Pricing Power Ain't What It Used to Be

Fortune ^ | September 4, 2003 | Geoffrey Colvin

[Starwind]

Pricing Power Ain't What It Used to Be
Businesspeople all have the same complaint: They can't raise prices, and it's killing them.

FORTUNE
Thursday, September 4, 2003
By Geoffrey Colvin

You remember how Michael Eisner turned around the Walt Disney Co. almost immediately after becoming CEO in 1984: He jacked up ticket prices at his theme parks. Realizing that Disney parks were far better than competitors', he started charging big premiums for admission, which consumers paid. Disney's profits rocketed, as did Eisner's pay, and the world deemed him a managerial genius.

Those were the days. Now, admission at the Universal Studios park in Orlando costs $51.95. A few exits down Interstate 4 at Disney's Magic Kingdom, admission is $52. That's what remains of Disney's price premium: a nickel. As I talk with businesspeople in all kinds of industries, they keep making the same complaint. They can't raise prices, and it's killing them. Now that the economy is just maybe picking up some speed, they hope they'll finally get back some pricing power. But the hard truth is that the economy has changed, and pricing power isn't simply going to come back-you've got to get it back. And the rules for getting it have changed.

Maybe some industry somewhere isn't loaded with global overcapacity, but I'm still looking for it. The worldwide abundance of capital, one of the business megatrends of our time, has made this capacity glut a long-term fact of life, sitting on top of prices like an anvil. In addition, new competitors arise more quickly and easily than ever in the Info Age; just ask traditional booksellers, insurance agents, and travel agents being hammered by online competitors.

It gets worse. Your customers have more information about you and your competitors than you yourself had five years ago, and they can find the best deal available at any moment-a revolution in many industries. As strategy guru Gary Hamel says, if your business model is built on customer ignorance, you're in trouble. And if you sell anything to consumers or small businesses, you cannot escape the price-crushing influence of the most important company in America, Wal-Mart.

You still want to try raising prices? You might succeed. A few factors can still bestow pricing power, though even these don't work the same way they used to.

• Brands The definition of a brand is something people will pay extra for, even if the product or service is identical to a competitor's. Trouble is, the Internet lets guerrilla warriors attack brands like never before. They've demonized McDonald's around the world for making people fat, impoverishing local farmers, or just being American. Similar attacks have hurt Nike, Coke, and others. Even the supposedly all-powerful brands can't muster much pricing power in a world of overcapacity and choosy consumers. Remember Marlboro Friday? Consider that Coke costs no more than Pepsi-and neither costs any more than it did 20 years ago.

• Intellectual property If you sell Viagra, Windows NT, or Saving Private Ryan, you hold enormous pricing power because no one else can legally sell what you sell. But increasing numbers of people are willing and able to break the laws. File sharing is a major reason CD prices are declining for the first time. The software you buy in some Third World countries is almost certainly an illegal copy. Now chemical engineers in various countries are learning to copy patented molecules and produce illegal pharmaceuticals, which they sell for a fraction of the real thing's price.

• High entry barriers Capitalist nirvana is a monopoly that no one can afford to bust up. But it's getting harder to find. A good example is a monopoly newspaper, long one of the business world's most beautiful money machines. It still may be true that no one could afford to start a competitor in a one-paper town-but eBay and Monster.com are draining monopoly papers' greatest profit source, classified advertising. Sometimes those entry barriers turn out to be facing the wrong enemy.

• Increasing returns Maybe you noticed that pricing power didn't disappear in the example above-it just shifted. Monster.com and eBay actually have plenty of pricing power because of the phenomenon known as increasing returns. Everybody goes to eBay to buy and sell things because everybody goes there. Ditto Monster.com for those wanting to hire or be hired. The more popular such exchanges are, the more popular they become. Increasing returns aren't new but seem to be more common, more powerful, and more valuable in an info-based economy.

So pricing power is still out there. It's just harder to find, and it doesn't lurk where it used to. If the economy bounces back, it may even venture out into the open a bit more. But the long-term trend is that it's getting harder to find every day.

[Starwind]

Fyi...

[webstersII]

It's called Deflation.

The economists have been so worried about Inflation for so long that they didn't see the trend of Deflation coming.

According to James Davidson, the 20th century was the most inflationary century on record (granted, they don't have that many on record but the data does exist back for a number of centuries). The natural result is that the pendulum swings the other way eventually, and given the Deflationary nature of increasing Technology, that just accelerates it.

[razorback-bert]

The worldwide abundance of capital, one of the business megatrends of our time, has made this capacity glut a long-term fact of life, sitting on top of prices like an anvil.

I am pondering this statement and what it implies for long term investment.

[Starwind]

The worldwide abundance of capital, one of the business megatrends of our time, has made this capacity glut a long-term fact of life, sitting on top of prices like an anvil.

The author touches on capitals' effect on capacity and hence prices, which is true.

Further and only tangentially mentioned however is capitals' ability to lower competitive barriers by facilitating R&D, automation, and infrastructure ramp up. Existing businesses already have these costs fixed and can do little with them except refinance with corporate paper issuance at lower rates.

But new competitors in greater numbers can enter capital-intensive markets more readily via funding without incurring the costs previously paid. If they have an abundance of cheap labor - the last barrier to entry falls, and if the IP is negotiated away, the future success is assured.

The over-capacity of capital is another by-product of Greenspan's decade of inflation.

[jjm2111]

Good post.