Price your product what it is worth. This sounds so simple but in fact is a bit of revolutionary theory. We have been studying price since Adam Smith, the “Father of Economics” himself, started writing about the effect on supply and demand on prices and vice versa. But it wasn’t until 1997 that the idea of pricing something for what it was worth started to be thoughtfully examined. One of the foundational books on “value-based pricing” was Power Pricing by Harvard professors Robert Dolan and Hermann Simon.
They argued that the method most managers used for pricing their product, to look at what was on the market and mirror other products’ profit margins, was not a good strategy. They called managers that used this tactic “pedestrian pricers,” arguing that it was possible to calculate exactly how much more differentiable value a product had from its substitutes and price accordingly. This would transform a pedestrian pricer into a power pricer and could affect everything from a company’s bottom line to how it positioned its brand in the market.
Now think about the property industry under this lens. The way space, both for lease and for sale, is appraised uses the prices of other buildings as the main calculation metric. The entire industry is just copying each other’s prices. Pedestrian pricing is hardcoded into its DNA. Interestingly, the products that are the most successful in using a value-based pricing strategy are ones that are the most unique and nothing is more unique than a piece of property.
One of the best examples in the office real estate sector of value-based pricing is the co-working model. Customers know that they are paying more per head than they would if they were able to lease a large office space. But many of them prefer the flexibility of the arrangement enough to make the price premium worth paying. However, renting space one desk at a time is not for every business. The huge majority of the office market is still looking for single occupier suites and this puts them back into the pedestrian world of real estate pricing.
Even for “traditional” leases, there is still value in increased flexibility. Companies know that committing to a long-term lease requires them to estimate where they will be, personnel-wise, until the lease term ends. For a rapidly changing company in an uncertain field knowing this kind of detail as far as 15 years into the future is a near impossibility. So, most companies just err on the side of caution. They lease more space then they need and they hope to fill it soon because where is a company to go but up, right?
It is in this excess space where the value arbitrage lies. The idea of value-based office suite pricing was explained to me by Scott Harmon, co-founder of the office leasing network Swivel. “Just think about it as if these companies are basically having to buy a house with an extra bedroom in case they have another kid,” he said. “They are locked into long term leases so they don’t want to outgrowth their space. We analyzed this overage and it came to be about twenty to thirty percent.”
With Swivel, Scott and his team have created a tool that adjusts the pricing of an office based on a number of parameters like lease length, options to move, finish out options, type of furnishings and layout. Companies can understand how any decision changes a transparent pricing model and make decisions accordingly. For landlords, the knowledge that they received a value-based premium for the arrangement helps ease the blow of the increased risk that shorter-term leases represent. customers and brokers get to ‘vote’ on their options through Swivel’s software, so they get to make better decisions about leasing terms and finish-out based on what will make them the highest profit margins.
One of the problems that Swivel hopes to solve is that the property industry, particularly the office sector, doesn’t have any framework for pricing tiers. Once more and more tenants prove that they are willing to pay a premium for the value of a short term turnkey lease it will be important to know what the pricing curve looks like. But, beware. Even if the industry adopts standard tiered pricing there will always be power in being a power pricer.
