Wednesday, February 23, 2011

Where does pricing power come from?

Warren Buffet was quoted recently as saying:

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... The extraordinary business does not require good management.

So what is pricing power? The ability to raise prices without loosing business.

Where does it come from? Pricing power derives from many sources. Bloomberg cited Buffet's holdings in railroads and utilities, which derive pricing power from their dominant market position. Buffet also has stakes in consumer companies like Coca-Cola Co. and Kraft with powerful brand appeal that attracts and retains customers. Businesses that serve value oriented customers who demand more than brand appeal and those without high barriers to entry rely on innovation, quality, extraordinary customer service, operational excellence, and value to achieve pricing power.

Bottom line: Pricing power is an indicator of a good business, but isn't the cause which makes a business great. History is replete with stories of titans laid low by disruptive upstarts, so I wouldn't discount the need for good management even in extraordinary businesses.

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