Zero Price Effect

The Basic Idea

In 2013, in celebration of Dubai being announced as the site for the World Expo 2020, Baskin Robbins declared that everyone in the United Arab Emirates could get a free scoop of ice cream. The crowds, as you may expect, were huge. The queues spanned for blocks, with lines for indoor mall outlets spilling outdoors.1 In all the madness, one might begin to wonder why people were willing to withstand these mobs for hours just for a $3 scoop of ice cream. Why are we so drawn to free things? This irrational urge towards getting free stuff is called the zero price effect.

The zero price effect is the principle that items with a price of zero are not accounted for by a linear utility model. In a linear model, a decrease in the price of a good would correspond to a proportional increase in utility and demand for the good. With the zero price effect, the increase in demand when the price drops to zero is much higher than at other prices.

In other words: “free goods have extra pulling power.”2

Generally, we evaluate whether an item is worth acquiring by its financial cost, effort to acquire, and benefit to us. Something priced at zero, however, tempts us to discard our regular decision-making process. When an item is free, our perception becomes distorted: we magnify the item’s benefits and ignore possible downsides.

People are willing to work for free, and they are willing to work for a reasonable wage; but offer them just a small payment and they will walk away.

– Dan Ariely

Key Terms

Cost-benefit analysis: A process of weighing up the costs and benefits of a decision

Affect heuristic: A mental shortcut to make decisions, resulting in decisions being influenced by present emotions.

History

The unique concept of zero itself has a long history, and its difference from other numbers sheds light on its role in the zero price effect.

While the zero price effect entails no financial cost, our reactions are also different when it comes to zero benefit. Early work in cognition uncovered how people perform cost-benefit analysis drastically differently depending on if rewards were small or non-existent. Festinger and Carlsmith’s classic 1959 study on cognitive dissonance theory revealed that people were more likely to enjoy the same task when getting no reward, compared to getting a small reward.3 In a similar vein, in 2000, Gneezy and Rustichini studied parent’s motivations in picking up their children from kindergarten on time. When a fine was implemented for late pickups, late pickups increased, and when the fine was removed, they dropped back down. The authors theorized that this was because parents felt less guilt about late pickups when a cost was attached, instead of social norms..4 This sheds light on the zero price effect, suggesting that zero price introduces social or intrinsic motivations.

In 2007, Shampanier, Mazar, and Ariely surveyed literature across disciplines and conducted a series of supporting experiments, finally giving the zero price effect its name, producing a formal definition, and characterizing it precisely. Their empirical studies found that pricing an item at 0 increases its intrinsic value, which accounts for the shift in demand for it. They reasoned that this happens due to the affect heuristic; people look at free things with a social mindset rather than a transactional one, leading to them being more influenced by emotion.3

In 2015, further work found that the zero price effect comes into play differently for different kinds of products. In this study, they examined two types of products: hedonistic products and utilitarian products. Hedonistic products are fun and pleasurable, whereas utilitarian products are functional, helpful, and practical, even necessary. Hossain and Saini paired a hedonistic product with a utilitarian product, such as chocolate cupcakes, packages of sugar, Lindt chocolates or canned fruits. They found that the zero price effect is more pronounced for hedonistic products than utilitarian – we’re more likely to want a free bite-sized, decadent chocolate than a bag of sugar.5 This lines up with the affect heuristic explanation for the zero price effect, since the emotional decision-making would be more powerful for emotional products.

People

Dan Ariely

Psychologist and behavioral economist Dan Ariely was the co-author on the original paper on the zero price effect along with Kristina Shampanier and Nina Mazar. In addition, Ariely has researched on how we apply social and normative norms to determine value of things in different situations as well as written extensively on irrational consumer behavior.

