This lecture draws on the work of Dan Ariely to demonstrate the psychological impact of a $0 price point. It also considers some of the consequences of that impact.

1. (Stanford BUS-21)
Martin Westhead
Mastering Marketing
The Psychology of Free
How to make money
by giving things away

2. Overview
 Pricing is all about perception
 Ariely and Shampanier
- Free chocolate experiments
- The exuberance of Free
 The Penny Gap
- The flip-side to Free exuberance

3. Pricing perception is not
always rational
 Cold beer on a hot day
1. From a grocer
2. From a Resort Hotel
 "Reasonable" price for (2) is
nearly twice (1)
 Even worse when it comes
to Free

4. Studying Free
 Zero as a Special Price: The
True Value of Free
Products – Ariely and
Shampanier

5. 1. Photo Survey
Pay vs. Pay Pay-1 vs. Pay-1 Free vs. Pay-2
Ariely and Shampanier
45%
40%
90%
40% 40%
10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 3
Hershy's
Ferrero
$0.02 $0.27 $0.01 $0.26
$0.00
$0.25

6. 14%
42%
40%
36%
19%
12%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1 2 3
Hershy's
Lindt
2. Real purchase: Money
where your mouth is
$0.01 $0.15 $0.00 $0.14 $0.00 $0.10
Pay vs. Pay Free vs. Pay-1 Free vs. Pay-2
Ariely and Shampanier

7. 8%
31%
30%
13%
0%
5%
10%
15%
20%
25%
30%
35%
1 2
Hershy's
Lindt
3. Removing Transaction
Costs
$0.01 $0.14 $0.00 $0.13
Pay vs. Pay Free vs. Pay-1
Ariely and Shampanier

8. 29%
64%
100%
71%
36%
0%
0%
20%
40%
60%
80%
100%
120%
1 2 3
$10 card
$20 card
$7
4. Gift Cards
$5 $12 $1 $8 $0
Pay vs. Pay Pay-1 vs. Pay-1 Free vs. Pay-2
Ariely and Shampanier
$10 $20 $10 $20 $10 $20

9. Conclusions
 Overwhelming positive over-reaction to Free
- Small reductions in price – no effect
- Go to free – adoption shoots up
 Zero is a disruptive price
 Why?
- We focus on downside of a transaction
- What is we don’t spend the gift card?
- Free eliminates the downside
- Cognitive transaction cost
- Is it worth the price?
- Act of asking the question
 Purpose of this class
To study effective business models that leverage this phenomenon

10. Assumption
Corollary: The Penny Gap
 Josh Kopelman
- http://redeye.firstround.com/2007/03/the_first_penny.h
tml
 Challenge of Freemium
- not $5->$50M, biggest gap is
free to $0.01
 Flip side of Free Psychology
 Free -> disproportionate
demand
Demand
Price
$0
$0.01
The Penny Gap
Reality

11. Paying for shopping bags
 2013 - 67 of 88 Municipalities
in California
- Ban on plastic bags
- Min $0.10 charge for
paper/reusable bags
 Huge change in shopper
behavior
 Its not the cost – the small
charge is a trigger
- Our brain recognizes the cost
- Extrapolates the
environmental cost

12. Summary
 Pricing is all about perception
 Ariely and Shampanier
- Free chocolate experiments
- The exuberance of Free
 The Penny Gap
- The flip-side to Free exuberance