The following quote appeared in an Andrew Frye and Dakin Campbell, February 17, 2011 Bloomberg article ‘Buffett Says Pricing Power More Important Than Good Management.’

“The single most important decision in evaluating a business is pricing power,” Buffett told the Financial Crisis Inquiry Commission in an interview released by the panel last week. “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.”

The article does go on to congratulate some excellent managers and criticize others.  Despite the title of the article, Buffet does look at both pricing power and management.  So what exactly is pricing power and how do you get it?

Pricing power

How do you get pricing power?

There are a number of sources here are the most common:

  • Innovation
  • Monopoly
  • Superior performance
  • Economy

Innovation

There are two types of innovation – disruptive (discontinuous) and continuous.  Continuous innovations are the enhancements we see to existing products/services.  Disruptive innovations are completely new, nothing like it exists in the market place.

Both can yield superior price performance.  Apple is the most recent example of disruptive innovation with its series of iMacs, iPods, iPhones and iPads.  During a time when most PC manufacturers were dropping their prices from $800 to $600 to ‘be competitive’, the iMac was selling for $1,100 or more.

The iPods, iPhones and iPad initially had no competitors allowing Apple to charge whatever it liked and still have people waiting in line to be the first to own one.  Even with the advent of ‘competitive’ offerings, Apple continues to hold its premium prices.

Intel, in the 80s and 90s, built the ‘Intel Inside’ brand on its disruptive chip technology, then continued to maintain superior pricing by releasing a faster chip just as their competitors came to market with one designed to compete with the slower version.

HP did the same thing in its printer division.  The superiority of its printers allowed HP to get $800 to $900 for its printers while other companies were competing on price.  HP, too, would release new printers just as competitors were catching up.

As you can see disruptive innovation has the ability to garner any price you like.  Continuous innovation (enhancements) allow you to maintain that pricing power.

Monopoly

When we think of monopolies we tend to think of the ‘robber baron’ days when people like Carnegie, Rockefeller, Mellon and Vanderbilt created huge empires achieving monopoly or near monopoly status.

In today’s world, we’re still seeing empires being built.  Microsoft was undoubtedly one of the greatest marketing firms that existed in quite some time.  Google, Facebook, Walmart and Amazon are also huge organizations although Walmart and Amazon have chosen not to translate their strengths into pricing power.

There is another way that monopolies arise that has nothing to do with growing businesses.  This happens through industry consolidation due to declining markets.  Think newspapers.  The sole survivor of an industry consolidation has pricing power by virtue of that monopoly.  The owner of a monthly business publication told me that, after reading my book, he had raised prices by 5% and realized an 8% increase in revenues.  His is the only monthly business publication for the market he serves.

Morale?  Just because you’re in a declining industry doesn’t mean that you can’t have pricing power.

Superior performance

This is an area in which management can certainly add a great deal of value, or lose it.  When you develop a reputation for superior quality, timeliness of delivery or any other performance measure you position yourself for superior pricing.

Well-established companies with reputations for stellar product/service performance and premium prices include Kraft Foods, Johnson & Johnson, Nieman Marcus and Ritz-Carlton.  These companies continuously delight their customers with their offerings which allows them to enjoy the ability to raise prices in good times and bad.

Conversely, Microsoft lost much of its pricing power, in part, due to performance issues.  Who among us doesn’t grimace at the memory of persistent glitches and countless crashes of our systems under a number of successive versions of Windows.

Economy

The most valuable insight into the impact of economic conditions I ever gained was from an economist who when asked “Do you see the economy improving or declining?” responded by asking “For whom?”

His message is that every economy has its winners and losers.  An economy that favors home building challenges home remodeling companies and vice versa.  That doesn’t mean that a remodeler can’t have pricing power in an economy that favors homebuilders, it simply means that the remodeler must do a better job in one of the other areas that create pricing power.

The remodeler could employ innovation to entice people who can’t get that innovation in a new home, use the ‘economic downturn’ in her industry to consolidate the industry or continue to build upon the reputation for superior performance.

We’re the victim of current conditions only if we choose to be so.  Those who excel and enjoy premium prices in good times and bad are those who enjoy pitting their creativity against the challenges they’re facing and are willing to roll up their sleeves and do the work necessary to put that creativity to work for them and their customers.

As Mr. Buffet says “…if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”  Now that you have a sense for the sources of pricing power, the choice is yours.  Choose wisely.