Consequences

Think about how many t-shirts, mugs, USB drives, tote bags, or stickers you have gotten for free from random organizations. Understanding the power of the zero price effect, companies, universities, and institutions spend a large budget in getting custom-made products to give away as “swag” at open houses, orientations, conferences, speeches, career fairs, and other such events. It’s hard to resist grabbing a free t-shirt, or the latest trendy item (hello, fidget spinners), regardless of how many you have lying at home. The promotional products industry has therefore grown massively, totaling $24 billion in the United States alone.6 By choosing the right product and design, companies can succeed in creating sentimental value. Presenting a swag bag to an intern will help to create a feeling of belonging in the company while giving away a nice notepad at a conference will make sure the name sticks in everyone’s minds whenever they jot something down. Besides, every person carrying your organization’s tote bag and sticking a cute sticker on their laptop is like having a walking billboard.

Providing materials, resources, and products for free is also a means of building trust with potential patrons. For instance, tiny bottles of skincare products allow people to test them before committing to the full product. One might choose to follow a free newsletter over a more reputable, paid one, and then decide that it is worth paying for the upgrade. At the same time, it is also a means of rewarding current customers. For example, Microsoft Teams is essentially a combination of Slack and Zoom. By releasing Teams to current Microsoft Office subscribers for free, they were able to outcompete similar products. Even though it is widely argued that Slack and Zoom are better software, the freeness of Teams gives it an edge.7

Shampanier et. al. also estimates that the effect can apply to realms other than price. For instance, they suggest that drinks that are zero-calorie rather than low-calorie will be more demanded amongst a calorie-conscious population.3

All being said, it is important to remember that some products are less susceptible to the zero price effect. A 2019 study searched for the zero price effect in the prescription drugs market in Sweden but did not find evidence that it existed. This could potentially be because pharmaceuticals are a utilitarian good, and are not influenced by affect. Another explanation could be that when products are equivalent, such as different brands of the same generic drug, people just go for the one with the lowest price. Finally, they found that certain individuals gain more utility from consuming the same brand repeatedly.8 Therefore, the necessity of the good, other accessible equivalents, and brand loyalty should be considered.

Controversies

In the modern economy, free things have a hidden cost. The transition to an increasingly digital economy means that we generate vast amounts of user data, simply by using the technologies now necessary for our day-to-day lives. By now, it is well known that this data is traded for the ability to use these products for free.

Companies tend to use the zero price effect to attract more users. By offering a free service, the user base becomes reliant on the product. The OECD reports that this can be done through limited free trials, premium versions, and selling complementary products.9 While this is useful, as it allows customers to get a feel for the product first, this reliance can also be exploited. Microsoft has continuously come under legal fire for their “embrace, extend, extinguish” strategy. For instance, their Visual Studio coding platform was created with publicly available and modifiable software and initially marketed as open-source, meaning that anyone can use it for free as well as contribute to the features. As the user base grew larger, Microsoft began to add proprietary features to the platform, making Visual Studio no longer open source. Users who intended to use it as a free, open-source product were thus incorporated into the Microsoft ecosystem, where you must pay to unlock features.s.10

The widespread adoption of swag bags has its controversial side too. Along with excess production and consumption of goods that won’t really be used in the long run, free merch also has an environmental cost. Elizabeth Segran writes that the manufacturers of these products – the ones who make t-shirts and put logos on them – are in a race to the bottom competing with each other, and thus compromise on ethical and environmental standards in the supply chain.6

Case Studies

Free tastes sweeter

An experiment by Shampanier, Mazar, and Ariely showed that consumers are likely to pick an inferior chocolate, merely because it is free. They set up a stall selling two chocolates: Hershey’s Kisses and Lindt truffles. Initially, the Lindt truffles, as luxury chocolates, were sold for 15 cents per piece, whereas the lower quality Hersey’s kisses were sold for 1 cent per piece. With these prices, 73% of customers bought the Lindt. But when the prices of each chocolate were knocked down a cent, (i.e. Hershey’s were now free, while the Lindt were 14 cents), the results almost flipped. 69% of customers now picked Hershey’s, while only 31% chose Lindt.11

When you had to pay for either chocolate, customers would do a cost-benefit analysis as normal, presumably deciding that the higher quality of Lindt was worth its higher cost. But when the ‘worse’ option was free, this analysis seemed to be discarded, even though the difference in price is the same. Somehow, pricing Hershey’s Kisses at zero increased their value.

