Burning down the house

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The purpose of this post

Readers living in South West London may have seen the opposite poster featuring prominently in a real estate agency’s (Acquire Estate Agents not to mention any names) shop front. It was probably designed with the best intent, but this is actually a very bad promotional mechanism.

Let us dissect the proposal. At first sight, the offer seems appealing. The poster indeed advertises a “flat fee of £700” which “includes VAT, EPC, floorplans and pictures” for home owners willing to sell their property. With the average London house costing as much as £531,000, a £700 fee is equivalent to 0.1% of the average transaction value, whereas other major real estate agencies typically charge around 3% of the priceIn that case, why should the prospective seller think twice before walking into the lion’s den?

The reasoning is detailed in-depth and supported by empirical evidence in Levitt’s and Dubner’s Freakonomics  – a book I have already had the chance to write about – and relates to the role of incentives. In a nutshell, with a flat fee, especially a low one, the real estate agent is not incentivised to maximise the transaction value on behalf of the seller but to complete the transaction as quickly as possible, even if it means making sacrifices on price. Quantity prevails over quality.

For the seller, the ‘great offer’ may thus backfire and leave him worse-off overall after the transaction. He will save an average of £15,230 in agency fees (3% * £531,000 – £700), but this saving can be easily more than offset by performing a marginally higher number of visits or by spending a little bit more time negotiating the buyers’ offers – especially given the fever surrounding the London housing market.

A good alternative mechanism could have consisted in offering lower fees as a percentage of the transaction value, which would have maintained the agent’s incentive – albeit at a lower scale.

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Daniel Kahneman

I have not been able to assess whether this marketing campaign ultimately proved successful for the agency or not. In any case, and to paraphrase Daniel Kahneman (2002 Nobel Memorial Prize in Economic Sciences) in Thinking: Fast and Slow, this is a perfect example of our ‘rational’ System 2 overriding the gut feels emitted by our ‘impulsive’ System 1.

P.S.: More on Kahneman and behavioural economics will be covered more in-depth in a later post.
P.S. 2: To finish with music…

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