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Pricing power

Jun 03, 2019
How can businesses underpin and enhance the pricing of their goods and services?
 
Pricing power is not always recognised as an important component of business success. It is the ability or otherwise to dictate the price of the product or service to the marketplace, and in some instances, this equates to the ability to exclude – or at least restrict – competition for a product or service for which there is a demand in the marketplace. At the same time, there are regulatory, competition and anti-trust authorities across the world trying to identify and/or control abuses of ‘pricing power’.

All businesses, adequately focused, seek to underpin and/or enhance the pricing of their goods and services. Sometimes this may not be obvious. For example, a few years ago the CEO of a UK supermarket chain was overheard saying that “everybody knows the price of a pint of milk or a loaf of bread, but not the price of a lightbulb or shoe polish”. He went on to say that the chain focused on achieving at least 20% of its turnover in non-price sensitive goods.

A company’s strategic pricing power advantage can be realised by playing to the strengths of one or more of the following:
  • Ownership of intellectual property, such as a patent or copyright. Pharmaceuticals is an obvious example;
  • Development of advanced integrated technology not easily replicated, or only at great expense;
  • Monopoly or quasi-monopoly through exclusive licence, regulation or similar;
  • Strong skills in product innovation and/or substantial investment in product marketing support. Widely promoted consumer brands with established distribution channels are examples; and
  • Strong management record on the quality of service, particularly involving complex technical products or services. In the early days of computer development, there was a saying: “nobody gets fired for buying IBM”.
The role of ‘branding’ is a conundrum in pricing a product. A prominent example is the fashion industry. Top brands can obtain high prices as against lower prices for similar non-branded products. Differences in quality can only partly explain this disparity. A perception of being seen to have a top brand may be the answer.

A higher price for everyday products may in itself be a form of pricing power. Confronted with a range of similar products, the higher price of one against another indicates a superior product or perhaps exclusivity. Toiletries on a supermarket shelf are an example. Brand recognition is probably a significant factor in pricing consumer products, though competition from ‘own labels’ and discount stores have eroded margins.

Recent research by travel companies suggested that keen golfers, visiting overseas, strongly perceived green fees as indicative of golf course quality. The golfers regarded high prices as exclusivity in terms of attracting only good players and therefore, playing there is a testimony to your golfing ability – deserved or not.
The acquisition of a business is usually subject to ‘due diligence’. Due diligence is a process of investigation and review, through which a potential purchaser gains a clear commercial, financial and legal understanding of the business, to evaluate both the strengths and weaknesses and decide whether to proceed with the transaction.

A wise commercial due diligence process will include a close review of the pricing power of the business, including not only the current position but, more importantly, its possible continuation. Companies and products with perceived high profit margins invite competition, so past performance may not be a reliable guide to likely future outcomes.

What about professional fees and pricing power? George Bernard Shaw made the pithy comment, albeit more than 70 years ago, that “all professions are a conspiracy against the public”. The legal profession, for example, has a reputation for high fees that may then become self-fulfilling. Medical professionals perhaps less so. Accountants? Well, apart from auditing (which is competitive within the profession), practising accountants have plenty of rivals in providing financial services. The ability to handle large-scale matters, such as complex liquidations, wide-ranging investigations and international transactions, is an exclusive domain and adds to accountancy firms’ pricing power, though there is a substantial investment in the resources necessary to carry out such work.
 
Des Peelo FCA is author of The Valuation of Businesses and Shares, published by Chartered Accountants Ireland.