Pricing Power

“Pricing power” is a term that one occasionally hears mentioned, but it seems to lack a standardized definition.

Two common sets of definitions seem to exist with regard to “pricing power” – one has to do with pricing elasticity and the other has to do with a more generalized concept of being able to increase prices without losing (much) business.  (This latter definition is discussed in the Forbes article of August 6, 2014 titled “Why Pricing Power Is The Real Secret To Value Investing.”)

However, it would also appear that the concept of pricing power should extend to how “defensible” a product’s (or service’s) price is against having to be lowered (i.e. discounted).  In essence, is a product’s price at a level that will not prove to be “too high” if the market changes, due to any number of reasons.  Some of these reasons include new competitors, new competitive products, changing market tastes, “price wars,” and less product demand due to economic weakness.  This last factor seems especially notable, given increased price competitiveness (often seen through increased retail discounting) that has intensified over the last year, as discussed in various pricing posts on this site as well as in the October 31, 2014 Reuters article titled “Wal-Mart to expand discounts as retail price war heats up.”

What has been occurring is that price sensitivity is in many situations increasing, and as such price is becoming the “focal point” in many competitive situations.  In many cases not only is the ability to exert “pricing power” through raising prices becoming increasingly infeasible, but also a considerable amount of downward pricing pressure is being exerted.

Given the above-mentioned dynamics, how can a company seek to avoid (continual) price discounting?

While generalizations concerning pricing and pricing strategies are inadvisable – as pricing-related characteristics vary among companies, industries, and settings – a key question continues to be what general pricing approach a company is using.

The above-mentioned Forbes article mentions three “pricing approaches” across industries, which it identifies as:

  • Cost-based pricing
  • Competition-based pricing
  • Customer value-based pricing

Another approach that seems common is pricing a product based off of past prices (of the same or similar product.)

Of paramount importance is whether a company’s general pricing approach is appropriate on an “all things considered” basis.  Also of primary importance is whether the pricing approach factors in the complexities of today’s business environment and its changing dynamics.  While proper pricing strategies have the ability to (greatly) benefit a firm, pricing’s inherent leverage has the potential to also work against a firm.

Achieving pricing power – both the ability to (successfully) raise prices, while also being able to maintain pricing levels in a challenging economic and competitive environment – will continue to be of tremendous benefit.