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ECONOMICS OF FREEBIES

Raveena Rana
II, Bcom Hons
Lady Shri Ram College for Women
University of Delhi

Hasan Ali
II, Bcom
Zakir Hussain Delhi College
University of Delhi
TABLE OF CONTENTS

1. Executive Summary
2. Methodology
3. Limitations
4. Findings and Analysis
(a) Business Models of Free
(b) Freebies in Digital Technology
(c) Behavioural Economics; Psychology behind free
(d) Externalities
5. Case Study 1: Reliance Jio
(a) Background
(b) Impact
6. Case Study 2: Government Policies and Elections
(a) Subsidies and Public Goods
(b) Election Manifesto
7. Conclusion
8. References
EXECUTIVE SUMMARY
The paper is an attempt to understand the Economics behind freebies. Freebies include all
the goods and services which are provided with a 'zero cost' or as a 'free gift' by the
government as well as the corporate industries. The paper studies the impact of freebies on
the financial burden and debt of the economy and through the profits/losses to a business
organization. The paper presents the analysis through the study of particular initiatives drawn
from different stratas of the society.
Mukesh Ambanis Jio which provides 'free' voice-calls, messages and data pack has an
impact not only on the telecom industry and the competitors at a macro level, it also has
serious repercussions on the financial soundness of the Reliance Group. The most recent
election manifesto for UP by BJP talks about 'free' laptops for students, free WiFi in
universities, free education among others. The AAP Election Manifesto for New Delhi had a
package full of 'Free' WiFi, electricity, healthcare and water supply to the residents of the
National Capital. All of these facilities bear a cost. If it is not paid by the recipient of the
facility, it doesn't mean no one pays for it. The tendency of paying too much when we pay
nothing would follow up next. In this situation, free-riders problem is also discussed
to gauge how people take the advantage of a good/service without paying any price for it.
The price of which is borne by other people of that very society. Finally, Subsides to farmers
and lower income groups.
Another aspect which is discussed is subsidies. On the contrary to the above, subsidies when
employed efficiently helps us to strengthen the economy by uplifting the poor and providing
them access to resources which at their original cost may be unaffordable to them. The
positive side of freebies serve as a welfare scheme to sustain the lower income group.
However, in this context, we also study the impact of awareness and exploitation of the poor
by the wealthy.
The reason for providing such freebies is then analyzed in context of the government which
wants to lure the citizens to vote for their party, leading to a political race where the
maximum freebies gets the maximum votes. This further results into a vicious circle of
dependancy on freebies, the promise of which are hardly accomplished - with reference to
the free WiFi promise of the AAP in New Delhi Elections of 2015. The reason for corporate
industries to provide freebies is understood through the construction of BIGI Model which
talks about Brand Building, Income generation, Government legislation and information
gathering.
In all, the paper draws attention to the economic viability of freebies and its impact on the
society.
METHODOLOGY
The paper is written to answer three questions: First, what kinds of 'free' goods and services
are offered in the markets of India? What is the motive behind these freebies and finally,
what is the impact of the freebies on the economic viability. In order to answer these
questions, it was important to collect primary data to identify the various forms of freebies
being distributed in the market. The freebies have been categorized on the basis of their
business models and motives, after which an analysis has been drawn taking into
consideration the profits/losses to the business organization, the welfare objective and the
market competition.
The method employed is simple and efficient as it draws conclusions from the existing facts
and applies the concepts of opportunity cost, behavioural economics, free-riders problem and
externaltites to understand the motive behind proving freebies and the scope they offer in this
competitive market. The research is backed by instances from the day-to-day life of the
citizens of the country.

