Once again the power of $0 price is in the news. This time in The Wall Street Journal, featuring research published in Journal of Consumer Research. It is the previously famous Hershey’s experiment from Dan Ariely’s work,

“In one of their experiments, participants were offered a choice between a cheaper lower quality chocolate (Hershey’s) and a more expensive higher quality one (Ferrero Rocher). The price of the chocolates was manipulated between subjects in the following manner: two cents & 27 cents, one cent & 26 cents, and zero & 25 cents. Results showed that whereas there was roughly an even split between the two chocolates in the first two conditions, 90% chose Hershey’s when it was free, indicating a discontinuity in the cost-benefit evaluations. In other words, consumers over-reacted to the free chocolate.”

As it had been said before, “something magical happens at $0 price”.   So a strong case is made for giving your product away for free regardless of the experimental conditions and its applicability to your particular scenario. You are told that Free is Free marketing. But no one bothered to do the math for you on what is the expected value of free. Let us do just that here.

Let us assume the costs are all sunk since you already bought the chocolates. From the text in bold above you can see that:

  1. When the price was 1 cent for Hershey’s and 26 cents for Rocher,  the choice was even, that is 50%. So the expected value of the customer is  (0.5 * 1 + 0.5 * 26) =  13.5 cents
  2. When the price was 0 cent for Hershey’s and 25 cents for Rocher, the choice was 90% Hershey’s and 10% Rocher. So the expected value is (0.9*0+0.1*25) = 2.5 cent

So which option would you choose? One that has an expected value per customer of 13.5 cents or 2.5 cents.

If you believe the free customers generate other revenue, then each one has to make up additional 12.2 cents from whatever means it is.

Just by giving up the 1 cent on the price you could lose much more than 1 cent. In this case, you lost  11 cents and left with the hope that you will somehow make up for it.

What does this say about the wildly famous Freemium model? The Freemium model is about having a free version to get users and hope that they will convert over to paid premium version. Simple calculation from Hershey experiment shows presenting a free version is much worse than presenting a low priced version alongside premium version.

Isn’t it time you do some hard math and reject fads and pseudo economics of social media gurus?

See also:

1. Opportunity cost of $0 price.

2. Dan Ariely cautioning on the dangers of $0 price.