Behavioral economist Dan Ariely worries about the consequences of giving away products and services online.

Topic: The concept of “free.”

DAN ARIELY: “Free” is kind of an incredibly tempting human hot button. And sometimes it’s great and sometimes it gets us into trouble. I’ll describe to you quickly the experiments we do. So in the experiments we do, we say “Okay what do you want, the Lindt Truffle for fourteen cents or Hershey Kiss for one penny?” Almost everybody says “Thirteen more cents for a better chocolate is a good deal because it could only take one of the other.” Everybody understands the value of the Lindt is high. Then we discount them both by one penny. Now, the difference and the qualities are the same – difference in price is the same – but now everybody goes to the free Hershey Kiss. And you thought about the transaction cause, you thought about all of those other explanation. The moment something becomes free, we go that trap. So think financially, I said “What would you like? You had two credit cards; one is nine percent interest rate and costs you hundred dollars a year, one is fourteen percent interest rate but it’s free.” People would basically go for the fourteen-free-cards and way from the other one and then consequence incur much more cost in average. Then they would otherwise. So we have this general tendency.

Now in the Internet we see through everywhere, right? People have huge value for free. Google is for free. Gmail is free; lots of services are free, now we see ads and we don’t think of them as pay but it’s free. Now because free to one penny is such a big barrier, what’s the chance we’ll pay 299 for another service? Very hard! And now the other problem is that it’s enough for one player to go free, that everybody has to. So imagine that you have lots of people doing email and every company charges you $5.99 a month. And now one company became free, right? Everybody would go there. There’ll be no way out of it. The moment you go into free is very hard to go back. One way to think about how bad this could be is to think about what happen with banking. So think about something like free checking, free ATM, all of those things.  How do you think the banks give it to you? Is it because they’re nice people? Is it because they make enough money on the measly amount that you have in your checking account, to justify that? No! What happens is that in order to get free, they create a huge punitive system that comes on top of that.

          So here’s what happen; imagine that today is the end of the month and you have three dollars in your checking account and your salary is coming in today. So you go ahead and you buy a latte for three fifty and then you buy a book for 20 dollar and you buy another ice cream cup. And then at nights, they settle your account. Now they could first put your salary in and then charge you but they first charge you.  They could first charge you for the small things and then for the big things but no, they charge you first for the book; for the big things. So as the consequence you’ve made three overdraft transactions; 35 dollars apiece would talk about 105 dollars just in penalties. And this is how the system works, right? To give the majority of us free checking. We penalize the poor individuals who don’t have enough money in their checking account - they are not on top of it- and get penalize repeatedly. There are very few people who got penalized occasionally; there’s a lot of people who basically pay a lot of money for these services.

Question: Can online services ever charge again?

Dan Ariely: It’s going to be very tough. It’s going to be very tough to take something that is free and get people to start paying for it. And one of the barriers is it’s very hard to figure out how much something is worth. So think about these videos that we’re making right now, right? How much are they worth? How much would you pay for it? What will be your reservation process? It turns out people are really bad at it. What we usually do is we get used to what the market told us the value of something is. Cup of coffee is two-fifty. Why? Is this really what we feel? No, this is what Starbucks told us. A can of coke is a dollar. Why? That’s what it says in vending machine not because of what we feel. So there’s a question of learning. It turns out that overtime we learn what the value of something is in terms of money. In this case we’ve learned it’s free. Free for money, it cost something in terms of ads but it’s free, free in case of money.  And it’s very hard to change from that perspective. It’s easy to start charging, and charge different amount. Moving for free to charging something is going to be incredibly challenging. 

Recorded on: July 29, 2009