Chris Anderson’s new book, Free: The Future of a Radical Price, was just reviewed twice in the New York Times (here and here) and got a Gladwellian treatment in the New Yorker.
Anderson argues that the price of zero is essentially different from all other prices. Anderson describes an experiment conducted by Duke psychologist Dan Ariely, the author of Predictably Irrational. Ariely offered a group of people two types of chocolates – Hershey’s Kisses for one cent, and Lindt Truffles for fifteen cents. 75 percent of buyers chose the truffles. Then, he reduced the price of both the chocolates by 1 cent – the Kisses were now free and the Truffles were 14 cents. One would expect the same buying patterns; the difference between the two chocolates is still 14 cents. However, with this new offer, 69 percent of the buyers chose the Kisses. Why?
There is a difference between cheap and free, and zero has its own demand elasticity. The book hits on a puzzle that has been showing up in development economics. To give the most prominent recent example, Jessica Cohen and Pascaline Dupas show a drop in uptake by 75 percent when the price of the anti-malarial insecticide-treated bed nets increases from zero to $0.75.
Turning to microfinance, the peer-to-peer lender, Kiva.org, offers a lender a zero return. You lose no money when you make a loan and you earn no interest. It’s not obvious, of course, that this is the optimal price. Why not charge lenders 2% for lending; the economic cost of these funds is already negative once you factor the opportunity cost. Why not highlight the social aspect of the lending and make the subsidies more transparent?
On the other hand, if lenders are motivated by financial returns, then why not provide a moderate return on these funds (i.e. the Microplace model).
In the slums of Dhaka, SafeSave is now pushing a new loan product (P9) which costs zero interest (at least nominally). So far, the zero interest rate has been a big seller.
From a marketing standpoint, it’s hard to argue with zero. From an economic standpoint, though, zero is just another number – but one about which we know close to zero.