What is Pricing Power?
Pricing power is the company’s ability to increase its prices, with little to no change on demand for its products. It is explained through the concept of price elasticity of demand, which measures the degree of demand reduction as a reaction to price increases.
Pricing Power Example
Let’s explain pricing power through two examples of Company A and Company B.
Company A sells undifferentiated products, that can be found at other stores under the same brand name or different brand names, with no difference in quality or specifications.
When Company A started raising its prices, customers quickly shifted to other stores to source the same products at lower prices. There was no reason for them to pay up for Company A’s products.
Company A has no pricing power.
When Company B started raising its prices demand got affected, but to a very small degree. It could easily increase its prices by 10% and 20% with minimal drop in demand.
Company B has pricing power.
Advantages of Having Pricing Power
Companies that posses pricing power have a significant competitive advantage in the market and among competitors. This gives them a powerful tool to secure their business longevity and have more control over their market and their destiny.
Companies that are able to increase their retail prices with no effect on demand can easily increase their profitability with no additional efforts.
With costs of doing business being relatively fixed, except for variable costs related to the transactions, each increase will mainly reflect straight on the bottom line.
In fact, we tested on a hypothetical P&L and projected a 1% increase only in sales, which is a result of increasing the prices by 1% and selling exactly the same quantity (i.e no effect on demand, and COGS remain the same).
We kept all the other costs the same, except for S&P expenses that are linked to the total sales amount.
The result was a 15% increase in profits, driven solely by 1% increase in price
Even if you intend to keep your prices fixed to please your customers, the world around you will not do the same to you.
Your suppliers will sooner or later increase their prices. The cost of shipping goods and storing them will increase. Your rent and staff salary will increase.
Inflation will drive your cost of doing business higher.
So in the absence of any pricing power from your end, this will only lead to squeezing your margins, by absorbing all those increases and not passing them to your customers.
Having the ability to adjust your prices for inflation, without reducing the demand on your products will safeguard your business on the long run.
Read Also: Shrinkflation
When the demand on your products is not tied to how much you sell them at, and how much your competition is charging, you will be able to predict such demand in better accuracy.
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