parts that argue why free as a starting price is not a good idea even when you reach a large number of customers.  The problem with Mr.Anderson’s book and his argument is he talks in absolutes without considering all arguments about a topic and quotes research (even from the same source) selectively. Here is what Professor Ariely said in an interview with WSJ regarding giving services away for free to attract users (WSJ (September 2008):

BUSINESS INSIGHT: On the other hand, what about companies that set the initial price of something too low, even offering a product or service free of charge in order to encourage people to use it? Isn’t that why so many online publishers are facing such great difficulties, because they initially offered their content for free and then consumers couldn’t move past that anchoring point?
DR. ARIELY: The truth of the matter is that it’s very hard to realize the value of something even after you’ve used it. Say you use e-mail. How valuable is it to you? Sure, if something is free then people will start using it. But what companies don’t realize is that the mapping of utility to money is very difficult. People won’t say, “This is so great. I’ll pay $20 for it.” Instead they’ll say, “I used it for free all along and now you’re charging me? I’m not interested.”

You can clearly see the effect of the initial price of $0. Once people get it for free, $0 becomes the reference price and it is very difficult to change that. The New York Times tried it with Times Select and failed. Airlines had a tough time charging for what used to be free and only could do it or baggage fees. USAir tried to charge for inflight drinks but backtracked on customer backlash.

You might succeed in stealing market share from the competitors but by giving away for free you set a bad reference price that destroys value in the long run.