A recent discussion on the "In Good Company" podcast between Nicolai Tangen, CEO of Norges Bank Investment Management, and Sir Chris Hohn, founder of The Children's Investment Fund (TCI), provided valuable insights into a key aspect of business success. Hohn, whose TCI manages over $60 billion and has achieved notable annualised returns of approximately 18-20% since inception in 2003, offered a clear perspective on what distinguishes truly exceptional companies.
He stated: "Most companies don't have pricing power – they can only price, if they're lucky, at inflation. That's why people don't focus on it – they don't even look at where growth comes from. They just assume it's volume plus inflation. But there is a special group of super companies that can price above inflation, and that's, as Buffett taught, the test of whether you have the moat. And this real pricing power above inflation can be very valuable because if you can price 1% above inflation and you have a 20% profit margin, your profits will grow 5% faster than revenue. People don't go into it or analyse it because there's so few companies that have it, but this is something we have in a lot of our investments because incremental pricing is pretty much all profits."
Hohn's observation highlights a critical driver of long-term value: authentic pricing power. This is the capacity of a company to increase prices beyond general inflation without significantly impacting customer demand, directly enhancing profitability.
Why pricing power is so topical right now
At 36ONE, while our investment team maintains a style-agnostic approach, a key factor in our assessment of a company's "quality" is its demonstrable pricing power. This attribute frequently supports a higher valuation multiple, as it signals a durable and resilient business model. A company capable of consistently raising prices without alienating its customer base possesses a significant competitive advantage – the "moat" that Hohn and Buffett describe.
Our focus on pricing power has become particularly relevant in the post-pandemic economic climate. We observed numerous companies adjusting prices amidst supply chain disruptions and fluctuating demand. Some were successful, underscoring the strength of their customer relationships and the essential nature of their offerings. Others, however, faced challenges in retaining market share or customer loyalty as economic conditions shifted and household incomes normalised. This pricing power will only become more important as companies look to navigate higher tariffs.
This period has provided valuable opportunities for our team. It has enabled us to identify high-quality companies with sustainable pricing strategies that can navigate economic changes. Conversely, it has also assisted us in recognising overvalued companies whose recent price increases were more opportunistic than indicative of genuine, long-term pricing capabilities.
Examples of strong pricing power
Two distinct examples illustrate effective and sustainable pricing power:
- The Coca-Cola Company (and its ecosystem): Coca-Cola is a prime example of a company with substantial pricing power derived from its exceptional brand equity, extensive global distribution, and adept marketing. Consumers globally often demonstrate a willingness to pay a premium for its products. This strength extends to its bottling partners, such as Coca-Cola Europacific Partners (CCEP), which is a holding in our global fund. The brand loyalty and perceived value associated with Coca-Cola facilitate consistent price adjustments, contributing to steady revenue and profit growth.
- FICO (Fair Isaac Corporation): FICO provides essential credit scoring services deeply integrated into the financial industry's operational framework. Although regulators are currently challenging FICO’s strong market positioning, its historic performance has shown strong pricing power which is rooted in several factors:
- Critical Service: Its scores are fundamental to lending decisions, making the service indispensable.
- Small Proportion of Customer Costs: For its clients (lenders), FICO's fees generally constitute a minor element of their overall operational expenses, making price increases more readily absorbed.
- High Incremental Margins: As a services business, a significant portion of any price increase typically flows directly to the bottom line, enhancing profitability – aligning with Hohn's point about incremental pricing being almost pure profit.
- High Switching Costs & Network Effects: The widespread adoption of FICO scores and the considerable effort required to replace its established system create substantial switching costs for its customers.
- Visa and Microsoft: Both companies show the pricing power of platforms (both are holdings in our funds).
- Visa: With its vast global payments network, Visa benefits from powerful network effects. The more merchants and consumers use Visa, the more indispensable its network becomes, allowing it to incrementally increase transaction fees over time.
- Microsoft: Its dominance in operating systems and enterprise software, coupled with high switching costs for its deeply embedded products, gives Microsoft significant pricing power.
When pricing power is unsuccessfully tested
Not all attempts to implement price increases are successful or sustainable. The luxury sector offers a nuanced illustration. While many high-end brands cultivate an image of exclusivity that would suggest significant pricing power, this can be less robust than it appears. True pricing power in the luxury domain depends on maintaining exceptional brand desirability, continuous innovation, and a strong aspirational connection with consumers.
If a luxury brand's equity diminishes, if its products become overly accessible, or if economic conditions adversely affect the discretionary spending of its target clientele, its ability to dictate prices can be significantly constrained. The post-pandemic era saw some luxury brands implement aggressive price increases. As economic conditions have normalised, aspirational brands such as Gucci (owned by Kering) have seen their target clientele reallocate spending from goods to services while the brands have become even less attainable at their relatively higher price points. This contrasts with the "super companies" Hohn references, whose pricing power is typically founded on more fundamental and less cyclical competitive advantages.
Conclusion
As Chris Hohn’s insights emphasise, pricing power is more than a theoretical concept; it is a crucial indicator of a high-quality company capable of generating superior, sustained returns. It signals a robust competitive advantage, resilience against inflationary pressures, and the capacity to translate revenue growth into disproportionately higher profit growth.