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Business
The Economist November 6th 2021
lot of angst on the part of investors that higher input costs would erode margins,” says Patrick Palfrey of Credit Suisse, a bank. “In fact, what we have seen is anoth er spectacular quarter on behalf of corpo rations so far in spite of input cost pres sures.” According to Savita Subramanian and Ohsung Kwon of Bank of America mentions of “price” or “pricing” in Ameri can earnings calls—a proxy measure for pricing power—increased by 79% in the third quarter from a year earlier. In the sec ond quarter, such mentions were up by 52% year on year. If costs spiral out of control, the power to raise prices will become ever more im portant. On November 2nd JPMorgan Chase’s global purchasingmanagers in dex, a measure of manufacturing activity, showed that input prices in the sector in creased in October at the highest rate in more than 13 years. But the prices of manu factured goods and services also rose at the fastest pace since records began in 2009. A gap between input and output price infl a tion is typically interpreted as a sign that fi rms are struggling to raise prices and that margins are being squeezed. That isn’t happening yet. Identifying fi rms with pricing power is crucial for investors. Analysts tend to look for three things. The fi rst is a big mark up—the diff erence between the price of a good and its marginal cost—which only fi rms with market power can get away with. Big and steady profi t margins are an other sign of pricing power. “If you are a fi rm that is dominant in your market, you are much more resilient to shocks,” ex plains Jan Eeckhout, an economist and the author of “The Profi t Paradox”, a book pub lished earlier this year. Size is another factor. All else equal, bigger companies with greater market share have more pricing power than small er ones. A recent survey of American cfos conducted by Duke University and the Fed eral Reserve Banks of Richmond and Atlan ta found that 85% of large fi rms reported passing on cost increases to customers, 2
Price discovery Market returns of strong pricing power S&P 1500 companies relative to weak ones Jan 2010-Apr 2021, %
12
Over 3 months Over 6 months Over 12 months
9 6 3
0.08 0.09 0.02
0 -3
<0 Source: UBS
0-1 1-2 2-3 US, inflation rate*, %
>3
*Six-month annualised
compared with 72% of small fi rms. A “pricingpower score” for companies in the s&p 1500 compiled by ubs is based on four indicators: markup, market share, and the volatility and skew of profi t mar gins. The bank found that fi rms providing consumer staples, communication servic es and it have the most pricing power and that energy, fi nancial and materials com panies have the least (see chart 1 on previ ous page). When ubs compared the fi nan cial performance of companies with strong and weak pricing power, they found that the former have delivered more profi t growth since 2010 and generated better stock returns, particularly during periods of high infl ation (see chart 2). Firms that score well on this index have lagged in the past year, notes ubs. This may be explained by cyclical factors. When pro fi t margins are expanding, the argument
goes, fi rms with pricing power tend to gen erate relatively low returns; when margins are shrinking, they produce high returns. At the moment, profi ts are still healthy. For now, demand is robust and con sumers seem relatively insensitive to price changes. But companies are planning more price increases. A survey by Ameri ca’s National Federation of Independent Business, a trade group, found that the margin of smallbusiness owners plan ning to raise prices in the next three months over those planning to lower them grew to 46%, the biggest gap since October 1979. This is a concern for some central bankers such as James Bullard, president of the Federal Reserve Bank of St Louis. In October he noted that for years companies have worried that if they raised prices, they would lose market share. “That may be breaking down,” he says. n
American basketball and China
The audacity of hoops
HO NG KONG
Player protests put a lucrative foreign market at risk
E
nes kanter’s campaign against Chi na’s Communist Party has been unre lenting. The basketball star has recently walked into professional games sporting custom shoes that read “Free Tibet”, a slo gan that has long raised hackles in Beijing. He has invited the cofounder of Nike, a sportswear fi rm, to visit “slave labour camps” in China’s northwest (Nike says it does not source products from the region). On November 2nd Mr Kanter, who plays for the Boston Celtics, posted a message for China’s president on Twitter: “Ruthless Dictator XI JINPING...hear me loud and clear: Hong Kong will be FREE!”. The slamdunk on China, America’s Na tional Basketball Association (nba) and clothing brands such as Nike has the po tential to do extraordinary damage. Ten cent, the Chinese internet giant contracted to stream nba games, has already blocked the Celtics. The league relies heavily on Chinese sponsors and has already had a taste of what cancellation means. The air ing of nba games was halted for more than a year in China starting in October 2019 after the general manager of the Houston Rockets voiced support for antigovern ment protesters in Hong Kong. The embar go was painful. Nearly all Chinese cor porate partners cancelled or suspended their arrangements at the time. The league’s commissioner estimated as much as $400m in lost revenue. It has projected income of $10bn for the current season.
Mr Kanter has also brought more un wanted attention to clothing brands caught in a controversy over sourcing cot ton from China’s Xinjiang region, home land of the Uyghurs and where human rights groups say forced labour is com mon. Multinationals are being forced to take a side on freespeech issues, says Ba diucao, the Chinese artist who designed Mr Kanter’s evocative shoes (he goes by a pseudonym). Some are doing just that. Ya hoo, an American internet giant, said on November 2nd that it would pull out of China, citing challenging business condi tions. Weeks earlier LinkedIn, a profes sionalnetworking group, announced it would shut down its main China opera tions after it was forced to comply with increasingly tough censorship rules. The nba is wildly popular in China. Ma ny fans disavowed the league in 2019 but were eager to resume watching it last year. Communist Party authorities must bal ance the popularity of the sport with their instinct to punish critics, says David Bach of the Institute for Management Develop ment, a Swiss business school. Instead of stirring up sentiment against the nba and announcing an allout ban on broadcasts, as in 2019, so far only Celtics games have been blocked. The nba has neither criti cised Mr Kanter nor affi rmed his rights to such speech. The standoff amounts to a form of bargaining between the nba and the Communist Party, says Mr Bach. n
