Pricing PowerThe ability to increase the price of a product without significantly reducing the demand for it

In theory, the price of a product should move according to its supply and/or demand.

When the product’s supply falls, its price should go up. When its supply rises, its price should go down.

On the other hand, when demand for the product increases, its price should increase as well.

And accordingly, when demand decreases, its price should decrease too.

This supply and demand theory is probably the most basic concept in economics.

However, in the real world, it doesn’t always work that way.

Some products maintain their prices (at least for a longer time than expected) no matter the changes in supply and demand.

This is because there are factors other than supply and demand that can affect the price of a product.

The presence of competition (or the lack of it) can be one of them.

There’s also the nature of the product itself. One can even consider the reputation of the company that is selling the product.

All of these factors (and more) can contribute to a company’s pricing power.

Basically, pricing power refers to the effect of a change in a product’s price on the demand for such a product.

It answers the question “by how much will demand change for every dollar increase in price?”.

Theoretically, the higher the pricing power is, the less likely that demand will decrease due to a price increase.

In this article, we will be discussing what pricing power is.

What does pricing power entail?

How can it affect a company’s ability to earn revenue?

Is it preferable to have higher pricing power?

If so, what benefits can it provide for a company?

We will try to answer these questions as we go along with the article.

What is Pricing Power?

Pricing power refers to the ability to raise the price of a product without significantly reducing the demand for it.

The higher the pricing power a company has, the easier it is for such a company to raise prices without having to worry about a significant decrease in demand.

Naturally, the more unique a product is, the more pricing power it has.

However, a product’s uniqueness isn’t the only factor that can affect pricing power.

Pricing power can influence a company’s growth in terms of revenue and profits.

The more pricing power a company has, the easier it will be for such a company to grow revenue each year.

In theory, when the price of a product increases, the demand for it will decrease.

Customers will want to seek cheaper alternatives.

However, if a company commands a high pricing power, it will have more leeway in increasing prices before demand for its products significantly goes down.

While pricing power is important for a company in general, it is especially so in inflationary times.

In times of high inflation, the prices of goods and services generally go up.

This can include the goods and labor that a company uses in the production of its products.

Not being able to raise the price of products will result in an increase in costs of production eating away at the profits of the company.

As such, being able to raise prices without worrying about a significant decrease in demand is especially important in inflationary times.

Pricing power is associated with the price elasticity of demand.

Price Elasticity of Demand

Price elasticity is a measure of how much customers, individuals, or producers change their demand quantities or supply quantities in response to price changes.

It quantifies how much the demand for a product changes when its price increases or decreases.

To calculate the price elasticity of demand, we have to divide the percentage change in demand by the percentage change in price.

Put into formula form, it should look like this:

Price Elasticity of Demand = % Change in Demand ÷ % Change in Price

The higher the price elasticity of demand is, the higher the effect is in demand when there is a price change.

A product that has this characteristic is said to be elastic.

When a product is elastic, the more likely that demand for it will decrease due to a price increase.

When a product has a low price elasticity of demand,  it is inelastic.

An inelastic product will tend to have more price power because demand for it is unlikely to decrease even if there is a price increase.

Luxury products such as jewelry and sports cars tend to be inelastic. Demand for them tends to stay consistent even if their price increases.

To summarize the relationship of pricing power with price elasticity, a product will have more pricing power the lower its price elasticity is.

What Affects Pricing Power?

There are several factors that can affect pricing power.

For example, some products naturally have more pricing power the more scarce they are.

Let’s think of hotel bookings.

During peak seasons such as Christmas or an in-demand local event, hotels tend to increase their booking rates.

This is because, during these peak seasons, lodging becomes scarce.

The demand for them increases but the supply usually stays as is.

As such, even if the price of hotel bookings increases, the demand for them is unlikely to decrease (during peak seasons).

Luxury products tend to naturally have more pricing power.

This is because those who purchase luxury products tend to not care about their prices.

Rather, some even appreciate the high price of such products.

A luxury product gives the customer a sense of exclusivity – like s/he’s part of something special and unique.

Thus, demand for these products is unlikely to fall to due price increases, which naturally gives them high pricing power.

On other hand, commodities tend to have low pricing power.

This is because more suppliers can supply these products.

If the price of a particular product from one supplier increases, the customers are more likely to jump to another supplier that sells the product for a lower price.

A company may increase the pricing power of these products by offering services or bonuses that its competitors cannot.

For example, a company may provide a longer warranty period.

Lastly, brand loyalty has a direct impact on pricing power.

This is why Apple products still have high demand even if they tend to be expensive.

Apple is able to capture and maintain its customers’ loyalty.

If a customer is loyal to a particular brand, s/he is likely to purchase their products even if other brands offer lower prices.