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BW Businessworld

The ‘Free’ Economy

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You shop for clothes, fuel or consumer goods; your credit card firm miraculously credits you with a hefty cashback. You recharge your phone or DTH, a couponing firm delights you with vouchers for free pizza or shopping.

You buy the latest AC or refrigerator — even a Tata Nano — the dealer obliges you with interest-free EMIs.
You walk into the supermarket and there’s a ‘buy one, get one free’ offer on products ranging from shampoo and soap to apparel and shoes.

On the Web, your email, search and maps are free. There’s free music, free video and free storage as well.

Gosh! What would you do if it wasn’t for ‘free’? Yes, what would you do if it wasn’t for those who make it free! For every product or service free to the consumer, there is a science, or rather economics, behind it — Freenomics. Unlike economics where prices are determined by demand and supply from buyers and sellers, Freenomics has a third axis — the third party, or parties, that enable the ‘free’ transaction between buyers and sellers. ‘Free’ works as a carrot to pull that one-time consumer and acts as a catalyst to hook him. But, keeping in mind that nobody minds things for free, firms deploying Freenomics often transfer cost and value to different parts of the value chain. Even to a different period in the revenue cycle. “When a product is at a price, you have to use your rational mind, but when it is free, it is a very easy decision-making process,” says Praveen Kopalle, marketing professor at the Tuck School of Business at Dartmouth.

Originally a clever marketing tool, the business of ‘free’ is now a thriving economy. Just in India, it is estima­ted to be worth $40 billion. “Free works everywhere. It just doesn’t get better than free,” says Jessie Paul, CEO, Paul Writer, a marketing advisory
 
Hail ‘King Gillette’
The earliest known proponent of the Free Economy was US businessman King C. Gillette who, in 1903, either sold razors at a loss or gave them away for free to business partners. They distributed them to employees and associates, creating demand for disposable blades that King Gillette sold at a high margin. It’s a strategy that has been adopted by scores of marketers, including HP which sells printers cheap to make its margins on the cartridges. Closer home, SC Johnson sells ‘All Out’ mosquito repellent machines bundled with the liquid to lure customers.



Over the past century since Gillette, Freenomics gave birth to one business model after another, posing a serious challenge to inflation economics (that as demand rises, goods and services become more expensive, except during recession). As of now, there are over 200 free newspapers in 60-odd countries with a combined circulation of over 40 million a day. The reader gets them free but the advertiser pays for the cost. This model has since been borrowed by a host of firms providing email, map, search and other services, like Google and Yahoo. Today, among the fastest growing businesses on the Web is free online gaming financed by ads. Low-fare airline Ryanair’s CEO Michael Leary once dreamt of flying passengers for free, though he never put it into practice. ‘Free’ is so integral to industries such as email that it’s hard to imagine an email service you have to pay for.

Yet, Freenomics continues to morph. It is practised in a dozen-odd variants, each one spawning hordes of firms. There’s Buy One, Get One, Zero Interest Loans, Cashback, Bundled Offers, Sampling/Trial Packs, Coupons, Loyalty Programmes, Interest Subvention, Gifts and Gift Vouchers, Enhanced Volume (particularly in FMCG), etc. So, how does the business of free work?

Bogo: Buy One, Get One
Nine out of 10 times, the cost of the Bogo offer is borne by the brand. Sometimes such offers are driven by large retailers to clear slow-moving stock. “One of the most successful examples is Godrej No. 1 soap. Even though the firm operated on lower margins by providing a 3+1 offer, it managed to recover lost margins by gradually acquiring customers and selling more,” says Divyaroop Bhatnagar, managing director of YFactor Marketing, who has earlier handled Hindustan Unilever brands such as Lux and Pears.

FMCG majors such as Unilever, Britannia and Dabur offer Bogo primarily for four reasons: induce trials for new products, cross-promote bra­nds, increase consumption level and liquidate products with short lifespan. BrandIdea, a consultancy, says liquidation is a significant part of an FMCG firm’s marketing strategy and such offers dent their profit and loss account by two to five per cent. According to experts, 60-70 per cent of FMCG promotions are given out for trials to boost consumption levels. Barely 5 per cent are meant to liquidate products. The costs are treated as marketing expenses.






“Bogo is either a liquidation strategy by the retailer or, to provide higher perceived value to a product,” says Angelo George, executive director, sales at Dabur. “The (Dabur) offers would be on products nearing the end of their shelf life since the cost of recall is high,” he adds. Dabur accounts for offers in its advertising and promotion budget, which is 11-14 per cent of turnover. According to George, among its best offers was Meswak toothpaste with Dabur Honey. And a Reebok sipper bundled with Activ juice packs. Dabur says it recovered the cost and was also able to hook new consumers. “You need to offer value to get return on investments,” adds George.

Happy Hour offers by bars and restaurants during lean business hours is another Bogo scheme. Bars often get free crates for bulk purchases, which they pass on to the customer. “In food service, the attempt is to make the average price per customer higher by offering combo options,” says Amit Burman, chairman of Lite Bite Foods.

