What is pricing power ?

A simple question from Prof Sanjay Bakshi on Twitter got a gamut of responses from his legion of followers, Don’t miss the entire discussion here

I have tried to penned down my understanding in form of few questions hope they help you next time when you are evaluating a business

When you think of Pricing Power

What’s obvious ?

When a company has following attributes

  1. Easily pass on increases in costs to customers without having volume declines
  2. Strong brands and customer loyalty allowing company to charge premium price over competitors
    1. Pricing power is when you can sell $120 phones(manufacturing cost) to people at $650 just because you are Apple
    2. Making/marketing a product that is so loved by customers that they find ‘value’ even at increased prices
  3. The ability to increase the prices of your product without losing market share to competition
  4. Ability to price ahead of inflation
  5. When elasticity of demand of your product is not price sensitive

What’s not so obvious ?

  1. Pricing power isn’t just about increasing prices of your OUTPUT .It’s also about lowering prices of your INPUTS
  2. Pricing power is not just about RAISING prices. It includes power to CUT prices, make life difficult for competition & still earn good ROE
  3. Pricing power through regulation – Can you start a tobacco company and launch your cigarette brand called WEEDY and undercut ITC? No, therefore here regulation is giving you pricing power

 

Are there examples where there is pricing power with no brands ?

Yes

  1. “Cost plus” business models like electricity if prices are linked to cost, example if I could charge 30% over my audited cost no matter what I have pricing power
  2. Monopoly businesses with no brand – Reliance polymer ,Euro rail, Air India or MTNL (when there was no competition) ,So even a pure commodity business which sells an undifferentiated product can have pricing power

Can industry dynamics create pricing power ?

  1. Companies in few oligopoly industries are able to maintain pricing without competitive advantage through collusion – e.g. Cement industry in India
  2. Industry consolidations – The obvious way is to increase prices post industry consolidation. Is there another way? Yes rather than increase prices, decrease in costs can help due to scale advantages in mergers

How do you detect pricing power ?

The answer lies in – Can the business defend margins when it faces cost inflation?

Margins are the difference between sale price and cost so stable margins are a clue, Any business with very stable margins should have some pricing power

Think on below lines

If raw material prices move up and down like a yo-yo but margins don’t ,we see pricing power

If both raw material & customers margins do a yo-yo and as a supplier your margins don’t its pricing power

 

How the not so obvious pricing power one which comes from lowering input cost be unleashed on competition ?

By having extreme low cost structures the company can offer exceptional value to customer, deter competition & still earn excellent ROE

Look at below quotes from Jeff Bezos to understand these

Jeff-1 Jeff-2

Related reading how Free Cash Flow Trumps Margins

 

Imagine a company has pricing power. Should it use this power ruthlessly on customers or competitors?

Making life difficult for competitors is enough. Killing them is not necessary for a business to become great.

Pharma cos, medical devices, apple are some examples of ruthless pricing and are also the highest wealth creators however Is that admirable? Is that how you’d like the world to be run? Or would you admire Costco and Ryan Air more?

Pricing power flexed today is customer loyalty gone tomorrow, You have to very thoughtful about how you use your powers. Very few businesses understand durability.

Can you have pricing power if your ROCE sucks?

Example HRM rails without intermodal. They still have good pricing power for heavy loads but ROCE is low without volumes

How does M&A activity create pricing power?

A lot if it’s UNTAPPED PRICING POWER. So now we have this idea mentioned by Warren Buffet, Read the below article to get full grasp of the concept Roll–up Merger here

There’s often untapped pricing power in industry consolidations- something the sellers are unaware of