Note: This commentary is written in response to an editorial by MFE editor-in-chief
Jerry Asicerto posted on April 18. Read Jerry’s piece here.
I listened intently as Jerry described the situation last year that caused him to question the long-term value of pricing and revenue management software. So let’s start with the facts (at least as he reported them):
- He leased a unit for 12 months;
- Come renewal time, he wanted to move but needed to extend his lease; and
- He was offered a month-to-month option at a 50% increase on his then-current rent.
From this, he felt like he “was treated like cattle” and concluded that revenue management software is essentially “anti-human.” Let’s look at this in more detail.
Daniel Ariely, author of the seminal book Predictably Irrational, discusses how every “deal” we ever make has both an “economic” and a “social” element to the transaction. Imagine if humans were truly homo economicus, that elusive metaphorical species who makes decisions only on the cold, calculated mathematical realities of what’s in her or his best interests and candidly exists only in the minds of economists.
For one thing, we’d stop buying presents for each other—they have a negative expected value (economically speaking). Because we have to guess at what the recipient wants, we’ll never buy the perfect gift every time. Economically speaking, both we and our recipients would be better off if we just gave the recipient cash for him to buy what he wanted. Then, he would return the favor, and we would just keep trading cash until one of us dies, leaving the other up one transaction.
But try that argument with your loved one next anniversary, birthday, or Valentine’s Day! (Big Bang Theory enthusiasts will remember Sheldon’s rant on this very subject.)
So let’s examine both the social and economic elements of Jerry’s experience.
Let’s accept at face value the economic elements of Jerry’s scenario—the RM system has assessed demand and supply and mathematically determined that a 50% increase is justified due to the short length of the term (month-to-month) and the demand for new leases (which will clearly be at a lower rent but for a much longer term).
I believe the real pain here is that Jerry felt the social transaction described by Ariely was being violated. With an increase of 50%, that’s understandable.
I think Jerry makes a good point that housing includes an implied social contract, given that it’s a “basic need” as opposed to a luxury, though it is worth pointing out that this scenario is about a Class A property—so I’m not sure the “human need” argument applies quite as much as if this were a workforce housing situation. Nevertheless, a 50% increase certainly strains any sense of meeting an implied social contract.
Of course any “contract” implies rights and responsibilities on both sides. It’s a well-known fact that very few people going month-to-month stay very long. So, economically and socially, Jerry’s pretty much told the owner he’s not going to be a resident much longer. In my mind, that negates much of the argument that the owner is being shortsighted and should be more focused on “a long-term relationship”—this resident has said he won’t be a long-term tenant.
I think the real issue here is that an increase of 50% feels shocking, no matter what the “facts.” It’s the social conscience that is offended.
At some point, a manager might be better off not allowing a month-to-month and explaining why, rather than putting such a large number out there. Personally, I wouldn’t stand by an offer that high no matter what the math said.
But that’s exactly the rub. I’m not ready to say the owner was wrong—provided it’s willing to accept the natural and logical consequences of an angry resident who might post on review sites and tell all his friends (or even an entire industry) how unreasonable the landlord seemed (though Jerry has been kind not to reveal the actual owner involved).
Faced with the same situation, I’d probably cap the increase at around 30% for a month-to-month, or at least engage in some conversation to try to balance the social and the economic components of the transaction.
At the end of the day, blaming the software seems mistaken. It’s a tool, and, like any tool, it can be used well or used poorly. The software didn’t make the MTM price 50% higher—the owner implemented a policy that allowed that price to be presented and then didn’t allow the community to negotiate off it. That’s a business strategy and set of policies and procedures, not a software problem.
All the software does is give a more-accurate view of the market value of the unit considering expected vacancy, current demand and a host of other variables. Metaphorically speaking, everyone has a “pricing knife.” PRM software just gives us a sharper blade.
A sharp knife lets us cut a lot better than a butter knife. But used incorrectly, it can also cut off a finger.
So what’s needed is a discussion about the policies and procedures that should accompany the use of automated software, not a condemnation of the software itself. Remember that pricing software can suggest price reductions just as easily as increases. It’s merely responding to the market and the user’s strategic inputs.
It’s not a coincidence that automated pricing and revenue management are in use in 3.5 million (or more) units at the same time that we’re seeing record occupancy and rent performance. Of course, great market conditions are driving that performance, but I don’t believe this level of sustained achievement would be possible without the courage and discipline to leverage those conditions that PRM software gives us.
If some companies are taking it too far, then let’s talk about the business process side that implements the software.
I know I’m still going to cut my steak tonight with a sharp knife—and I’ll be just a little bit extra careful not to cut my finger.