Pricing power

What is pricing power?

Pricing power is the ability to raise prices without losing customers. It comes from demand that is not very sensitive to price, usually because the offer is differentiated or switching is costly for the customer. Morningstar treats high switching costs as a sign of pricing power, and it is one way a company can keep earning above-normal profits.

Why it matters to a revenue leader

Price has an outsized effect on profit. A 2003 McKinsey analysis found that for the average S&P 1500 company, a 1 percent price increase with steady volume would lift operating profit by about 8 percent. For a revenue leader in commercial services, pricing power shows up in escalator clauses that stick and renewals that close at the new rate. Heavy discounting at renewal is a sign the company has less of it than the plan assumes.

A fire protection company with $40M in recurring agreements applies a 6 percent increase at renewal and keeps 95 percent of the agreements. Revenue from that base comes to about $40.3M even after the losses, and margin improves because the increase carries no added delivery cost.