Pricing power

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Pricing power Passing the buck

Businesses’ ability to pass on costs is highly prized by investors

Mcdonald’s has employed a “barbell” pricing strategy for decades, luring boss, suggested in an earnings call in October that customers do not seem bothered. customers with lowcost items in the hope that they will then splurge on pricier fare. This balancing act is now at risk. On October 27th the fastfood giant said that, due to rising costs, prices at its American restaurants will increase by 6% this year compared with 2020. The burger chain says labour expenses have risen by 10% at its franchised restaurants and 15% at its companyowned locations. Add the rising cost of ingredients and the result is higher prices for burgers and fries. For now, it seems, customers can stomach it. Chris Kempczinski, McDonald’s boss, said the increase “has been pretty well received”. After digesting the news, investors have sent shares in the fastfood firm up by 6%.

A growing number of companies are raising prices as costs for labour and raw materials rise, often with no ill effects. This summer PepsiCo, an American food giant, lifted prices for its fizzy drinks and snacks to offset higher commodity and transport costs; it plans further increases early next year. Ramon Laguarta, the firm’s “Across the world consumers seem to be looking at pricing a little bit differently than before,” he said. In September Procter & Gamble, a multinational consumergoods giant, raised prices for many of its products. The effect on demand was minimal. “We have not seen any material reaction from consumers,” Andre Schulten, the firm’s chief financial officer (cfo), told analysts last month.

“Pricing power”, the ability to pass costs to customers without harming sales, has long been prized by investors. Warren Buffett has described it as “the single most important decision in evaluating a business”. It is easy to see why. When hit with an unexpected expense, firms without pricing power are forced to cut costs, boost productivity or simply absorb the costs through lower profit margins. Those with pricing power can push costs onto customers, keeping margins steady.

Today, firms are eager to flaunt their pricesetting clout. “We can reprice our product every second of every day,” Christopher Nassetta, boss of Hilton Worldwide, a hotel operator, told investors last month. “We believe we’ve got pricing power really better than almost anybody if not everybody in the industry,” boasted John Hartung, cfo of Chipotle, a restaurant chain, in October. Companies such as Starbucks, Levi Strauss and GlaxoSmithKline make similar claims. “We are a luxury company, so we do have pricing power,” bragged Tracey Travis, cfo of Estée Lauder, a cosmetics firm, on November 2nd.

They are not alone. Of the s&p 500 companies that have reported thirdquarter results, over threequarters beat projections, according to Bank of America Merrill Lynch. “This earnings season there was a

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Pricing-power score* of S&P 1500 companies Jan 2010-Apr 2021, standard deviations from mean 1

Sector 0-0.5-1.0 1.00.5

Consumer staples Communication services Information technology Consumer discretionary Health care Real estate Industrials Utilities Materials Financials

→ Can raise prices without harming sales