Pricing Power and Economic Moats

seescandieslogoWhat products do you use that you would be willing to pay double the current price? Food and energy, being necessities, would be likely candidates. Of course, doubled prices would likely change your consumption habits. How about discretionary items? Books, news subscriptions, your iPhone?

Yesterday we observed Warren Buffett describing the importance of investing in businesses that could raise their prices “rather easily without fear of significant loss of either market share or unit volume.” In 1981, consistently raising prices was a necessity for business survival, with the consumer price index increasing at 10% annually. For Buffett, inflation was a giant corporate tapeworm, which “preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism.” In many ways, highly competitive environments often treat a business in the same way; as the competition spends capital to update its stores, you have to spend just as much to maintain your market share.

Excellent businesses then—those with wide economic moats—are able to survive difficult macroeconomic environments because their products carry pricing power. For Buffett, See’s Candies and Coca Cola wield this power; for See’s, Buffett has unfailingly increased prices on the day after Christmas.

These days, newspapers, magazines, and periodicals—faced with declining advertising revenues—are considering price increases. As The New York Times recently reported, the average Time subscriber only paid 58 cents per issue, and Newsweek readers paid 47 cents. True to its moniker, The Economist raised its price per issue to $6.99 last year, all while seeing its subscriptions rise 60% since 2004.

At our house over the last few months, we have been surprised to find—instead of subscription notices—cancellation notices from publishers. With declining advertising revenues, these periodicals were forced to close their doors for good. And I recall thinking—why didn’t they raise their prices? Because I would have easily paid twice what I had been.

For many goods and services, tight economic times trigger the tightening of budgets. However, even during such times, the most desired goods and services will still command a premium and increasing price. For the investor, these are the wide moat businesses that should find a home in one’s portfolio, at an attractive price.

So, is The Economist for sale?

Disclosure: I, or persons whose accounts I manage, own shares of Berkshire Hathaway.

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7 responses to “Pricing Power and Economic Moats

  1. Generally agree, however, butcher cannot raise price for a pound of beef unless he is the only butcher for 100 miles, same for a gas station owner.

    What is it so special about See’s candies that allow Buffet to raise prices every year?
    I’m not a regular See’s consumer, perhaps that why I don’t get it.

    I’ve got other example that I understand. That is Pavel’s yogurt http://www.pavels.net/.
    It is different from other yogurts and much better to my taste.
    This one product by the way, make’s me head to the Lunardi’s instead of Safeway. The $5 dollar item determines where other $80 are spent.

  2. With See’s, my sense is that their chocolate is an occasional purchase used for specials events; people will pay more because it is known and considered qualitatively superior.

    Interesting on the yogurt–looks like Pavel’s is privately owned?

  3. I think that because See’s (or candy in general) is something special, something we crave but do not need. Typical purchase is for a safe gift when visiting (hence the airport kiosks) or for a gift for valentine’s, mother’s or christmas day.

    because it is meant to be a special gift, the as long as the ingredients are top notch, the pricing can be kept high (or at a reasonable rate of return on investment) without someone else competing and driving the margins to zero.

    You sell cheaper chocolate?

    Fine, I’ll sell mine to someone who doesn’t want something cheap.

    Interesting to me is how closely RMCF resembles the metrics that Buffett laid out about his see’s purchase.

    I’m long RMCF, so scrutinize my thoughts, but Buffett talks about what he paid for see’s in two different letters, and RMCF approaches those prices.

    one major difference being the franchising arrangements, and that lots of RMCF’s revenues are wholesale to the franchisees, so the revenues appear lower than the original see’s metrics.

    the nice thing about this type of business is that there is only so much reinvestment you can do, so they spin out cash after the equipment is purchased.

  4. I’ve looked at RMCF briefly, but I’ll do so in greater detail in the next week.

    One thing about their model is that the franchisees need to be healthy for the company’s future to be secure. Leases are expensive these days (though coming down), and overhead at the shops is fairly high. Same should be true for See’s, but their brand seems to be stronger than RMCF in their part of the country.

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