LIMITATIONS OF THE RESEARCH


The major limitation of our approach is the analysis of only one country - India. Therefore,
to draw conclusions for the global economy isn't appropriate. Also, the analysis of various
concepts is driven by the understanding of the researchers about the topics covered. They
represent their opinion and foresight.
FINDINGS AND ANALYSIS

Source: https://summaries.com/index/Free.pdf
The findings of the research cater to two important spheres of the economy: government and
business organisations. To understand the two spheres, conclusions have been drawn with
the help of existing goods & services and by understanding the governments election
manifestos scheme for freebies and Reliance Jios. The model of freebies adopted by
business organisations is discussed through the following categorization

In the Indian market, when Nestle Maggie launched its new product line of Hot Heads
Maggie, it provided the latter for free with every packet of Nestle Maggie. Both increased
the sales of each other. When the Indian Express provides its e-newspaper for free with an
advertisement to install the Times of India application, The Indian Express is earning money
through the advertising revenue. The ubiquitously used Adobe Photoshop lets you have the
basic application for free and then charges you for the upgrade to the premium mode of
Adobe Photoshop Professional or even mobile games which makes you pay for additional
coins/rewards after youve downloaded the game for free. Similarly, when the government
provides mid-day meals to the students studying in their schools, they do not charge anything
from them. The above examples highlight the different forms of business models selling
their output for free.
ImageSource: www.huffinggtonpost.com
FREEBIES IN DIGITAL TECHNOLOGY
Be it Facebook, Google, Instagram or Pinterest, all of these internet based applications
charges nothing from the consumers. Particularly with the advent of internet, providing free
services is on an altogether high.

At the beginning of the twenty-first century, were inventing a new form of Free, and this
one will define the next era. The new form of Free is not a gimmick, a trick to shift money
from one pocket to another. While the last centurys Free was a powerful marketing tool, this
centurys Free is an entirely new economic model. The new form of Free is based on the
economics of bits, not atoms. It is a unique quality of the digital age that once something
becomes software, it inevitably becomes free. Free is creating a multi-billion-dollar
economythe first in historywhere the primary price is zero. [1]
The above explanation clearly highlights how a search engine like Google makes money.
While Google also employs advertising revenue as a source of income, the distinguishing
feature of Google is its minimal, almost negligent marginal cost (the cost of providing the
services to an additional customer). With the increasing research and development in the
field of digital technology, disseminating information online isn't a complex challenge.
BEHAVIOURAL ECONOMICS; PSYCHOLOGY BEHIND FREE
Buyers are naturally suspicious, drawn by intuitions and would possibly avoid losses more
than gaining profits.
Suppliers of the free good may be taking into account an important newly-acknowledged
lesson from behavioral economics. While the allure of free is intuitive, recent studies have
shown that a free good can have a much stronger lure than its actual value. Zero often serves
as a focal point, signaling to consumers that the product or service has a substantially higher
benefit than if the same product or service was made available at a very low, but positive
price. This effect has been found to be so important, that it is often called "the zero price
effect" or "the free effect."

In his research paper Duke professor Dan Ariely offers an idea from the perspective of
behavioral economics. He His study of 398 MIT students measured peoples reaction (and
overreaction) to two different products: Hersheys candies and Lindt truffles. Under normal
circumstances, the Hersheys products are already significantly cheaper than Lindt products
and the latter also have an air of exclusivity or cache, too. By all measures, the Lindt item
has a higher value. Yet, when asked to choose between a free Hersheys product or a
dramatically discounted Lindt candy, the vast majority of students opted for the item that
was free, even if it wasnt objectively the best deal.

Source: www.smallbiztrends.com
The advent of freebies hasnt spared any. In a survey conducted by an online website named
smallbiztrends, they displayed how consumers have started looking up for free products
before making up any purchase decision.
EXTERNALITIES

Image Source: Mikm,English language Wikipedia

When an individual (firm) through its actions (activities) affects others by imposing a cost or
benefit on them, without making any compensation for the additional cost or demanding
revenue for the benefit, the individual (firm) is set to impose a externality on them. The
imposition of cost results into a negative externality while the benefit provided results into a
positive externality.

