Pricing Free Motives

Friday, 21 August 2015

What is more ‘beyond price’ than ‘free’? ‘Free’ is a very emotive word. A few years ago at Gresham College, we emblazoned ‘free lectures’ on the brochure and more prominently on the website. Despite never charging for lectures over four centuries, attendance soared.

Free Is Your Emotion

Dan Ariely explores ‘free’ beautifully in the chapter, "The Cost Of Zero Cost", in his book, Predictably Irrational [Harper Collins, 2008]. Zero cost is an asymptotic negotiating point where we become irrational.Marketeers are highly attuned to ‘free’ in many special offers. Ariely describes experiments from chocolate to book vouchers all showing that under ‘free’ conditions we make foolish choices. For example, when museums are free the queues are lengthy, despite the fact that museum fees may not be high. When confronted with ‘free’, we underestimate the value of our own time and accept much higher crowding.

Taking something offered for ‘free’ is emotionally intense. 'Free' removes an entire host of defensive mechanisms from your commercial armoury. 'Free' restructures the principal/agent relationship so now you wonder if you are the one with an obligation to discharge rather than the ‘vendor’. Are they still a ‘vendor’ if it’s free?

Trust and money are uncomfortable partners. Ariely also amusingly describes an imaginary trust-busting scene – instead of saying ‘thank you’, you offer your mother-in-law three hundred dollars, no, how about four hundred dollars, in appreciation of a wonderful family holiday meal. Imagine the family problems that would create. He points out that social and market norms conflict. We live in two worlds simultaneously, the social world and the market world. A simple solution is to keep the two separate. But this is often not possible.

Understanding another party’s self-interest is crucial. We implore children to stop and think about why someone would offer something for free and tell them not to take free sweeties from strangers. Good negotiators should always ask, ‘what’s in it for the other party?’, ‘what do they really want?’. The concept of self-interest and enlightened self-interest is fundamental to all of economics since Adam Smith.

Today’s financial crisis is, at heart, a crisis of trust. A couple of years ago, banks knew how badly they managed their own risks, how aggressively they’d priced their own assets, and how much their own bonuses depended on these aggressive valuations. ‘If we’re acting so irresponsibly, think how much more irresponsibly other banks must be acting.’ When valuations started being repriced, projections of social norms indicated that the repricing and credit terms should be more negative than market norms indicated. When banks failed to trust each other they withdrew credit, thus creating liquidity and solvency problems at fellow banks in a domino-effect.

Self-interest is a common feature in establishing trust. Yet when you’re offered something for free, you often spend much time asking ‘why?’ And so you should. For example, many conventional norms in banking may not be ethical.

A tech industry phrase for free and freemium approaches is: "if you're not paying for the product, you are the product". An echo of the Jerry Maguire film, “show me the money”. In the UK, ‘free banking’ is the norm, though it’s hardly free, just that the charges are hidden within poorer deposit returns. UK banks begin their customer relationships with a lie. Banks make money from ‘free’. You are the product. But a good bank that offered ‘cost-based banking’ would be hard to sell in the UK. A more ethical approach might be to say ‘no charge at this time’ banking.

Dictum Meum Pactum - My Word Is My Bond

But it is very hard to move forward if you’ve lied in the past. Products and services that are originally free, that then change to requiring payment, can create a tremendous amount of resentment. There are numerous online services I now refuse to use because they started as ‘free’, then moved to trying to charge me. I didn’t mind them adding services that required payment, but cutting back on our original ‘deal’ meant I cut them off.

The open source movement works on these underlying principles of ‘free’. If free is abused, as one blockchain community has done, there can be tremendous resentment, even antagonism. When I start using something free, then I assume that’s the relationship. Heck, I’m possibly even doing something of value for the other side. When they try to change their business model to charge later, I resent it as both a change of relationship but also an implication that what I’ve provided hitherto has been of insufficient value to justify staying free. They have devalued me.

The desire to establish self-interest hits another paradoxical peak when politicians, businesspeople and non-governmental organisations (NGOs) meet. I’ve attended quite a few conferences where the first words to many presentations are, ‘I work for the public sector’ or ‘I’m a public servant’, or ‘I represent an NGO’, or ‘I work at a not-for-profit’. These anti-commercial opening litanies are perceived to be important in allaying concerns about self-interest, and are then properly followed by what the presenter and their organisation do. Of course, despite the reality that I, like many other people, have multiple governmental, non-governmental and commercial roles, I often can’t resist having a bit of fun at these conferences. I’ve been known to open some of my controversial presentations with, “Unlike some of the previous speakers here today, I direct a for-profit organisation and can prove I add value to society”.

Enlightened self-interest is also crucial to public choice theory which recognises that problems with the behaviour of politicians and government officials are amenable to traditional economic analysis as they are self-interested agents and interact with social and economic systems under alternative constitutional rules. Once people establish commercial motivation, in many ways they can relax - the self-interest is clear. I can trust you to seek to make money, or seek votes.

At the end of the day, we must decide whether commerce corrodes or enhances trust. We must choose between Irish dramatist Oliver Goldsmith’s (1730-1774) assertion that “Honor sinks where commerce long prevails” [“The Traveller”] or Irish dramatist George Bernard Shaw’s (1856-1950) character assessment, “He’s a man. I know him: his principles are thoroughly commercial.” [Man And Superman, Act 4].

For me, commercial self-interest ensures that successful commercial people must maintain a basic level of trustworthiness, while competition ensures that basic trust levels increase over time. Or am I just too trusting?

This article is part of a series on the Future of Price.