3 minute read
Basketball in China
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 another spectacular quarter on behalf of corporations so far in spite of input cost pressures.” According to Savita Subramanian and Ohsung Kwon of Bank of America mentions of “price” or “pricing” in American earnings calls—a proxy measure for pricing power—increased by 79% in the third quarter from a year earlier. In the second 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 important. On November 2nd JPMorgan Chase’s global purchasingmanagers index, a measure of manufacturing activity, showed that input prices in the sector increased in October at the highest rate in more than 13 years. But the prices of manufactured goods and services also rose at the fastest pace since records began in 2009. A gap between input and output price inflation is typically interpreted as a sign that firms are struggling to raise prices and that margins are being squeezed. That isn’t happening yet.
Advertisement
Identifying firms with pricing power is crucial for investors. Analysts tend to look for three things. The first is a big markup—the difference between the price of a good and its marginal cost—which only firms with market power can get away with. Big and steady profit margins are another sign of pricing power. “If you are a firm that is dominant in your market, you are much more resilient to shocks,” explains Jan Eeckhout, an economist and the author of “The Profit Paradox”, a book published earlier this year.
Size is another factor. All else equal, bigger companies with greater market share have more pricing power than smaller ones. A recent survey of American cfos conducted by Duke University and the Federal Reserve Banks of Richmond and Atlanta found that 85% of large firms reported passing on cost increases to customers, compared with 72% of small firms.
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 profit margins. The bank found that firms providing consumer staples, communication services and it have the most pricing power and that energy, financial and materials companies have the least (see chart 1 on previous page). When ubs compared the financial performance of companies with strong and weak pricing power, they found that the former have delivered more profit growth since 2010 and generated better stock returns, particularly during periods of high inflation (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 profit margins are expanding, the argument goes, firms with pricing power tend to generate relatively low returns; when margins are shrinking, they produce high returns. At the moment, profits are still healthy.
For now, demand is robust and consumers seem relatively insensitive to price changes. But companies are planning more price increases. A survey by America’s National Federation of Independent Business, a trade group, found that the margin of smallbusiness owners planning 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
Price discovery
Market returns of strong pricing power S&P 1500 companies relative to weak ones Jan 2010-Apr 2021, %
Over 3 months Over 6 months Over 12 months
0.08 0.09 0.02 2
12
9
6
3
0
-3 American basketball and China The audacity of hoops
H ONG KONG Player protests put a lucrative foreign market at risk
Enes kanter’s campaign against China’s Communist Party has been unreMr Kanter has also brought more unwanted attention to clothing brands lenting. The basketball star has recently walked into professional games sporting custom shoes that read “Free Tibet”, a slogan that has long raised hackles in Beijing. He has invited the cofounder of Nike, a sportswear firm, 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 National Basketball Association (nba) and clothing brands such as Nike has the potential to do extraordinary damage. Tencent, 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 airing 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 antigovernment protesters in Hong Kong. The embargo was painful. Nearly all Chinese corporate 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. caught in a controversy over sourcing cotton from China’s Xinjiang region, homeland of the Uyghurs and where humanrights groups say forced labour is common. Multinationals are being forced to take a side on freespeech issues, says Badiucao, the Chinese artist who designed Mr Kanter’s evocative shoes (he goes by a pseudonym). Some are doing just that. Yahoo, an American internet giant, said on November 2nd that it would pull out of China, citing challenging business conditions. Weeks earlier LinkedIn, a professionalnetworking group, announced it would shut down its main China operations after it was forced to comply with increasingly tough censorship rules. The nba is wildly popular in China. Many fans disavowed the league in 2019 but were eager to resume watching it last year. Communist Party authorities must balance the popularity of the sport with their instinct to punish critics, says David Bach of the Institute for Management Development, 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 criticised Mr Kanter nor affirmed his rights to such speech. The standoff amounts to a form of bargaining between the nba and the Communist Party, says Mr Bach. n
