In a world vastly abundant with examples of free business models – either freemium or ad-supported, understanding the value of the free pricing strategy seems to come very intuitively to most startup founders.
That said, behind the surface, there are important factors that need careful consideration when you are building your startup pricing strategy. The zero price tag has strong psychological effects on your clients, and in order to make educated decisions as a founder, you need to understand those effects.
Why is a Free Pricing Strategy a Great Opportunity for new Products?
In 2007, behavioral economist Dan Ariely, author of the book Predictably Irrational, co-authored a study in which participants were asked to choose between two brands of chocolate – Hershey’s Kiss and a Lindt truffle. The truffle is a premium product that retails for a price multiple times higher than the presented alternative.
First, the price of the Lindt truffle was set at $0.13 apiece while that of Hershey’s Kiss – at $0.1. 30% of participants chose the truffle, while only 13% the Kiss (56% chose neither).
Then, the price of Hershey’s Kiss was dropped to $0. This totally flipped the outcome – 31% chose Hershey’s Kiss, while only 13% were willing to part with 13 cents for the premium product.
In other words, the difference of one cent doubled the number of people that chose the lower-quality product.
The authors of the study dubbed this the zero price effect – people tend to overvalue things that are free and make irrational decisions in the context of a cost/benefit analysis.
Free pricing works in multiple ways, however. A free offering (a present or a sample) could trigger a reciprocity effect – people would feel obliged to return the favor. Free sample promotional strategies in Costco resulted in sales increases from 71% to 600% of products in various categories.
Consequently, a free pricing strategy is a powerful tool for startups with an innovative offering because the non-monetary cost of switching to a new service or trying out a new product is high. The zero-price effect or the feeling of indebtedness (reciprocity) might be required to push your early adopters to give your offering a try.
This is especially true when you are competing with established brands with a non-free business model.
Why is a Free Pricing Strategy Dangerous in the Early Startup Stages?
At the same time, a free price is definitely not the right choice for all startup projects.
First, it can mislead you. In the early startup stages, the main goal of your project should be to validate your offering. If you don’t go through this process, you risk wasting resources on building something the market doesn’t need.
Because of this, the traction that you see because your offering is free could be misleading you to think that your product provides more value to users than it actually does. It’s important to attempt to upsell free customers to your paid pricing tiers in order to test if your offering is economically viable.
Moreover, the zero price effect doesn’t work in all circumstances. In industries that are dominated by free business models (like online content), consumers view this as the standard rather than a great deal. For example, 40% of Americans say they would never pay for news – after all, news has been ad (or government) supported for decades, and it’s hard to convince people of the value of paying for a traditionally free product or service.
In summary, as a startup founder you should:
- Use the zero price effect to overcome the high non-monetary cost of trying out new offerings. Keep in mind that this effect doesn’t exist in all industries.
- Take care not to misinterpret the traction you gain from a free offering for validation that your idea is economically viable.