The externalities imposed by a firm giving a freebie can be divided into two:
(a) It creates a behavioural change in the minds of consumers where they want more and
more of free. When a product is offered for free, consumers tend to expect the other firms
dealing in the same line of products to even offer their product for free.
(b) It puts an additional burden on the competitors who are either forced to reduce their
prices or differentiate their product in terms of quality or utility, else they exit the market.
The impact of these externalities are situation specific. Let us now understand the same
through taking two case studies, one from the corporate sector and from the government
sector.
CASE STUDY 1: RELIANCE JIO

Reliance JIO recently made its debut in the telecom industry of India with a perfect package
of freebies including free voice calls, SMSs and cheap data for all and is potentially the
biggest threat to all other companies in the market. The business model considers debut in
the data market as an initial huge investment with minimal post installation cost. The idea is
to provide all telecom services through high speed 4G internet at low costs. Although the
data cost seems cheap post free trial period until 31st March 2017, but analysts suggest ones
expenditure shall remain the same or may even increase as only the bundle of services are
being presented cleverly. The current average earning per customer per month for a Telecom
company in India is about Rs 150 for all the services, whereas, Jio shall have a fixed basic
plan of Rs 149. Also, the next data plan introduced costs, directly, Rs 499, luring its
customer into the ask for more bait.
According to a Reuters report, Reliance Industries initial investment to lay down a 2.5 lakh
kilometres optical fibre all over the country is about $15Billion. The report also states that
the filings at the Commerce Ministry suggest that Jio has more than $4.5 billion of long term
loans and other liabilities topping over $8 billion. According to a Fitch Ratings report, the
company is under tremendous pressure, its management has committed to repay a part of its
debt through the sale of towers and merging its mobile business with smaller telco, Aircel
Limited. If this commitment does not result in debt reductions which bring its FFO (funds
from operations)-adjusted net leverage below 4.5 times (5.5 times in FY16) on a sustained
basis, then negative rating action may result.
The report also suggests that Jio is not likely to recover their costs anytime soon, as
currently, fewer than 5% of Indian consumers have such 4G compatible handsets. However,
this is likely to change quickly, as over 70% of new handsets are now 4G, but it is unlikely
that Jio will be able to win more than 20-30 million subscribers and 3-4% revenue market
share over the next year. The larger chunk of customers, almost 22% of subscribersthat Jio
is targeting with its Rs.149 plan are 2G customers that yield an ARPU (average revenue per
user) between Rs.150 and Rs.300. According to a Bernstein Research report dated 1
September 2016, for these 2G customers, a handset for as low as Rs. 2,999 offered by Jio
could be unaffordable.
Image Source: www.jio.com
Apart from the company taking a huge risk investing in this business model, the very
predictable impact of the debutants aggressive tactics, have struck the already existing
businesses in the market. Soon after the launch of Jio, as Business Standard reports on 1st
September 2016, Reliance Industries and three telecom companies Bharti Airtel, Idea
Cellular and Reliance Communication (RCom) have collectively lost Rs 22,522 crore of
market capitalization (m-cap) in a single day.
The Economic Times reports that analysis suggests plans will push smaller mobile service
providers such as Aircel, Telenor India, Tata Teleservices and Reliance Communications to
the fringes, if not to exit altogether.
Concluding the impact of industrial freebies in the economy, Jios debut suggests that
freebies in the telecom industry have brought it to the verge of huge risks and losses. The
promising model with such risks involved, may, or may not, enable a low cost internet
accessibility to the huge population of a developing country like India. Prashant Singhal,
Global Telecommunication Leader, EY said for a price sensitive market like India, launch of
affordable data services and free voice calls is indeed a welcome step and it is expected to
drive greater data adoption across segments. He, however, said that the telecom sector is
currently reeling under financial stress, high debt burden and slowdown in revenue growth
and further decline in data tariffs may impact operators profitability and sustainability.
Since the introduction of freebies to this industry in 2016, the future has been uncertain with
one of the sides being extremely bright and essential for the growth of the economy and the
other being a major setback.

