Do You Really Have Pricing Power?

Posted by Patrick McCullough on Mar 19, 2019 11:42:58 AM
Patrick McCullough
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Investors have long heralded pricing power as one of the best predictors of a company’s long-term financial success. Warren Buffett’s famous quote from 2010 captures the sentiment.

“The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business.”

However, the simplicity of this statement doesn’t reveal the complexity of pricing power; how to know when you have it, how to build it, and how to use it effectively.

Let’s have a look at some key questions to get started on your way to true pricing power.

jason-blackeye-138263-unsplashDo you have pricing power?

Jack Welch was once quoted as saying, “Any idiot can raise prices,” and he was right. For most in competitive markets, if the price is too high, it will result in the failure to achieve desired sales volumes when customers either find a suitable alternative or choose not to purchase at all. However, there are many instances in which a suitable alternative or even a competitor doesn’t exist. Let’s use Martin Shkreli as an example; do you think he had pricing power when he raised the price of a 62-year-old drug 5,000%? If you think your product is a commodity, do you see an opportunity to build pricing power?

Key Question: Is your product or service commonly sold at a discount?

If the answer is 'yes', you either lack pricing power, have the wrong offering structure, or both.

Can you build pricing power?

Pricing power isn’t just about raising prices, it’s about matching the value you deliver to the price customers pay for your products or services. So yes, you can build pricing power when you create a situation in which customers believe they receive more value from your product or service than the price they pay. However, what happens when customer needs and expectations change? How long will your pricing power last? The flow of information and the speed of innovation intensify competition and continually change the playing field. Jeff Bezos famously said, “your margin is my opportunity” demonstrating Amazon’s, along with many other companies’, interest in driving market disruption. What do you do?

Key Question: How well do you know your customers and can you segment them into groups that have similar value needs?

The increased availability of information not only empowers customers to learn more about their options, but also empowers companies to learn more about their customers. You may, in fact, have pricing power in certain cohorts of your customer base that you haven’t identified or do not understand.

 Long-term vs short term pricing power:

A few weeks ago, a friend in the investment industry sent me an interesting article: Pricing Power: Delighting Customers vs. Mortgaging Your Moat. In the article, a distinction is drawn between companies who use pricing power to delight their customers versus those who use it to exploit their customers. This distinction, between two different uses of pricing power, is very important and more subtle than you may think. Let’s look at the following scenario:

A raw materials supplier has the advantageous position of excess inventory in a time of market-wide shortages.

  • Option A: The supplier who “delights” customers will use pricing power to create a tiered offering based on delivery lead times and allow their customers to choose the price they are willing to pay based on the speed at which they wish to receive their goods
  • Option B: The supplier who “exploits” customers will raise the price for the supplied item across the board, giving customers no choice but to pay the higher price

Is there a right option? Consider the alignment of your commercial strategy to your corporate goals and identify the critical opportunities to drive both short and long-term profit growth.

Key Question: Why do your customers do business with you?

Customers always ask for a discount and most will continue asking. “Delighted customers” are those who have a choice and continue to choose you, time after time, despite holding your price.

The most important question to ask is “do I really have pricing power?” Pricing power is one of those things that is very easy to identify in retrospect, but significantly more difficult to proactively create. Why? Because you must continually scan the market, competitors, and customers to understand how your products and services provide impactful value and how it changes over time. Only then, will you be able to define an offering structure in which customers feel they are receiving greater value than the price they pay.

You may not “have a prayer session” before each price increase as Warren Buffett joked, but I encourage you to dig deeper into each of your unique customer cohorts to better understand the value they perceive/receive from your products and services.

If you raised your hand when asked if your product/service is commonly sold at a discount, you may be interested in our whitepaper “Kick the Discounting Habit” below to learn how to get control of this margin-eating behavior.
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Topics: Pricing with Confidence