The Probability Factor
Several parts of the Free Economy work on the principle of probability — like insurance, or banking. The free coupons business works on the probability of no more than 3-5 per cent of coupon holders turning up to claim freebies. Of late, over 50 coupon firms have emerged in India. Take, for instance, freecharge.in, started by Kunal Shah, a 34-year-old serial entrepreneur, in August 2010. Freecharge offers free coupons of an amount equal to or higher than every recharge of a phone, DTH or data card. On a recharge of Rs 501, one gets coupons worth Rs 550, encashable at 140-odd brand outlets such as Barista, Café Coffee Day, McDonald’s, VLCC and Domino’s. “We may be giving up our margins by offering a freebie, but we make up for it when the number of people opting for it goes up,” says K. Ramakrishnan, president, marketing, Café Coffee Day.

Here is how Shah earns his bread and butter. Over 70–80 per cent of his earnings are from merchant commi­ssions. About 10 per cent come from handling charges for delivering vouchers — offline or online. Another 10 per cent comes from the telcos/DTH firms Shah has tied up with for online recharges. Margins can go as high as 5-8 per cent depending on the segment. Electronics usually offer 2 per cent, while fashion can be 5 per cent or a flat fee of Rs 200-300 per sale.

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According to McDonald’s, Freecharge’s coupons have helped the fast food chain increase frequency of customers, especially during lean hours.  According to Rocket Internet’s cuponation.in, of the total e-commerce transactions 0.4 per cent or $32 million are via coupons. This is likely to go up to $460 million by 2016. In the US, nearly $1.57 billion in coupons were traded in 2012; it’s expected to grow to $19 billion. But not many are happy with free vouchers. “Vouchers are a trap,” says Rajat Kapoor, an IT consultant. “The voucher was valid on the basic menu and we ended up paying for most of the items.”

At Rs 0.00
So who pays for the coffee maker that came free with the microwave bought last summer? Consumer durable companies make a provision in their budget for such offers. For instance, in 2012, Panasonic India gave away goods worth Rs 6 crore as club offers — such as 3D glasses free with a 3D TV. In 2011, this amount was close to Rs 4 crore. Panasonic says free gifts are well thought out. Else, it hurts the company’s reputation. “We give out freebies mostly during festivals. We make sure they compliment the product,” says Panasonic India MD Manish Sharma. Rivals LG and Whirlpool prefer discounts.
 
RECALL VALUE: Bryan A.
Pearson, CEO of LoyaltyOne, feels loyalty programmes help build great recall for the customer and the retailer
“Mostly, these offers are a liquidation strategy, or the costs are built into the margins,” says Ashwani Arora, senior vice-president, Market Xcel Data Matrix. Whenever companies upgrade models, old versions are sold at a discount.

“Similarly, if the production of an item is more than its sales, it is put on offer since storage costs are higher than the discounts,” says Arora. Typically, the perceived value of goods offered free is far higher than their actual value.

Cashback: Shop And Earn Back
In India, petroleum companies were pioneers in leveraging cashback and loyalty programmes for customer stickiness. India’s second-largest oil refiner Bharat Petroleum introduced its pre-paid Petrocards as far back as 1999. Today, it has 1.6 million members. It offered generous loyalty points on every purchase, which could be redeemed either for fuel or for goods at its ‘In & Out’ stores. About 70 per cent of such redemption costs are borne by the oil company, while the rest is shared by the franchisee and the dealer.

At the other end of the loyalty programmes are cashback offers — also invented by oil firms. Customers using credit cards are credited between 2.5-5 per cent of their purchase value in the form of cashback (often with a ceiling of Rs 350-500 per month). At least half of that amount is borne by the oil company. For the other half, the bank waives its transaction charge of around 2 per cent and cre­dits the customer instead. “At IndianOil, it’s a flat Rs 50 off on every Rs 1,000 of petrol,” says 28-year-old Tushar Pulyani. Cashback offers have since proliferated in the retail industry through loyalty cards offered by firms such as Future Group, Shoppers Stop and Lifestyle.

A variant of cashback is cashkaro.com, launched in November 2012 by Swati Bhargava and her husband Rohan who quit their investment banking jobs to start the venture. “For every sale we bring to a brand, we get a commission. We keep our margins and pass on the rest to the consumer,” says Bhargava. Cashkaro gives away 80–90 per cent of the commission. It has 175 firms as Jabong, Myntra, Jet Airways, Yatra, MakeMyTrip and Flipkart on board. “This concept is to increase the number of transactions. For every customer we bring to our affiliated retailers, they pay us a percentage,” says Ravitej Yadalam, founder of pennyful.in.

Cashback companies also gain from low redemption, though it’s not as low as coupons. Companies even add layers of barriers to redemption. “There is the physical cost and the psychological cost that come into play. In some cases, to get a cash back, companies ask for a form to be filled. Or, you have to present the receipt. It automatically reduces the redemption rate,” says Kopalle.

