March 29, 2011
In a recent Bloomberg article Warren Buffett claims, “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.” Buffett is speaking in terms of what he looks for when deciding whether or not to purchase a company. In his opinion, pricing power can give a company one of the largest competitive advantages.
Currently, U.S companies are facing rising inflation in countries they source their raw materials from, while U.S. inflation has remained relatively stable. These economic circumstances force companies to either absorb the costs or attempt to pass these costs unto consumers. With the high unemployment rate coupled with consumers’ cautious spending habits, companies are attempting to raise prices in a resistant market. In economic times such as these, a company’s pricing power becomes a distinct competitive advantage. Yet, few companies think about pricing power in the context of their own business.
Here are some ways executives can assess their ability to increase prices across their business:
- Clear segmentation for products and/or services – Enables companies to differentiate prices in accordance with value to each segment without risk to business in other segments.
- A wide range of negotiated prices within a segment – Indicates opportunity to move low end of distribution up towards the median.
- A high win rate in a segment – Creates the opportunity to increase prices in that segment with a reduce risk losing business.
- Strong repeat purchases – Indicates either high perceived value or high switching costs relative to current pricing.
- High cross-sell rate or higher cross-sale prices relative to non-cross-sell prices – Allows for the opportunity to “add-on” sales at current prices (at generally lower cost of sale) or grow higher-priced “add-on” business.
Taking the time to review these factors gives executives a clearer understanding of the perceived value of the products and/or services they offer and their ability to raise prices without adversely affecting volume. With this strategic pricing insight, companies can develop effective price optimization and price management strategies to drive higher profits.
– Colin Carroll