Apart from the problem of financial soundness for both Reliance Industries Ltd. as well as
the Telecom Industry, the next problem in hand is of externality. How the free voice calls
will lead to a phenomenon where people would demand more and more of such free
packages will have serious repercussions on the competitors.
IMPACT OF FREE SERVICES OF RELIANCE JIO

Market Penetration Entry Barrier

Opportunity Cost Price War

Externality Monopoly

Jio currently is leading to a price war within the telecom sector. Due to the free calls,
messages and data, the other competitors are forced to design such packages which offers
minimal costs to the consumer. Jio is financing the free provision through the huge initial
investment and stability of its other ventures (oil, retail etc.) which is bound to get exhausted.
However, by the time the economy settles to these fluctuations, the price war would have
reached to uncontrollable heights.
To a consumer who is shifting to Jio from say, Airtel- the opportunity cost lies in the
transition and this transition isnt fair, essentially because the transition wasnt influenced by
price and quality but by the freebie. Under competitive situations, firms compete on the basi
of price and quality. However, Jio is relying on its free services hampering the competition
in the market.

As soon as the trial period for Jio ends, the behaviour of the consumers towards the telecom
industry is bound to change. When once they have been accustomed to free services,
charging prices for those services might lead to dissatisfaction and loss of customer base for
Jio. The policies adopted by Jio has a negative impact on the competitors due to the Price
War and to the consumers by making them accustomed to free services. This would, in
future, lead to a situation where people would demand more and more free goods, thus
complicating the profits and business model of profit maximising firms.

A first-mover advantage definitely creates lucrative opportunities for the entrant. In the case
of 4G services (the service on which Jio extensively promotes and distinguishes) Airtel
followed by Vodafone had already entered the market much before Jio in 2012 and 2015
respectively. Yet Jio takes on the credit for the 4G.
Motive of providing 'free goods'?
In 1998 the U.S. Department of Justice (DOJ) sued Microsoft for violating the Sherman Act.
The DOJ claimed, in part, that giving away the Internet Explorer (IE) browser for free,
with a promise that the browser would be forever free, was one of a number of practices
whose intent was to maintain Microsofts monopoly on the PC-based desktop operating
system.
The case of Microsoft is very similar to that of Reliance Jio.
The objective behind the free services were simple: Market Penetration and Creation of
Entry Barriers. The method employed however wasnt the one which a competitive market
prefers.
CASE STUDY 2: GOVERNMENT POLICIES AND ELECTIONS
In the context of the Government of India, two kinds of freebies have been dicussed:
(a) Subsidies and Public Goods
Types of goods in the market:
Before we differentiate between the different types of goods available to the consumers,
understanding of two terms is imperative.
A rivalrous good would mean one whose consumption prevents another from consuming it.
When I consume a particular packet of a Lays, I prevent another consumer from consuming
that very packet. However in the market, there are numerous packets of similar chips
available but the rivalrous characteristic relates to that specific unit I consumed. On the other
hand, excludable good would imply that you can deny the access to that good to any
consumer, usually on the basis of the price. When Lays is charging Rs. 15 for a single
packet, it is denying access of that packet to any consumer who doesnt wish to pay that
price.
Excludable Non-Excludable
Rivalrous Private Goods Common-pool resources

eg. Food, clothing, cars, eg. Fish Stocks, Timber, Coal


parking spaces
Non-Rivalrous Club Goods Public Goods

Eg. Cinemas, Private Parks, eg. Free-to-air television, air,


Satellite Television national defense

Source: https://en.wikipedia.org/wiki/Public_good#cite_note-8

Post Independence, India was living under abject poverty. Subsidies are essential for survival
of the poor, to provide them the basic physiological needs for their existence and to stabilize
the socio-economic policy of the country. The problem occurs when Subsidies which were
once targeted to solve a particular problem, continues to be granted for an infinite time
period. The reason primarily being political rather than economic, when it becomes a
sensitive (even in terms of vote share) issue to draw the subsidies back. This leads to cuts in
allocation of the government's resources towards development and infrastructure.

This again highlights the problem of dependency on the subsidies where instead of
increasing the potential to earn higher, people tend to become dependent on the source of
subsidy because when it's free, no one would let it go. Essentially the Free Riders problem
where if everyone is enjoying the benefit of the free product/service, then no one would pay
(in this case increase their skill to earn) for the product/service.

