The Proper Price for a Domain, Part 8: Calculating a Comprehensive Price Cap | #20 in Series: What Businesses Need to Know about Domaining

In this series I address people running a business or organization of any size, from entrepreneurs to the whole C-Suite, as well as Business Development, Marketing, Sales, Finance and IT. But I welcome all readers, including of course domainers.?Series Table of Contents

In previous articles we've been developing a process to determine the worth of a domain to your company, or the maximum you should be prepared to pay for it. Here we complete that process. We get there. (At least for a single-payment purchase, that is.) Let's continue.

15) Having the money (or being able to get it) is obviously one factor in affordability. Another is what I incorrectly called 'opportunity cost' in article 15, and will here define as choice cost.

• The choice cost of an investment, at any point in time, is the amount of funds you don't have available to spend on other choices at that time because they were spent on the investment, and returns from the investment have not yet covered those payments (paid the company back).
• For an investment with the full price paid in full up front, the choice cost is initially equal to the price, then shrinks to zero at breakeven.

Choice cost may sound like a number of things it actually isn't. The distinctions are important.

• Choice cost is not price. If the price is $100k to be paid in 10 equal installments, then after two payments the choice cost is only $20k, the amount of money you no longer have because of the investment.
• Choice cost is not debt. If you have $1 million, and you buy something for $100k on credit instead of from the $1 million, at that point you still have the $1 million, whereas choice cost is defined as funds you don't have. Until you begin paying the debt, the choice cost is zero, even if you are reserving funds to cover the debt payments. (You still have those funds you're holding in reserve until you actually make the payments, so you could potentially take them out of reserve and spend them, planning on covering the payments some other way when they're due.)
• Choice cost is not the amount spent. If you spent $100k on an investment, and after 6 months it's earned $40k profit, the choice cost at that point is only $60k, because $40k of what you spent is back in your pocket — it's been returned ('return on investment', or ROI) so you have it again. It's once again available to spend on other choices.
• Choice cost is not opportunity cost, the term I incorrectly applied to it in article 15. Opportunity cost is the return on the most profitable investment choice you could make, minus the return on the investment you actually make. If you spend $100k on the most profitable investment you could make, the choice cost is $100k, but the opportunity cost is zero.

The word choice in the term 'choice cost' does not refer to your choice to make the investment, but rather to the constraint which that choice places on your ability to choose alternative or additional purchases, costing you the loss of the option to make those purchases as well.

But the actual constraint differs from the choice cost, and depends on exactly what alternative purchases the investment precludes, as well as the extent of your financial reserves. In fact, the best way to define the actual constraint is in terms of the specific alternatives the investment precludes. So let's define another term, choice constraint, which is the actual constraint.

• The choice constraint of an investment is the set of sets of options of things you'd like to do whether you make the investment or not, and which you could do if you don't make the investment, and can't do if you do make it.
• Choice constraint is defined as a set of sets of options. Each group of options — that is, each set of things you would like to do — such that if you don't make the investment you could, and would want to, do all the options in the set together, but if do make the investment you couldn't do them all together even though you would still like to, is a set of options within the investment's choice constraint. The group of all such sets is the set of sets comprising the choice constraint.(1)
• The things included within the choice constraint are things you'd like to do whether you make the investment or not. There may be things you'd like to do if you don't make the investment, but would not still want to do if you do make the investment — for example, because the investment would just be a different way of accomplishing the same thing, or because in some other way the investment would make those options unnecessary, superfluous. These options are excluded from the choice constraint.
• Choice constraint can take into account your total available funds, the possibility of buying alternative options on credit, how opportunities and/or costs can combine, and how they can compound over time, as well as any other factors that can affect which alternatives would actually be precluded by making the investment.

To understand why we need two concepts — choice cost and choice constraint — even though they're closely related, with choice constraint dependent on choice cost — it's critical to understand the difference between them.

The choice cost is a function only of the investment price, payment schedule and profit over time —financial characteristics of the investment itself — and is itself a financial quantity. By contrast, the choice constraint is not a financial quantity, and depends also on other factors.

