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Pricing power is a critical part of any business’s profitability. Some businesses, such as mining companies, have zero pricing power as they are price takers.
They will mine their commodity and then sell it into the market at whatever price is current. Sure, they could try hoarding in the hope that prices will move higher, but they need the revenue.
There is also the “razor blade” model, whereby you are sold a razor at a cheap price with the hope that you are now locked into buying the matching bespoke razor blades. This is captured pricing.
Others, such as a run-of-the-mill food retailer, really have very little pricing power. Baked beans are baked beans, and if one retailer pushes the price up, customers will simply go elsewhere to get their beans.
If anything, the pricing power here is downward via specials and loss-leaders that will draw customers into the store in the hope they will buy something else as well.
Another is fixed pricing whereby prices are regulated. Locally, we only see this in the fuel industry these days, where the government determines the price based on a formula and all fuel retailers charge the same price with the same margin. It is about service and location.
I have written before on all of the above, but there is another form of pricing that I want to write about in this column.
And that is pricing at what the market will bear, in other words charging as high a price at which you are still able to sell the product, regardless of actual cost to produce.
Take, for example, Richemont*. Richemont sells very expensive watches and the retail price bears very little resemblance to the actual cost to manufacture the watch. This is because it is all about the brand power.
If you think Cartier is absolutely the best watch in the world, you will desire to own one and will not be bothered shopping around for different brands, or for a better or cheaper watch. You want the Cartier and they know it and price it accordingly.
An investment with this pricing ability is great as the margins are huge and, all things being equal, so should the profits be.
Of course, first you need something that has this brand power and most of these will be the older, established brands.
But we have seen the emergence of new brands with this pricing power in recent decades. Apple certainly has a very healthy margin, as do the luxury German vehicle manufacturers.
The challenge is to then maintain the brand power, which is largely why Richemont bought back watches from the sales channel, rather than allowing them to be discounted in the sales channel.
This short-term cost for Richemont was all about holding on to the brand power that enables this pricing power and, as such, about the long-term profitability of the business.
One of the oddities over recent years was the introduction of cheaper models of luxury German cars.
Sure, this opened them up to a wider market, but also eroded some of the exclusiveness of the brands.
I have no doubt that they did this with the view that they would make up for the potential losses with the extra sales at the lower price points – and they likely did. But some of the exclusiveness of the brands has been eroded.
Investing in these sort of businesses means watching margins but, equally important, it also means watching the brand.
A hit to the reputation of a brand such as Cartier could be fatal to Richemont.
Locally, we have very few listed stocks with this sort of pricing power, with Richemont being the only real top-end example. As such they are certainly well worth considering for inclusion into an investment portfolio.
*The writer owns shares in Richemont.
