What Is Pricing Power?
Pricing power is an economic term that describes the effect of a change in a firm's product price on the quantity demanded of that product. Pricing power is linked to the price elasticity of demand. Price elasticity is a measure of the degree to which individuals, consumers, or producers change their demand or the amount supplied in response to price changes. For example, if the price of a good goes up, the tendency is that the demand for that good will go down as people will look for cheaper alternatives.
Pricing Power Deconstructed
If a company does not have much pricing power, an increase in their prices would lessen the demand for their products. A company that has substantial pricing power is one that provides a rare or unique product with few rivals in the market. In this case, if the company raises its prices, the increase may not affect demand because there are no alternative products on the market that consumers can choose instead.
Scarcity of resources can give a company high pricing power; if the resources for a product cannot be easily obtained, the price of those resources will increase because there is insufficient supply to meet demand, which pushes up the price of the final product for consumers.
For example, when the iPhone was initially introduced by Apple, the company had strong pricing power because it was essentially the only company offering a smartphone and associated apps. At the time, iPhones were expensive, and there were no rival devices. Even as the first competitor smartphones emerged, the iPhone still occupied the high end of the market in terms of pricing and expected quality. As the rest of the industry began to catch up in service, quality, and app availability, Apple’s pricing power diminished.
The iPhone did not vanish from the market as more entrants arrived because Apple began to offer new models of iPhones including cheaper models for budget-minded consumers.
- Pricing power describes the effect of a change in a firm's product price on the quantity demanded of that product.
- A company's pricing power is linked to price elasticity of demand for its product.
- If there are plenty of competitor products, the company will have weak pricing power.
- If a company has a unique product, it will have strong pricing power because the customer has no alternative supplier for that product and must pay the price charged.
Scarcity and Pricing Power
The scarcity of a resource or raw material affects pricing power significantly even more so than the presence of competitors with similar products. For example, various threats, such as disasters that put the oil supply at risk, lead to higher prices from petroleum companies although rival providers exist in the market. The narrow availability of oil combined with widespread reliance on the resource by multiple industries ensures that oil companies retain significant pricing power over this commodity.
Other industries exhibit strong pricing power during times of high demand and scarcity. Referred to as dynamic or surge pricing, hospitality, transportation, and travel industries tend to increase their prices for accommodations and services at peak times such as holidays or during special events.
Investors consider a company's pricing power when deciding the value of a company and its shares. The ability to raise prices without reducing demand means that a company has a way to increase revenues other than relying on the effectiveness of its management.
For instance, on New Year’s Eve, taxi and car services significantly increase their rates because of the high demand for driving services. Hotels increase the rates for their rooms on dates close to locally hosted conventions as well as during major holidays when tourism is expected to increase. These are all instances where the pricing power of companies is strengthened because the demand will not be affected by price hikes.