Pricing power and competitive advantages (NISM Series XV, chapter 7)

Pricing power

A key thing to study in any business is its pricing power, because that is what lets a company maintain and grow its profit margin. Pricing power is the ability to independently determine and charge the price of its products. A company with strong pricing power can pass on any escalation in input costs to customers, and can raise prices when demand is strong and grow its margins.

ConceptIndustry drivers and company drivers

Most often pricing power is set by industry factors that affect every player: the intensity of competition, the price elasticity of the product, and the degree of commoditisation of the product. Certain company-specific factors then separate one player from its peers: a natural leadership position in the industry, brand affinity among customers, and the cost base.

Worked exampleThe syllabus's three company cases

For several petrochemical products, smaller players price their product off the prices set by Reliance Industries Limited, seen as the natural industry leader, which gives RIL the ability to price independently. A company with strong brand perception or brand loyalty can likewise price independently. And a low cost base lets a company keep prices low without fear that competitors will follow, because matching the price is not financially viable for rivals with higher costs.

Studying this tells the analyst which industries are likely to do well and which player within an industry is likely to outperform its peers.

Three ways to beat the competition

In every industry some players do better than others, so the analyst must judge how a company will perform against its competitors. The differentiating factors fall into three areas.

Product differentiation

Better features that appeal to the target customers, in quality or functionality, creating a value proposition that attracts more customers. It requires a strong research and development (R&D) team and a culture of innovation. In a highly competitive industry where players keep launching new products, leadership shifts from one to another, but strong innovators outperform laggards. Compare the products against competitors' and look for data that substantiates the advantage; do not be carried away by superficial marketing claims.

Competitive pricing

If customers see many companies' products as similar, they prefer the cheaper ones. Competing on low prices is sustainable only with a low-cost advantage; otherwise competitors mimic the strategy and cut prices too, whereas a rival cannot sustain a price below its own cost. Price differences are easy to spot in commoditised industries and hard elsewhere: a Honda Civic may be cheaper than a Toyota Camry but the Camry has more features, so the two are not like-for-like. Identify which product offers better value for money through primary research or by analysing how similar models performed in the past.

Execution

Companies that communicate better with customers or execute a focused sales strategy do better. Execution capability shows in the past track record of the company and its management. The syllabus cites Flipkart, Airtel, Haldiram and Hero MotoCorp, competing pan-India through branding, advertising, strategic alliances and positioning.

Exam trapLow price without low cost is a temporary advantage

A company underpricing rivals while carrying the same or a higher cost base is not differentiated; it is subsidising customers until competitors match it. The syllabus's condition is explicit: competitive pricing is sustainable only if the company's cost is lower than the other players'.

Take these into the exam

Pricing power is a company's ability to independently determine and charge the price of its products: to pass on input cost escalation and to raise prices when demand is strong, growing margins.
Industry drivers of pricing power: competition intensity, price elasticity of the product, degree of commoditisation. Company-specific drivers: natural leadership (smaller petrochemical players price off Reliance Industries), brand affinity or loyalty, and a low cost base that lets a company keep prices low where competitors cannot follow.
Three points of differentiation: product features (quality or functionality, needing R&D and an innovation culture, verified with data not marketing claims); competitive pricing driven by operational efficiency (sustainable only with a low-cost advantage; Toyota Camry versus Honda Civic is not like-for-like, so judge value for money through primary research or past model performance); and execution (customer communication, focused sales strategy, track record; Flipkart, Airtel, Haldiram, Hero MotoCorp).