What is Hedonic Pricing? Explanation of the Hedonic Pricing Method

Most pricing strategies focus on pricing based on internal factors. However, when it comes to such a product as a house, for example, it is impossible not to take into account external factors.

Pricing that takes into account both external and internal factors is hedonic pricing. In this article, we will touch upon the advantages and disadvantages of this strategy, discuss how to apply it, give some examples, and also talk about hedonic regression and analysis models.

Hedonic pricing is a strategy or model in which internal and external factors participate in price formation. Usually, such pricing is applied to products or services related to ecology or ecosystems.

Thus, environmental factors will be external factors of price formation. Earlier, we gave an example of a house as a product to which hedonic pricing can be applied, because the location of the house, the climate, and the general environmental situation in that place will be external factors that do not depend on the house itself (area, design, interior) in any way.

Just like any other strategy, this one has its own benefits and disadvantages.

The main advantage of this model is its flexibility. To form a price, you need to take into account many factors that can also change, which means that the approach to pricing for each object will be different, depending on the factors. Factors can be both external (the infrastructure of the area, proximity to the city center, the number of various benefits near the object, the well-being of the area) and internal (the area of the object, repair).

At the same time, hedonic model is not the easiest approach, due to the complexity of calculations, but it is this model that allows you to get a reasonable price for an object. The hedonic model is adaptable, so despite its complexity, it can be used to determine the cost of almost any object.

There are five main disadvantages of this strategy: availability of information and knowledge, verification of measurements, market limitations, multicollinearity and price fluctuations.

Let's start with the availability of information. Hedonic strategy implies that the specialists who form the price should have all the positive and negative characteristics of the property. In fact, not all the information can be collected, sometimes there is no access to some data, and sometimes you can miss something.

Speaking about the validation of measurements, we have to notice that independent variable measures should have superiority and should not be based on indirect indicators, since this directly affects the coefficients.
Market restrictions relate to customer preferences. Such a factor is included in hedonic pricing and it is impossible to get rid of it. It's just that there are various properties and characteristics on the basis of which the buyer chooses housing. Your object may not be suitable for the requests of a particular client. Multicollinearity can occur in hedonic models because it may be challenging to separate certain variables.

The last disadvantage is price fluctuations. Price fluctuations do not pose a particular threat, since this is typical for any market, the disadvantage is how long it will take to react to market changes. Often, price changes lag behind market trends.

A house located in a bad area, with polluted air, with a bad view, will cost less than a house in a prosperous area, with a good view and ecology, in an area with good infrastructure.

Another example: one house is located next to a school and a train station and is 5 minutes from the highway, with an area of 60 m2. The second house has an area of 90m2 and is located 20 minutes from the train station. In this case, the first option will cost more, despite the smaller area. The buyer will be willing to pay more, as this will cover their travel expenses.

There are two parts to performing hedonic regression analysis.
To begin with, it is necessary to determine the cost of the object, taking into account the characteristics of ownership, as well as external factors. Here you need to determine the relationship between the price of the object and the independent variables (which are the characteristics, including the property’s features, the location features, and the environmental features).

Further, price fluctuations occurring due to changes in characteristics will be a hedonic price. This price is the additional value of the asset based on the additional benefit that depends on the merits of the property.

The model of analyzing the willingness of customers to pay, taking into account their income, preferences and opportunities, is the final part of the hedonic pricing. At this stage, it is determined whether there will be a deal or not. It also depends not only on the family which acquires the property, but also on the property itself: area, renovation, location, and so on.

Hedonic pricing method formula depends on two steps:

The first step is to determine the value of the dependent variables of the object, such as land and property. Next, you need to determine the connection between dependent and independent variables.
The next step of hedonic regression is to determine the price based on how much the buyer is willing to pay. The degree of readiness is determined based on the internal and client characteristics of the object.

Following these steps, you can determine a fair price for the object without missing the benefits that can be obtained from the characteristics of the property. In fact, the change in the hedonic price is associated with changes in the internal and external characteristics of the object, changes in dependent and independent variables. It will take a lot of time and resources to take into account all the factors, but this model will allow you to sell real estate at the best price.

Hedonic pricing is definitely not an easy model, and only professionals should implement it. There are too many factors that are individual in each case, and which are also constantly changing. To implement such a model, a lot of resources will be required, but the main advantage will be that, thanks to hedonic pricing, an additional cost will be formed due to various external factors. If the external conditions are attractive, then the cost can increase significantly. You can use Priceva’s service Rule-Based Repricing Software to determine the price, taking into account all the factors needed.

Hedonic method allows you to form a fair price for each property. Using this strategy, you will not miss the opportunity to make an additional mark-up on your house, which can be created due to the characteristics of the environment around it.

A hedonic product is a product (real estate) whose value is determined not only by internal characteristics, but also by external ones. This method makes the price fairer for the market.

As the names suggest, a utilitarian product is a product that serves some practical purpose, while a hedonic product is something that provides a more emotional impact, such as fun or excitement.

Hedonic price adjustment is the adjustment of prices according to changes in external environmental factors. If, for example, the ecosystem has deteriorated, then the price of a hedonic product may decrease.