A Pricing Question on Free

oh-yes-its-freeThis came from a reader:

“Hey Mark, Hope all is well, the pricing knowledge from the course has certainly helped in many of our team discussions in ‘doing the right thing’ when it comes to pricing. I thought the below question may be a good topic for your pricing blog. We offer various promotions throughout the year for different services, some of which may include delivery. One area that comes up continually with any promotion that involves delivery is should a promo period where services are offered for free include free delivery or not. Interested in a pricing experts take on it. Thanks for considering this as a topic and look forward to the insight if it is picked.”

I replied:  “I’m happy to share my thoughts but don’t really understand the question. Can you give me more context around the product, market segment and the customers decisions?”

 His response:

“Thanks Mark, The services in question are payroll services, which is certainly a ‘which one’ product. The market for payroll services is targeted for companies with 10-99 employees. The key decision making timeline for many of these target companies is at the start of a quarter for tax purposes (Jan, Apr, July, Oct) so we look to develop a promotion to drive incentive to transition. The market supports promotions, such as a month or two of free payroll services, to drive a reward at the start to ‘try out; our services. With services being month to month without a long term contract it is similar to a trial period. It is also beneficial from a financial prospective for free months versus greater discounting which is for the life of the account (typically 5-6 years). One area that continues to arise is what a free month of payroll services means. The market views payroll services as payroll, tax, checks, delivery, etc. The whole process of getting their employees paid. Though internally (from an accounting/finance prospective) payroll services is aligned with the actual billable for payroll services and they still want to charge courier charges (delivery) for the payroll since it is a hard cost of ours. These are necessary to deliver reports or any physical checks to the client for their payroll if they are not 100% online (this can be due to a single employee not electing for direct deposit and wanting a physical check, which is more common that anyone would think). Thanks a ton for your guidance and expertise, I hope I provided enough context for you.”

What a fascinating question.  In essence, the industry has particular times that buyers buy (switch) so sellers put their promotions on at that time.  This is just like Black Friday in the US.  If a huge proportion of the population is going to spend money, then each store puts on big sales because they are trying to win as much of that spend as possible.  Same thing here.  This company has a small window to win lots of deals.
One of the incentives they use is a couple free months of service.  This is easy when there aren’t any hard costs.  The challenge comes when they have to pay out hard dollars for things like mailed checks to fulfill their commitments during a free period.  They are questioning if they have to give away the things that cost them money in their free months.
Surely there are more nuances in this situation, but those seem to be the driving issues.  It is not possible for me to answer the question, should they give away items that have hard costs, but here is a way to think about the answer:
  1. Test it.  Research shows and it certainly feels true, that free is so much more powerful than 1 cent.  If they can offer a service truly for free, they will probably win more buyers, but they should test it.  They could offer completely free to one set of clients and almost free to another set.  Do they get a difference in take rate?  That should drive their decision.  I may have an opinion, but it’s just one opinion.  They should want data.
  2. If they choose to give away the items that have hard costs, then think of these hard costs they incur as marketing expenses or customer acquisition costs.  That’s what they are.  Further, they could cap those expenses at some reasonable number.  For example, 10% of checks could be hard checks.  After that there is a price.  This probably won’t effect customer’s buying decisions, but it will cap this seller’s expenses.
  3. Don’t give the same client the free period more than once. If clients are constantly jumping from company to company just for the free period, dump them.  Don’t serve them any more.
  4. Run the profitability numbers.  When they take on a client for 2 months for free, how much does it cost?  On average, how long will that client remain a client?  How much profit will they make over that time frame?  If the profit doesn’t exceed the expense, they need to rethink their marketing.
 Often times we get all psychological in our own heads, thinking about pricing in non-rational ways.  In this example, there is a methodical means to determine the optimal answer.  The best way to get out of our own heads is to simply test it, measure the results, and project it into profitability numbers.  Try to quantify it.
Oh, one more thing … remember your costs rarely drive your optimal prices.  🙂
Good luck!