Buffett and Pricing Power

http://www.futureofcapitalism.com/2011/03/buffett-and-pricing-power

The Wall Street Journal has a column trying to explain the $9.7 billion purchase of fuel additives company Lubrizol by Warren Buffett's Berkshire Hathaway. From the Journal's explanation:

4. It has pricing power.

Mr. Buffett recently said "the single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business."

As always with Mr. Buffett, the thing to watch is what he does, not what he says. At year-end Berkshire owned about $2.1 billion worth of Walmart stock. It also wholly owns the Geico insurance company, which specializes in auto insurance. The pricing power that Walmart and Geico have is not "the power to raise prices" but the power to cut prices to consumers by running efficient, well-managed businesses and, particularly in Walmart's case, using its own size to negotiate low-cost deals with suppliers. If either Walmart or Geico raised prices by 30% or 40% tomorrow, the customers would be gone. The ads for Geico ("15 minutes could save you 15% or more") and Walmart emphasize their low prices. That doesn't mean they aren't good businesses or good investments.

There may be cases in which Mr. Buffett is right, and the best investment is a company that can charge customers more without losing them. Apple, for example, can charge more for a personal computer than most Windows-based manufacturers do.

But there may be other cases in which the best business or the best investment is the one that figures out how to deliver a service or a good at a cheaper price than a competitor, while still making a profit. Facebook or Groupon, for example, may have figured out how to sell advertising to companies for a lower cost-per-customer-acquired than the company would spend on broadcast television or newspapers.

by Ira Stoll  |  Mar 18, 2011 at 1:19 pm Related Topics:  Warren Buffett receive the latest by email: subscribe to the free futureofcapitalism.com mailing list