In 2013, total expenditure by government was 13.8% of GDP. Out of this revenue
expenditure (consumption) was 12.1% of GDP, leaving just 1.7% of GDP for Capital
expenditure (investments). Out of this revenue expenditure, non-plan expenditure was 9.5%
of GDP. Further, non-plan expenditure had following breakup:

Non-Plan Revenue Expenditure

13.20% Interest Payments


Defense Services
7.30%
36.90% Subsidies
6.30%
Grants to states & Uts
24.20% Pensions
12.10% Others

Source: www.insightsonindia.com

It goes without saying that it is in interest of nation to minimize this consumption part of
expenditure and increase allocation to capital expenditure which stood at just 1.7% of
GDP. [2]
The majority of the subsidies granted by the government are aimed at the Agricultural
Sector, which is also the non-taxed component of the economy.
National Defence and free education to children between the age group of 6 and 14 in
government schools are two examples of Public Goods provided by the government. Itll be
incorrect to conclude that these are entirely free because the government provides for them
through the tax collected from its citizens.
As per a study conducted by IndiaSpend on the basis of data revealed by Central Board of
Direct Taxes, As many as 48 million individuals were tax assessees in the assessment year
2014-15, or 3.81 percent of Indias population. The data further revealed that there are just
over 1.33 million income-tax assessees in India declaring income of more than Rs 10 lakh
per year. Maharashtra paid Rs 2.7 lakh crore as tax in FY 2014-15, 40 percent of all tax
collections, followed by Delhi, Rs 91,247 crore, about 13 percent of total.
Clearly, not every citizen of the country pays a tax, neither do states share equal tax
liabilities. Yet every citizen enjoys the benefit of public goods.
Are public goods justified?
The free rider problem is a market failure that occurs when people take advantage of being
able to use a common resource, or collective good, without paying for it, as is the case when
citizens of a country utilize public goods without paying their fair share in taxes. The free
rider problem only arises in a market in which supply is not diminished by the number of
people consuming it and consumption cannot be restricted. [3]
However to simply put it, this could be dealt with stringent regulations and ensuring
adherence to tax rules (easier said than done).
The free-riders problem is a result of the non-rivalrous and non-excludable characteristic
of a good, like in this situation national defence and free education. Neither every citizen is
paying the taxes (also because of the Free-Riders problem) nor are the states sharing an equal
liability towards these taxes. Therefore, some citizens do enjoy their benefit free of cost.
The provision of national defence and free education is in the best interests of the entire
country, creates positive externalities and increase the social welfare. Hence, freebies which
are aimed at increasing the social welfare, without hampering the competition in the market
can be well suited, only with the tax burden issue to be demystified.

