Friday, 5 September 2008

Structured pricing in the property market

Pricing, fundamentally, is a way of transferring a fair share of value from buyer to seller in return for the service the buyer receives.

However, it is sometimes challenging to measure the value that each party obtains in a transaction. Also, economic theory contains a concept called asymmetric information which means that either the buyer or seller has information that the other does not. This is often as simple as “how much do I really want this” but it may be that one party actually knows something concrete that the other doesn’t, and can take advantage.

For these reasons, in the early stages of development of a market, simplified pricing models arise. These act as proxies for the real value of the transaction – making it easier for people to negotiate. In the property sector, the typical proxies are fees based on a percentage of sale or rental price. In professional services, the typical proxy is a fee per hour which may vary according to the experience of the individual being employed.

The reason these proxies exist is to make it simple for unsophisticated buyers or sellers to do business with each other. However, they have a huge drawback: they prevent viable economic transactions from taking place. By viable I mean transactions which would benefit both parties, and which we would naturally wish to happen – a new service would be provided for a buyer, and a seller would receive money in return. This is because the pricing models are too simplistic to capture the extra value provided by these additional services, and so there is no room for the seller to be creative in finding new solutions to the buyer’s needs.

As markets become more sophisticated and mature, economic activity will stagnate if new models are not found. Buyers and sellers learn more about the marketplace, and become capable of negotiating and measuring better models which provide more value to both parties. The old models become outdated and start to show the strains – which we’re seeing in the market now, and which the Carsberg report endorses.

Structured pricing is the solution to this.

Structured pricing means that the price of a service is based on the value generated by the service, and not on a simplified percentage-based model. The user of a service gets value in many ways which are not reflected in a percentage-based fee.

For example:
  1. A buyer may find the home of their dreams – bringing a degree of happiness far beyond the satisfaction of getting the house a few thousand pounds cheaper.
  2. A vendor may have a fast and hassle-free completion, saving them weeks or months of worry and stress
  3. A landlord may let their property to tenants they trust, who they know will take good care of it and pay their rent on time – removing the worry that rent may not cover mortgage payments or that the fabric of their house will be destroyed
  4. A commercial tenant may gain the reassurance that their property will meet the functional and productive needs of their staff, and any problems will be fixed promptly – helping them feel like a more professional business as well as saving money on facilities management
These benefits are what people really want when they buy, sell or let property. So why stick with a pricing model that actively discourages these goals from being successfully achieved?

Structured pricing analyses the values of each party in a transaction, and puts a price on each of them. This encourages everyone involved to find the best way to meet each other’s needs and can transform the experience and the success of a negotiation.

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