This is Part 2 of the Behavioral Economics series. Check out Part 1 here.
Within the personal finance/financial independence community, we all love free stuff. What better way to advance our financial goals than to get something for nothing!
But have you ever thought about the power of marketers using "free" to get people to buy more than they otherwise would have?
I guarantee that it has happened to you (and me).
The power of free stuff
Do you remember when Amazon first introduced free super saver shipping for any purchase above $25? I sure do. I always did my best to get my purchases as close as I could to $25 exactly.
Of course, sometimes I would fall a few dollars short. So what did I do? Just pay for shipping?
No way! Why would I pay $3.99 for shipping when I could buy something else for $4 and get FREE shipping? It makes some sense, assuming that there are things in the $4 price range that I actually want or need. Unfortunately, that's not always the case.
I actually looked back at my old Amazon purchases to see some of these "add-on" items I bought so that I could get free shipping. These items included:
- An extra USB adapter that I never used (you know, just in case)
- A set of crappy headphones that stopped working almost immediately
- This ridiculous coffee table book: You May Not Tie an Alligator to a Fire Hydrant: 101 Real Dumb Laws (yes, really)
Looking back, it's easy to see that these purchases were not the smartest. But FREE shipping is just too good to pass up, right?!
Dan Ariely on the zero price effect
As we discussed in the first part of the behavioral economics series, I love reading Dan Ariely's work. He always seems to find a way to strike an entertaining balance between philosophical thought exercises and actionable "duh" moments.
He ran several experiments on the power of free stuff and wrote about them in his book Predictably Irrational (highly recommended).
Let's take a look at one experiment he ran (with his colleagues Shampanier and Mazar) with Hershey's kisses and Lindt truffles.
- The control group was offered the choice of a Lindt truffle for 15 cents, or a Hershey's kiss for 1 cent.
- Within this group, 73% of participants chose the Lindt truffle and only 27% chose the Hershey's kiss.
- This makes sense. Most of us would agree that a Lindt truffle is much more tasty than a Hershey's kiss.
- The next group was offered the same candies for 1 cent less (14 cents for Lindt truffle, FREE for Hershey's kiss).
- The result of this group was almost the exact opposite! 69% chose the Hershey's kiss and only 31% chose the Lindt truffle.
This is an amazing illustration that shows the difference between behavioral economics and traditional economic theories. The 1 cent change in price shouldn't have impacted behavior so drastically. But in the real world, it did.
Why? Ariely believes that humans are inherently loss-averse. By getting something for free, we automatically think there is no downside (because we paid nothing).
Getting something for "free" makes us grossly overestimate its value.
Amazon: a real world example
Let's go back to Amazon for a minute. Another case study that Ariely points to is Amazon's introduction of free super saver shipping. When the company first started offering the program, they saw a huge increase in sales globally. Except in France.
Instead of offering free shipping in France, they offered shipping for 1 Franc. What's the difference? It's basically free, right? Nope.
Turns out, the zero price effect was all too real for Amazon. As soon as they switched to free super saver shipping in France, the country saw a sales increase in line with the rest of Amazon's regions.
"Free" pitfalls in the consumer world
Ever since I first learned of this concept, I have constantly caught myself falling into the "free" trap. Marketing professionals are very skilled at offering things for "free" at just the right times.
As a consumer, there are many things to watch out for:
- Buy one get one free: These sales sound all too enticing. Just remember to think about what you really need. If you don't need/want any new pants, what's the point in getting 2 new pairs just because they're discounted? It's still 2 more than you needed in the first place.
- Free sample/gift card/coupon: Some companies might offer a free sample with the purchase of another item. Do you need or want that free sample? Maybe, maybe not. Either way, a small giveaway shouldn't be the reason any of us decide to open up our wallets.
- Free trials: Try before you buy. A lot of companies do these promotions. Because they work. There's nothing wrong with taking advantage of a free trial if it's a product you like. Just don't forget to cancel if you end up not using it.
- Standing in line: Time is money. Yet, people are willing to wait in line for outrageously long times to get free stuff. Think about how much you are saving on a per hour basis, and then decide if it's worth your time.
- And of course, free shipping: I used to add silly little things that I didn't need just to get free shipping. I still do sometimes, but at least I think about it first.
It's impossible (and probably unnecessary) to catch yourself every single time. That would get tedious. Fast. But becoming a more conscientious consumer can have a huge impact over time.
Free stuff can be great, if it's something you already wanted. But it can also compel you to spend money on something you wouldn't normally have bought in the first place. Remember that next time you see a BOGO sign at the store.
This is Part 2 of the Behavioral Economics series. Check out Part 1 here