Breakfast for free

Potential vacationers are more likely to choose a hotel that offers free breakfast, even if it wouldn’t have been their choice otherwise. Building on the basic zero price experiments, researchers Nicolau and Sellerstested if the theory held up when purchasing two or more things together. Participants were offered a choice between a more expensive, reputable hotel and a cheaper, single-branch hotel, as well as between a low-cost breakfast and a free breakfast. When the breakfast at both hotels cost the same, cheap price only 8% of participants opted for breakfast at the cheap hotel, showing that quality still trumped price. But when the breakfast at the cheap hotel was made free, 46% of participants chose it.12 In totality, this experiment showed that even when the alternative is cheap, people tend to stick to their guns. However, as soon as the alternative becomes free, they are willing to forego their favorite choice.

Related TDL Content

The Value Perception Dilemma

So we value zero-priced items higher than normal, but how do we value things in general? Perhaps unsurprisingly, we forego the rational cost-benefit analysis in many other situations. This article offers an interesting perspective on the different ways we decide how much to value a good or service, from habit and normalization of price to customer experience and attention.

Affect Heuristic – Biases & Heuristics

Our emotions influence our decisions in places other than facing free things, more often than we think. This is especially important to be aware of when it comes to critical decisions. To thoroughly understand the potential source of the zero price effect, how it influences other contexts, and how to not let it limit you, check out this deep dive into the affect heuristic.

The Power Of FREE On Consumer Decision-Making

This quick read offers a summary of the zero price effect and dives into the comparison between social and market norms, all while talking about cookies.

Sources

  1. Francis, S. M. (2013). UAE Expo 2020 win: Mad rush for free ice-cream at Baskin Robbins. Emirates 24/7. Retrieved from https://www.emirates247.com/business/economy-finance/uae-expo-2020-win-mad-rush-for-free-ice-cream-at-baskin-robbins-2013-11-28-1.529606
  2. https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/zero-price-effect/
  3. Shampanier, K., Mazar, N., and Ariely, D. (2007). Zero as a Special Price: The True Value of Free Products. Marketing Science, Vol. 26, No. 6, 742–757. Retrieved from https://people.duke.edu/~dandan/webfiles/PapersPI/Zero%20as%20a%20Special%20Price.pdf
  4. Gneezy, U. and Rustichini, A. (2000). A Fine is a Price. Journal of Legal Studies, Vol. 29, No. 1, 1-18. Retrieved from https://rady.ucsd.edu/faculty/directory/gneezy/pub/docs/fine.pdf
  5. Hossain, M. and Saini, R. (2015). Free indulgences: Enhanced zero-price effect for hedonic options. International Journal of Research in Marketing, 32, No. 4, 457-460. Retrieved from https://www.sciencedirect.com/science/article/pii/S0167811615001172.
  6. Segran, E. (2018). It’s time to stop spending billions on cheap conference swag. Fast Company. Retrieved from https://www.fastcompany.com/90260185/its-time-to-stop-spending-billions-on-cheap-conference-swag.
  7. Molla, R. (2019). Why the government is investigating Apple, Amazon, Google, and Facebook for antitrust — but not Microsoft. Vox. Retrieved from https://www.vox.com/2019/10/14/20910510/microsoft-government-antitrust-investigation-apple-amazon-google-facebook.
  8. https://econ.hkbu.edu.hk/eng/Doc/The_Zero_Price_Effect_Using_Field_Data_An_Application_to_the_Market_for_Generic_Pharmaceuticals.pdf
  9. https://one.oecd.org/document/DAF/COMP(2018)14/en/pdf
  10. https://github.com/microsoft/pylance-release/issues/4
  11. Ariely, D. (2008). Predictably Irrational: The Hidden Forces That Shape Our Decisions. HarperCollins.
  12. Nicolau, J.L. y Sellers, R. (2012). The free breakfast effect: an experimental approach to the zero price model in tourism. Journal of Travel Research, Vol. 51, No. 3, 243-249. Retrieved from https://journals.sagepub.com/doi/10.1177/0047287511418370

Read Next