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. And if you have to have a prayer session before raising the price by 10%, then you’ve got a terrible business.
Pricing power is a company’s ability to raise prices without losing too much sales volume because of this increase. This factor has some clear advantages from a financial point of view, as higher prices usually mean bigger profit margins for the company and higher returns for investors in the long term.
Also, pricing power says a lot about a company’s competitive strengths. Competition tends to keep prices at bay. If a company raises prices too much, consumers will typically go for a competitor’s cheaper product. Businesses with superior pricing power are those with competitive differentiation, meaning that consumers find something unique or superior about that company and its products.
To have pricing power, you need competitive strength. This can come from a higher-quality product, a differentiated brand, or technological superiority, among other possibilities. In addition to generating higher profitability, competitive strengths protect the business from the competition, and this substantially reduces the risks for investors.