Zero pricing sets trend

By Song Ki-hong

In the classical micro-economics theory, price is to be determined in the market by “invisible hands.” However, the demand-supply mechanism is often too conceptual to provide a working framework in the real world to marketers who try to find an optimal price point at which the sales and profit of the product are maximized.

Therefore, in management science, several different pricing approaches have been introduced. The most common is cost-plus pricing in which price is set by adding desired margins on the total cost of a product. This approach seems reasonable, but often fails to capture the full potential (either the sales or profit potential) of the product.

Another approach is value-based pricing. The idea is to measure the relative value of a product or service to each customer and set the price accordingly to capture the fair share of the value. Often the perceived value of the same product is different customer by customer and the willingness to pay is also different based on the marginal utility.

Regardless of the technical difficulty of measuring the relative value and price willingness, value-based pricing is believed to be a more advanced approach. However, both approaches have a fundamental limitation of assuming that the value is fixed at the time of the transaction.

Over the past decade, we witnessed product and service convergence due to technology development and consumer life style change. This trend has fundamentally changed how consumers get value from a consumption activity. The value of a product is no longer isolated.

For example, smart phone users can hardly judge what percentage of the utility is from the device, application, and telecommunication service, respectively. Total value a consumer extracts from consumption combines different usage values over a product lifecycle.

In case of an automobile, the total amount consumers pay over 7 years is on average 2.5 times of a car price.

This spending includes gas, insurance, maintenance, tuning and so on. When the post-purchase portion gets significant in the total lifecycle value, initial customer acquisition becomes critical in the overall performance across value chain.

This is how the ‘free pricing’ concept emerges. As pointed out in the Deloitte’s article, even high ticket items such as car, phone and TV can be offered free if appropriate arrangements can be made to capture value in the following transaction. In order to consider “free pricing,” companies should develop a thorough business plan and check fundamental assumptions, uncertainties, and potential risks carefully in order to make the business case sound.

A product or service once offered free is difficult to be priced fairly in the later stages. More often than not, the free pricing decision is irreversible. This is why companies need to pay even closer attention to the free trend.