This one is fairly straightforward. It’s nice to own a business that can consistently raise prices. I don’t think there’s any grand revelation there.
However, over the years I’ve come to realize that pricing power is most valuable when it is not utilized.
I’ll use Netflix as the classic example of this. In the early days of the streaming service, most everyone knew that it was underpriced at $7.99 a month. Would you continue to subscribe at $8.99? Of course you would! How about $9.99? No sweat! and as the monthly fee creeped up, so did the content library. A lot more entertainment for just an extra dollar a month? Sign me up!
This latent pricing power explains why the company traded at such lofty multiples in the early days. As the company tests the limit of what people are willing to pay, the multiple has to shrink.
Warren Buffett talked about pricing power in describing his investment in See’s Candy. As he told biographer Alice Schroeder, “We thought it had uncapped pricing power. See’s was selling candy for about the same price as Russell Stover… You were buying something that perhaps could earn $6.5 or $7.0 million if just priced a little more aggressively.”
The key word in the passage below is uncapped. Buffett saw the potential for ongoing price increases that simply wouldn’t exist if he raised prices by 50% on day one. Instead, he saw a long runway of regular price increases. "When we bought See's Candies, we didn't know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no one cared. Learning that changed Berkshire. It was really important.”
The problem with pricing power is that the more aggressively you use it, the less valuable it becomes. Perhaps this is why Costco is so slow in increasing the annual membership fee (and why it continues to trade at such a high multiple). Or why the market has recently been so brutal in punishing FICO for getting too aggressive with their own price increases.
Think about Jeff Bezos’ pricing strategy for Amazon Prime. He settled on $79 per year because it was "large enough to matter" but "small enough that they would be willing to try it out." And then he kept adding services to the Prime membership without increasing the price. He wanted signing up for Prime to be a “no brainer” decision. And even though the Prime membership price has gone up, for many families, it remains a no-brainer.
This is how I like to think about pricing power. Any company that can maintain a consumer surplus over the long term is in a very strong long term competitive position.
Thanks for your work on this. Valuable points, succinctly made.