Source: Income Tax Department, Central Board of Direct Taxes, Government of India.
* Note: This includes corporate tax as well as individual tax.
(b) Manifesto Promises
Freebies for political motives has a major contribution to the Economics of freebies. Election
time in Indian states very often mean the freebies season. From free petrol to pressure
cookers, smartphones to cycles, voters across Uttar Pradesh, Punjab and Goa are being
promised all kinds of gifts if they vote particular parties to power.
In Punjab, the government has added tea and sugar to a current subsidized scheme that
already includes rice and pulses. The Bharatiya Janata Partys manifesto for Punjab this year
promised, among other things, 2.5 kilos of ghee and sugar to be distributed free if the BJP -
SAD coalition returned to power. Congress had earlier included free tea leaves and
subsidised canteens in its own manifesto, while the Aam Aadmi Party had offered subsidised
powder milk and meals. The subsidised atta-dal scheme was introduced by the Akalis in
2007, which offered Atta at 1 per kg and dal for 20 a kg for Blue card holders. The
number of Blue card holders has grown from 16 lakh to 28 lakh over the years, and the
number of beneficiaries is estimated at one crore.
Similarly, in Uttar Pradesh, Freebies actually are the major part of manifestos of political
parties in Uttar Pradesh where laptops and smart phones are being promised. What mattered
more were castes, Dalits or Muslims, the BJP,
BSP and Congress-SP had their own vote banks which they were able to lure, but, to move
out of their own reserved vote bank, there is no better option than freebies. The situation in
Indian state or central elections has always been favourable for anyone with more freebies,
voters are divided by castes, but certainly, united by freebies. The ruling Samajwadi Party
has promised pressure cooker, food grains for the poor and ghee and milk for students
besides expanding pension benefits under different schemes to one crore people. The BJP,
because of motivation or insecurity has gone a step ahead, promising laptop to every student
"without discrimination" along with 1 GB internet data every month for a period of one year.
Congress has promised to provide free school education for every girl child and give free
bicycles to girl students from Class IX to XII. BSP has announced waiving farm loans of up
to Rs 1 lakh Flashback to 2014 when the state government promised to give away laptops to
students passing class XII, talking figures, Rs 3.44 Lakh Crores were spent over these
freebies. In addition to such financial burdens, neglect of administrative duties by officials
busy on election duties have spelt disaster for the state's economy. Most government
employees being out on election duty, the administration fear a 25% knock on the revenue
targets. The Sales Tax Department has seen a drop in collections in the past three months.
While it earned Rs 4,494 crore in tax in November, the collection slipped in December and is
set to go down further in January and February due to engagement of employees and
officials in election duty. The stamp and registration revenue target was Rs 12,130 crore but
has been downsized in a big way, with collections dropping to Rs 9,222 crore. The target for
this month has been scaled down to Rs 13,953 crore from Rs 16,319.60 crore (a loss of Rs
2,366 crore). The Sales and Trade Tax target has been revised from Rs 57,940.30 crore to Rs
51,508.93 crore. The Excise Department, the cash cow, has also taken a beating in revenue
collection. An official said that as against a target of Rs 1,443 crore in December, the
collection was down at Rs 1,345 crore.
Backed by the figures, it is very much evident how hardly the development and growth is hit.
The sole objective is to provide and impress the public with free goods and services to
remain in power. According to Hindustan Times, UPs economic status has only fallen since
Indias independence its per capita income, which was 97% of the national average has
slipped to 40.5% in 2014-15. The states economy grew at 6.56% annually, lower than the
national average of 7.52%.

Punjab and the Uttar Pradesh are now in the freebies loop and might very well end up like
Tamil Nadu. Elections in Tamil Nadu are all about freebies; not about anything else certainly
not development and growth. And for both the ruling party and the opposition what matters
today is not the performance of the government but intelligent packaging of freebies.
According to political analysts, the parties at Tamil Nadu started believing in freebies after
the 2006 state elections when offer of free TVs and subsidised rice at Rs 2/Kg got them the
elections over the DMK. Since then it has been a belief that elections in the state are won by
winning the peoples hearts or pulling them out of the pit of poverty and helplessness.
CONCLUSION
REFERENCES

FREE: The Future of a Radical Price: Chris Anderson [1]


http://www.indiaspend.com/special-reports/3-81-indians-pay-income-tax-maharashtra-delhi-
pay-53-35668 [2]
http://www.investopedia.com/terms/f/free_rider_problem.asp#ixzz4ZiFPEmuk [3]

www.investopedia.com
http://www.economicshelp.org/blog/1626/economics/free-rider-problem/
http://www.epw.in/system/files/pdf/1962_14/42/state_tax_burden_in_indiaa_comparative_st
udy.pdf

http://www.citylab.com/navigator/2015/06/psychology-of-free-donuts/395021/
The economic paradox of the freebies phenomena: how and why companies give stuff away
for free: Dr Romuald E. J. Rudzki & Shaomei Li
The Hidden Costs of Free Books: Implications for Anti-Trust Enforcement Michal S. Gal
and Daniel L. Rubinfeld
Something for Nothing? An Investigation into Online Product Sampling: Joanne Kuzma,
Warren Wright
Predictably Irrational: The Hidden Forces That Shape Our Decisions, Duke professor Dan
Ariely