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|Subject: 101: Industry dynamics : Pricing power||Date: 5/7/2005 2:29 AM|
|Author: Cogitarius||Number: 38249 of 46885|
One of Buffett's recent comments got me thinking : "It's not a great business when you have to have prayer sessions before raising prices a penny... The long-term strength of a business is closely related to its ability to raise prices without much agony... You can learn a lot about the durability of the economics of a business by observing pricing habits."
I have to agree with Morningstar's Pat Dorsey, a longtime WEB fan : 'One of Buffett's biggest strengths as a communicator, in my opinion, is his ability to boil a complex issue down into a single pithy insight.'
Professor Michael Porter's seminal Harvard Business Review article 'How competitive forces shape strategy' showed how the ultimate profit potential of an industry (long term R.O.I.C.) is the collective result of 5 key forces :
1. Threat of new entrants
2. Bargaining power of customers
3. Bargaining power of suppliers
4. Rivalry among existing firms
5. Threat of substitute products or services
Extending Buffett's 'Pricing power' insight beyond its purely literal meaning provides a neat way to capture some of the essence of Porter's model in one power-packed phrase. However, this is not to say that competitive advantage is merely about pricing power. In some cases, other aspects of competitive advantage (e.g. patent protection, exclusive access, economies of scale) can actually be drivers of pricing power.
1. Threat of new entrants:
Predatory pricing power is a double-edged sword that can either cut out new entrants or cut down incumbents. Netscape learned this bitter lesson when it started giving away its browser free to kill Mosaic, which it did, to become the first browser monopoly. Though Netscape charged ISPs for offering their browser to clients, they assumed they could keep Microsoft at bay with their 'free-for-consumers' offer. Unfortunately Microsoft woke up to re-define 'free' by bundling a much improved Internet Explorer into Windows to squish Netscape!
Predatory pricing also helped Toyota dismantle US automakers' dominance by offering cheaper – and eventually better – Japan