The Power of Pricing Power
In 2011, Warren Buffet told the Financial Crisis Inquiry Commission, “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.”
For now, ignore the words “pricing power” (which are awesome words to a pricing person). Instead focus on his description of it. He says pricing power is having the ability to raise prices at least a little without a huge negative impact on demand. What types of companies or products have that characteristic? That is the million dollar question.
Three types of products or companies have this power.
First, there are “Will I?” products. If you are a regular reader of PragmaticPricing you know that Will I products are those products where buyers make the decision “am I going to buy this or not?” They don’t choose between competitive products. Examples of Will I products include popcorn at the movie theater, iPhone, Rolex watch, meat grinder option on a kitchen-aid mixer, bottled water in a hotel room, and any product with a monopoly. In each one of these cases, companies have the ability to raise prices at least slightly without a significant impact to demand.
Next are highly differentiated products. If you can create a product that is so much better it practically stands on its own you have significant differentiation. This is especially true when you target a market niche and add a capability specific to that niche that your competitors don’t have. These products are similar to Will I products except that there is a competitor; it’s just that the competitor is significantly inferior (or at least different).
Stephan Liozu has been researching the sources of pricing power and he found one of the biggest drivers of pricing power is differentiation. I had the pleasure of interviewing him for the Pragmatic Live podcast series.
The third key type of pricing power comes from large portfolios where a company owns the entire ecosystem. A great example of this is Apple, with Macs, iTunes, iPods, iPhones, iPads, and Apple Watches all working together on a single platform. Apple is able to set and maintain high prices because most of their customers are committed to their ecosystem. Most users choose to go all Apple because they know everything works well together.
Let’s bring this back to Warren Buffet. He evaluates companies for future and long-term profitability and he thinks one big indicator of this is pricing power. It is likely that you are trying to build a company with long-term profitable growth, the type that Warren Buffet may be interested in investing in some day. If so, how are you obtaining pricing power Once you understand pricing, you can make better product decisions. If you have the goal of creating a great company, you just read about three different approaches you can create to achieve that goal.
Power to the Pricer!!!
Photo by NeetiR
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