The Idea:An easy-to-implement policy allows firms to determine the effect of future financing and performance milestones on pricing decisions, even when firms face uncertain market conditions.
Lenders and investors impose sales milestones on developers of large-scale real estate projects to reduce their risk of default. For example, in some real estate markets it is typical for a lender to require that pre-construction sales of units cover 100 percent of the total loan amount. These milestones affect the pricing decisions made by developers and the project’s profitability. Similarly, a retailer’s impending quarterly payment of sales commissions might function as an informal sales milestone if it prompts sales staff to increase sales efforts in the final weeks before commissions are paid.
Assessing the effect of all future milestones to decide the best price to apply today can be formidable. How should a real estate developer, for example, adjust pricing to accelerate sales and secure the viability of a project, particularly in today’s uncertain market?
Professors Omar Besbes and Costis Maglaras studied how firms should best set their prices over time when facing sales or revenue milestones. Their analysis produced a practical and easy-to-use feedback tool that determines when prices are best increased or decreased to maximize the project’s lifetime profitability subject the various milestones. Their tool uses an intuitive formula to combine up-to-date performance with all future milestones to decide whether prices should be adjusted, and by how much. The tool is effective even under highly uncertain market conditions, and can be used in real estate, retail and other industries engaged in selling a large number of units over a long time horizon. Most recently, it has been applied successfully in several residential developments in the South Florida real estate market.
Real estate developers, sales and marketing firms
You can use this research to make financial projections for large real estate projects, and to estimate the risk associated with such projects (or a portfolio of projects), when simulated against possible market scenarios. You can also evaluate the impact of the milestones imposed on developers and adjust your requirements to align with your institution’s objectives and risk preferences.
You can use this research to value portfolios of large real estate assets or assess a purchase price for a portfolio of assets given your own financing constraints, milestones and objectives.
Pricing and sales executivesYou can use this research to assess the impact of incentive milestones on overall performance and the likely short-term pricing behavior of store managers as well as to design the appropriate sales incentives to best align sales performance with your firm’s profitability.
Omar Besbes is assistant professor of decision, risk and operations at Columbia Business School.
Costis Maglaras is David and Lyn Silfen Professor of Business in the Decision, Risk and Operations Division at Columbia Business School.
Volume: 58 | Issue: 9 | Pages: 1715-1731
Publication type: Journal article