The Asymmetrical Power of Pricing: A Hidden Profit Engine
-How Dominant Companies Harness Upward Price Movements While Insulating Themselves from Downside Risks-
Pricing power is the ultimate business superpower. It allows companies to dictate their own terms, maintain healthy profit margins and cash conversion cycle. Companies with pricing power are basically businesses with a highly competitive status. Such companies display great brand strength to market dominance.
The power of less downside
The upside of things are often easily recognized but protecting company from downside risk is less discussed. Price leaders demonstrate a pronounced ability to insulate themselves from downside risks while capturing the full benefits of upward price movements.
Imagine recent upwards of US stock. Everyone wants to participate upside. The power of compounding is profound and well understood about following benchmark. But as investor, less downside, or downside protection is the real differentiator for long term consistent performance.
The key of pricing power
After COVID-19, US money supply(M2) was up 30% in just 2 years after 2020. In 2024, the price of goods and services increased by 30% as compared to 2020. Actual inflation rate was 21%, less than prices change. Companies with significant market power could pass on costs to consumers during inflationary periods by raising products & services price.
The important point is that they are talking only about price up and not talking about price down.
Downside protection perform more than its short term purpose
Companies with significant market power can pass on costs to consumers during inflationary periods(downside protection in earnings) and “maintain higher prices even when input costs decline.(consumers neglect about already raised gross margin and companies can enjoy upside in earnings after several years)”
Imagine recent big layoff from US top companies. SaaS providers all raised price by over 30%. Whereas actual inflation rate was 21%. Additionally through layoffs and the adoption of cloud technologies, price leaders were able to shift costs to lower-paid labor markets (either domestic or global supplychain ). They reduced their overall cost base in the tough time. After market recovers, they do not re-hire already laid-off persons. Thus price leaders could increase EBITDA margin after inflation if price up more than inflation rate and cost-cutting added. They usually make price up action whereas making no price down action even if cost was overcut. Usually growing EBITDA fosters additional R&D expenditure.
Overcut cost is usually neglected by consumers
This business superpower can be seen by looking the ability to raise prices without losing customers, which is exception of the law of demand. Usually it’s difficult to keep perfection against third party when company raise product price but dominant players for nessecities have ability to command premium prices.They can dictate payment terms due to brand equity or control over supply. When macro economics changes, less price elasticity products can earn big gain. Time is the biggest advantage of such less price elasticity products and vice versa for high price elasticity products. Time and inflation is poison for high price eleasticity products: e.g. when seller make price 10% then demand will decline more than 10%.
You will earn premium when you quickly respond to macroeconomics change
Price leaders demonstrate a pronounced ability to insulate themselves from downside risks while capturing the full benefits of upward price movements. Price leaders exhibit asymmetrical risk, capturing upside premiums while avoiding downside risks quickly. I really suprised about too early layoff news of US cloud companies because market was still not so bad in the end of 2022. Many Japanese companies were behind US companies about raising price and cost cutting. Huge earnings power gap is derived from macro economics sensitibity.
This concept is quite difficult to figure out by numbers or statistics, because when the managements do nothing, there is no way to calculate the performance of doing nothing. e.g. when macro economic price goes up by inflation and product price rose more than inflation rate(menu cost,price adjustment costs is usually more than inflation rate), after lay off and cost shift to lower-paid labor markets, earnings power increased but the company will not decrease price of the products(the actual premium can be calculated by [adjusted new price – old price] – [macro inflation rate]+ [cost shift benefit]). The ending result is when there is market turnaround, they can earn premium without paying money to already off balanced assets: laid-off persons or entities.