Loyalty Programmes
While loyalty programmes are offered by airlines (air miles) as much as hospitality chains, in India retail is the flag-bearer of the loyalty business. “We have been involved in India for three years and have brands such as Kaya, Levi’s and Domino’s. We work on loyalty based on a coalition, which is nothing but retailers allowing customers to share and redeem points on a common platform,” says Bryan Pearson, CEO of LoyaltyOne. This builds recall for the customer and the retailer. The Indian loyalty market is worth Rs 5,000 crore and is only going to grow as organised retail grows. Retailers can enjoy better offtake if they jointly focus on the consumer. Say you shop at a grocer and fill fuel at a station, the points you gather for grocery shopping can be redeemed at the pump. “The business model is simple; retailers buy points from us and give it to the customer. We pay where the points are redeemed,” says Pearson.
 
CASHING IN: Cashkaro founders Swati and Rohan Bhargava have roped in 175 brands into their cashback venture
Top retailers in the country retain 2 per cent of their turnover towards redemption against loyalty programmes every year. This does not mean they are being charitable. Rather, every time a consumer redeems accu­mul­ated bonus points, he comes back and shops more. “Retailers are waking up to linking data between shopping behaviour and loyalty,” says Future Group CEO Kishore Biyani, adding that the loyalty programme helps him retain customers and win new ones.

The group’s Big Bazaar, Central and Brand Factory have over 3 million members. Future Group is now mining data to enhance loyal customers’ buying and redemption experience. Rivals LifeStyle and Shoppers Stop, too, have 2.5 million members each. Shoppers Stop has one of India’s most successful loyalty programmes with 75 per cent of its revenue coming from holders of its First Citizen loyalty cards. “Loyalty programmes help us understand what we need to sell at full price, discount and keep aside for redemption,” says Govind Shrikhande, CEO of Shoppers Stop.

A customer earns 1 point for every Rs 100 of purchase. Most retailers price a loyalty point at 25 paise. The retailer buys loyalty points from aggregators such as PayBack and LoyaltyOne. For 100,000 accumulated points, the customer gets a freebie worth Rs 25,000.
 
LOYALTY PAYS: Loyalty point redemption is less than 40 per cent in India; in markets like Germany it‘s as high as 93 per cent

“This is a long-term customer engagement strategy,” says Vijay Bobba, MD, PayBack in India. PayBack works on a points redemption model. If you bought at a retail store and redeemed for free petrol, PayBack would pay a certain amount to the pump after retaining a commission. According to Colloquy, a US researcher, $48 billion is spent on loyalty programmes every year. Of that, $30 billion gets redeemed in the US. Despite an eight-year history, loyalty-point redemption is less than 40 per cent in India.

Services And Bundled Offers
Offers bundled with services are rare, but one of the most visible recent offers was Aircel’s service plan bundled with an Apple iPhone 5. Aircel offered a 16 GB iPhone worth Rs 45,500 bundled with services perceived to be worth Rs 21,000 for 12 months. This included a 3G data plan of 1 GB, free SMSs and calls. “At the end of the day, it is a win-win deal for both the customer and us,” says Anupam Vasudev, chief marketing officer of Aircel India. For Aircel, about 4-5 per cent of the sales go to marketing activities and the cost of such offers forms part of the marketing budget.

The ‘Zero’ Sum Loan
With the slowdown and high interest rates hitting sales, durables companies invented interest-free EMIs to make goods affordable. Now, 20–30 per cent of consumer durables are sold through EMI schemes, about 50 per cent of which are interest-free. The model has also been adopted by companies such as Tata Motors and Volkswagen for its Vento sedan and Skoda for its Rapid cars. Zero interest EMI is offered jointly by the manufacturer/retailer and the bank. The retailer bears the cost of debit/credit card processing fee plus an interest burden that could vary from 2–5.5 per cent. The bank gives up 20-25 per cent of the 9-12 per cent lending rate it would have otherwise charged. The retailer gets the full payment from the bank within 24 hours. Typically, the manufacturer bears 80 per cent and the bank 20 per cent of the burden.

Among e-tailers, “banks pass on the entire cost to the firm,” says Ankit Khanna, vice-president, product development at Snapdeal.com. The e-tail company also absorbs the processing fee of 1.5-2 per cent. But the bank pays it the money within 24 hours of the purchase, waiving the lending rate it would have charged otherwise.

It’s ironic that despite its ubiquity and growing popularity, the Free Economy continues to be talked about in hushed tones. Manu­facturers and brands are reluctant to be seen associating with the ‘F’ word for the stigma attached to it, even if they gain from it. However, those in the business of ‘free’ have more than proved that they are here to stay. If the consumers are on their side, can the brands be far behind?

With inputs from ­Chitra Narayanan and Ankita Ramgopal

shrutika(dot)verma(at)abp(dot)in;  shrutikaverma(at)gmail(dot)com twitter(at)shrutikaverma

(This story was published in Businessworld Issue Dated 08-04-2013)