How to come up with a rental rate?

Discussion in 'Growing and Managing a Business' started by ronyoz, Oct 19, 2011.

  1. ronyoz

    ronyoz
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    Hello everyone.

    Does anyone know of a general formula or model for figuring a rental rate for a product?

    Let's say I want to rent a plasma screen. How do I come up with a rate?

    I know that I could look up a common rental rate with other companies and have an idea, but is there a formula that I could follow to come up with the rate?
    Does it varies according to the product?

    For example take the price of the product minus depreciation plus labor, plus administrative expenses, divide it by the time....I don't know, something like that.

    Thank you all in advance.
     
  2. patrick0001

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    Let me try to answer:

    we assume that plasma screen depreciate value year to year, and estimate that it last for 5 years. e.g:

    1st year - value 3000 (Monthly rental 3000/12 = 250)
    2nd year - value 2500 (Monthly rental 2500/12 = 208.33)
    3rd year - value 2000 (Monthly rental 2000/12 = 166.66)
    4th year - value 1500 (Monthly rental 1500/12 = 125)
    5th year -value 1000 (Monthly rental 1000/12 = 83.33)

    With the cost value, on top of it we added labor, plus administrative expenses and expected profit margin.
     
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  3. ArcSine

    ArcSine
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    Ronyoz, your pricing will be driven largely by the established market prices in your area, to which you've alluded in your question. More so if your area is well-served by established lessors who are already competing on price to capture each other's customers; less so if you'll be the only game in town (for a while, anyway).

    As Patrick wisely notes, you'll want to consider the age and condition of the equipment. (With a plasma screen I'd imagine it's not so much that a 3-year-old unit delivers a lesser-quality picture than it did when it was new, but rather that it's competing against new stuff sporting brand-new technology and superior capabilities.)

    Especially if the consumers in your service area are well-informed of the available rental choices, you'd find it next to impossible to move even one unit out the door if your pricing is higher than your competitors' (after equating for differences in ancillary services that you might offer; e.g., faster delivery).

    Going the other way, you have little incentive to mark your rental rates significantly lower than the competition. If you have X units available in inventory, all you need is a price that's attractive enough to draw X renters. As long as you're getting the word out, you probably don't have to undercut by much. Any further price reduction just results in more demand than supply, and hence is wasted revenue for you. (You might consider buying more units to meet demand, but if it's still profitable to rent at this lower price, your competitors will similarly increase inventory and cut prices.)

    So with the established rental rates in your service area giving you a pretty good idea of where you need to be price-wise, compare this against all your costs and operating expenses. If the revenue-vs.-cost difference shows a sufficiently attractive net profit, you're good to go. If not, you could consider: Distinguishing yourself from the competition with auxiliary services, enough to justify a higher price; add-on services where the additional revenue exceeds your cost of furnishing such services; and/or re-working your cost and expense structure.

    In other words, your costs won't determine your pricing; they'll determine how attractive the bottom line is, given the established pricing in your service area.

    Best of luck with the business, Ronyoz!
     
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  4. firstchoicecar

    firstchoicecar
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    I think you can add your profit on how much is the TV,then it also depreciate when time comes.
     
  5. ronyoz

    ronyoz
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    Hi, thanks for all your answers.

    So from what I'm getting here, there is no general formula to come out with a rental rate. I have to base my prices according to the already established market prices.

    I thought that maybe a general rule existed when coming up with rental rates for a specific product, based on the cost of the product.

    Just one more thing, what if the product is new and there is no established market rates that I could base my prices on?

    Do I just come up with a rate based on my costs and see if the market accepts it?

    Thanks again for your kind answers.
     
  6. ArcSine

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    In mature industries in which prices have long since settled into a groove from the market's equilibrium forces, the industry's old-timers will have pricing rules of thumb that they can quote in their sleep. These would be formulas or rules that give prices as a function of costs, or give some formulaic relationship between costs and prices based on standard mark-ups, say. It might be something like this to which you're referring.

    So there might be such "formulas" existing in your particular business, but first of all these would be specific to your business. There aren't any blanket formulas that give price-vs-cost relationships that are applicable across all---or even many---different industries. Very high turnover businesses (groceries, say) have razor-thin gross profit margins, whereas sellers of low-turnover durables will be at the completely opposite end of that gross margin spectrum (where "gross margin" implies the price-cost relationship in any particular case).

    You might check around among insiders within your line of business. Trade groups and associations, informal on-line support groups for independent electronics lessors, stuff like that. That's where you'll most likely dig up some standard rule of thumb formulas.

    Nevertheless, such price formulas weren't originally derived from any notion that prices are determined by costs. They result from having prices finding their long-run groove from market demand and market competition forces. Once the prices have been determined that way, one can then see what formulaic relationship exists between costs and the market-determined price.

    But for a new product with no real market pricing having taken hold yet, it's a whole 'nuther matter. If it's possible to dip your toe in the water by testing customers' responses to a proposed pricing, without irrevocably committing yourself to a major cost outlay, that's certainly one way to go. Depending on the nature of the intro product---and the size of the budget---there are also market-research outfits that might be worth exploring.

    If you go the do-it-yourself market research route, that's when you'd certainly want to consider your costs, and see if sufficient demand would be there, at a price that gives you an attractive net profit.
     
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  7. ronyoz

    ronyoz
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    I really appreciate your very well explained and detailed response.

    I think I understand how a product can reach a final selling price. In the retail business for example.

    But I have always wondered how the rental industry works, how they calculate their rates. I think it must be a totally different formula than just taking the cost of the product, adding fixed and variable costs, plus markup and see if your final selling price is competitive.

    Like you mentioned, someone working in the business of renting any kind of product might have this specific answer, but you've clarified a lot. Thanks again.

    I take away this: "your costs won't determine your pricing; they'll determine how attractive the bottom line is". This is gold.

    Great community here!
     
    #7 ronyoz, Oct 20, 2011
    Last edited: Oct 20, 2011
  8. ArcSine

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    Glad to hear it helped a bit, Ronyoz. It's interesting that you brought up the issue of pricing for retailers, because rental rates will be affected by retail prices.

    From the consumer-choice perspective, renting Item X is an alternative to purchasing Item X. If rental rates and the retail prices for the same good were too far apart, everyone would eventually gravitate toward the better bargain, leaving no one renting or no one buying (depending on which was high).

    Similarly, if rental rates were such that one makes a much better profit leasing out the goods rather than selling 'em, the retailers would start renting their inventory and discontinue retail sales. If profits were higher from retail than from rentals, it'd go the other way.

    One might argue that the rental store and the retail store have dissimilar clienteles: a lessor of Item X is in effect acting as a secured lender to parties of weaker credit who can't obtain financing for Item X at the retail store. But even so, the rental rate will take into account the retail pricing of Item X, and then build an implied "risk adjusted interest rate" into the pricing. So while there's certainly a separate demand for both retailers and renters, you really can't completely disconnect retail prices and rental rates.

    Ultimately, you've got all sorts of factors (including retail prices) swirling around that all try to push rental rates in different directions, but eventually the rental prices arrive at that equilibrium point that most folks refer to as "what the market will bear". At that point one could come up with some formula that "the rental rate should be cost + x%". Then, new rental entrepreneurs could use that simpler formula in setting their rates, but that's only because rental stores tend to have similar cost structures, and the market had long ago decided on the correct rental rate, thereby making the formula correct.

    Coming back around to an earlier point, though; if you can find some other experienced rental-store owners (in non-competing markets, natch) with whom to have a few chats and compare notes, you'll likely pick up a bunch of valuable pricing tips. Best of success with the business!
     

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