Wi-Fi In Airplanes – Stuck in $0 Reference Price

Update 2/1/2010: Southwest planning to offer Wifi (for a price). It definitely will help them to read this.

How much is getting Internet connectivity at 30,000 feet above sea level and while moving at 240 miles per hour worth to you?  How much are you willing to pay for it? How much are you willing to pay for WiFi connection in an airplane?

I predict that most will say different numbers  for these questions, progressively decreasing from a non-zero number to none other than $0 for the Wi-Fi question. The Wall Street Journal writes on the uptake of Wi-Fi in airplanes:

“There’s a very substantial decline in passenger usage the minute you start charging for the service,” said Michael Planey, a consultant specializing in in-flight passenger technologies. “It really begins to invalidate the model on which this service is being built for the next 10 years.”

wifi_demanAlaska Airlines found that even at a price of $1 lot fewer people used its service then when it was free. So the demand curve for this service will look something like the one shown here, dropping abruptly at a price just above $0.

Having connectivity is definitely of value to customers, some segments valuing it more than the others. But why are customers unwilling to pay for this value? The answer once again is the same one I showed in my Airline Unbundling study – Reference Price. Reference price is the price a customer used to paying for the service or expects to pay despite the value they get.  The purchase context does not matter to the customers, it is the price for the service. Everywhere they go, from coffee shops to hotels they received free Wi-Fi. So their reference price is $0.

The airlines should not have made this offer free to begin with but they need to do that for testing. They should have recognized this reference price effect and should have first worked on improving it before charging for it. One option I showed that worked in the unbundling study is introducing options, one high priced and another low priced. Presence of high priced option helps to improve reference price and hence customer acceptance of lower priced option. The airlines could have introduced a guaranteed speed, unlimited bandwidth version and a limited speed, limited bandwidth version at two different price points.

Another takeaway in this story is how a marketer can destroy future profit by setting a low (or $0) reference price. I am afraid however that this story is going to be  used by “Free” proponents like Mr. Chris Anderson. A case will be made about why free is the future and once again a reference will be made to the attractiveness of  $0 price, quoting Prof. Ariely’s work. I would like you as a marketer to be aware of the reference price effect and find ways to charge for this service that adds value to customers.

It is true that providing Wi-Fi at 30,000 feet is a high fixed cost operation and once you rolled out the service your costs are sunk and your marginal costs are $0. But before you made the business case for the investment the costs were not sunk and you should have made an analysis how much you expect to charge and how many customers would pay. You should not have invested with the hope that you will first get the customers and then figure out how to monetize it.

The net is, if the service is of value to customers then you should charge for it. What the customers are willing to pay for the service is not commensurate with value but lower because of the reference price. Focus on improving the reference price to capture a fair share of the value you add.

Survivorship Bias and Other Flaws in Anderson’s FREE

[tweetmeme source=”pricingright”] In his new book, FREE: The Future of a radical Price, Mr. Chris Anderson supports his arguments with many examples of businesses that used razor-razor blade model, advertising model, and free + premium model. The last few pages of his books are just a list of examples of businesses that are successfully implementing, according to him, what he calls the “freemium” model. Are examples enough to state absolutes like “the future of a radical price”?

Even if that is enough, Mr. Anderson lists only those businesses that seem to have made it, at least for now, and does not include those businesses that tried many of the free models and failed. That is the classic survivorship bias. If we restrict just to the new media businesses that Mr. Anderson focuses on, there are many instances of ventured that went under. Even the small subset one can find in TechCrunch’s  “DeadPool” is a daunting number.

Even among those businesses selected,  the time horizon is too short to say they are successful or will deliver long term profit growth. Mr. Anderson uses  a different metric, “uptake among customers” rather than profit to measure their success. His careful choice of metric is not by accident, it is about cleverly framing the argument and directing his readers and listeners to focus on a metric that is irrelevant but supports his argument.

The next problem is confusing correlation with causation. Among the blockbuster success stories he quotes like YouTube, he attributes the customer uptake to the free model. He uses  Prof. Dan Ariely’s  Hershey’s experiment to substantiate this claim on causation. You can see Prof. Ariely’s comments on people using his experiment in his blog. In his Hershey’s  experiments, the claims were based on experiments that used control groups and treatment groups. But Mr. Anderson makes his claim based on YouTube being free.

Businesses, before jumping on Mr. Anderson’s far-reaching conclusions, should ask about his decision making process and analyze their own business based on hard data. As professors Pfeffer and Sutton point out in their book Hard Facts, the difference between an academic (who is much maligned by the new media Gurus) and a self proclaimed Guru is  that an academic gives you an open system of decision making where as a Guru gives you a closed system that talks in absolutes, ignores evidence, focuses just on benefits and minimizing the drawbacks of their recommendation.