Suppose it's the end?of the fiscal year, and you want to spend down $1 million from your budget. A $100k investment with those funds will not constrain you from also making a different $200k purchase. The choice cost of the investment is $100k, but there's no choice constraint, because there's plenty of funds to cover both purchases.

Now suppose instead that you have only $250k unallocated funds to spend down. You could still make either the $100k investment or the $200k purchase, but now the $100k investment with those funds will constrain your choice to also make the $200k purchase. The choice cost here is exactly the same as in the previous example, but the choice constraint ?is not the same as in the previous example. Notice that the value (or at least the price) of the choice constraint here is twice the choice cost.

The choice constraint tells you what you'll be giving up if you make the investment. If you really wouldn't be giving up anything, why wouldn't you make the investment, regardless of how much it cost?

Although the choice constraint is not directly determined by or proportional to the choice cost, the choice cost is the single financial attribute of the investment itself that most directly determines the choice constraint. And the choice cost is a function of time. Therefore, the choice cost over time is one of the most relevant attributes of the investment itself in deciding whether or not to make the investment.(2)

So with the choice cost and choice constraint concepts under your belt, once you have your maximum feasible adjusted, qualified, effective modestly cautious prospective circumspective price cap, you need to ask:

1. What else do you want to do — that is, besides purchasing the domain — that you could and would do if you don't get the domain, and that if you do get the domain you still would do if you could but in fact now could not do??In other words, if you don't get the domain you will do them, but if you do get the domain you can't do them even though you would still want to?(3)
2. Of those alternative purchases, are there any which are so important that if you had to choose between them and getting the domain, you would forfeit the domain? Or at least, that you absolutely would still want to do even if you do get the domain, so that forfeiting them for the domain is off the table?
3. If so, subtract from the maximum feasible adjusted, qualified, effective modestly cautious prospective circumspective price cap, the cost amount by which getting the domain would make the most costly of these alternatives unaffordable.
4. The difference is your prudent price cap. It's prudent because spending that much for the domain wouldn't preclude also getting that essential alternative which would be precluded by a higher price.?In other words, the prudent price cap mitigates an unacceptably high choice constraint.

We could also call the prudent price cap a comprehensive price cap, because it takes everything together into account — for a single-payment purchase, that is.(4)

But extended payments could change the equation yet again. And that's not the only reason for making extended payments. See my next two articles.

(Like this article? 'Like' it! Have a question or comment? Comment! Think it's worth sharing? Share it! Thanks! - Keith)

___________________________

(1) Here's how that works. Suppose that if you don't make the investment, you could do A, B and C individually or in any combination. If you do make the investment, you could still do A or B or C, but not any combinations of?them. Then none of these individually would be part of the choice constraint, but each of the following sets of options would be included within the set of sets of options constituting the choice constraint: (A and B), (A and C), (B and C), and (A and B and C).

However, if you couldn't do all three (A and B and C) together even if?you don't make the investment, then the option set (A and B and C) would not be part of the investment's choice constraint, since you couldn't do it anyway — so it's not the investment that would keep you from doing it.

On the other hand, if D is another thing you'd like to do, and which you could do if you don't make the investment, and making the investment would preclude your doing it, then D would be a single-member set within the investment's choice constraint set of sets.

(2) The other two aspects of the investment itself most relevant to your price cap and decision to purchase are profit over time and the effective payback period. But these are not unrelated. Choice cost and cumulative profit are both functions of time. The effective payback period is simply the length of time from the purchase date to when choice cost permanently reaches zero as the cumulative profit overtakes the payment(s). Choice cost, in turn, is a function of the payment schedule and ongoing profit, which are the only independent variables (in the sense that they're dependent only on time).

(3) This where you determine the choice constraint, and it needs clarifying. As explained earlier, if without getting the domain you could do both A and B, and with the domain you could still do A or B, but no longer A and B, then the inability to do A or B is not an choice constraint, but the inability to do A and B is a choice constraint, providing that you would still want to do A and B if you get the domain. For more, see footnote 1.

(4) 'Comprehensive' means grasping together. The prudent price cap gives you a handle on all the factors together which should influence your domain purchase decision for a single-payment acquisition, so it's comprehensive.