One of the main characteristics of companies with strong competitive advantages is their ability to set prices. Companies like Coca-Cola do not worry that carbonated cola drink is sold in the supermarket at a quarter of its price, since their customers are willing to pay much more for the original product. To delve into the issue of pricing power, I recommend this article, which is a translation of the publication "Why pricing power is the real secret to value investing”, Written by Greg Petro in Forbes.
Pricing power is the real secret of value investing
Warren Buffett, the billionaire CEO of Berkshire Hathaway, once said:
“The most important factor to look at when valuing a company is its pricing power. If you have the ability to raise prices without losing business at the hands of a competitor, you have a very good business. "
Buffett, of course, is talking about his favorite type of companies, those with strong brands and business models that have a "moat" around them, allowing them to better control the price of their products.
However, according to the Professional Pricing Society, less than 5% of Fortune 500 companies have a division dedicated full-time to pricing. If this is the case, most companies will have little or no idea whether they can raise their prices without losing business to a competitor.
Investors who have spent time delving into retail pricing know there are different approaches. According to MIT Sloan University, pricing approaches in different industries, countries, and companies can be classified into three categories:
- Cost-based pricing
- Competitor-based pricing
- Pricing based on value generated to consumers
The price you have vs. The price you put
The ultimate goal of any company is to achieve an average unit retail price (AUR price) as close as possible to the initial price they have set for the product.
Of the three pricing strategies mentioned, the one that offers the best way to achieve this goal is pricing based on value to consumers.
Value-based pricing (VBP or value-based pricing) uses data on the perceived value of the product as the main factor in determining the final sale price. Instead of trying to figure out how to raise prices in a competitive environment, VBP asks how to create additional value for consumers and increase their willingness to pay. in spite of strong competition.
Two examples of companies that follow this approach (in part) are Under Armor and Apple. Both companies have strong brands and have enjoyed great pricing power that has resulted in large profit margins. However, I think both companies are missing the great promise of value-based pricing.
Under Armor has successfully communicated the value and differentiation of its products through technology and marketing. Although Under Armor has to face competition, consumers appreciate the quality of its products and are willing to charge premium prices for them. An example of this is the price of their Highlight Football Cleat shoes. Last year it sold for 110; this year for $ 130. Even though Under Armor is succeeding in capturing the added value of the shoes this year, wouldn't it have been better to have known about price elasticity last year than to have priced it initially at $ 130?
Apple uses value-based pricing throughout its product line. However, even Apple is not immune to price resistance when they exceed the barriers of consumer expectations. When the iPhone was released, it was priced at $ 599. Apple realized the price was too high and lowered it to $ 399, offering gift vouchers for the first to purchase the product. Like Under Armor, Apple managed to find the "right price," but you could have avoided trouble if you had known the true value to consumers before launching the product.
According to MIT Sloan University, value-based pricing is based on a deep understanding of consumer needs, consumer valuation, and long-term price elasticity. Engaging consumers in a meaningful way with the brand allows companies to understand in advance how people value the product rather than simply trying to guess it.
Today, the barriers between companies have disappeared. Unfortunately, most companies still seem to be far from using value-based pricing because they are not actively looking for the kinds of data that help them understand consumer valuation.
As retailers constantly try to maximize their profits, investors must be able to understand the different pricing approaches used by companies that may be part of our investment portfolio. You must ask yourself:
How vulnerable are the companies in my portfolio to price competition?
Are they in a position to allow them to achieve the highest possible unit average sales price?