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Lesson 5 of 10 · 11 min
Pricing power
Management can set any price it likes, but pricing power, the ability to raise prices without losing volume, depends on market structure and competitive position, and shows up as margins that hold or rise over time.
In short
- Pricing power: the ability to set prices and other terms with customers without hurting sales volume. It is mainly a function of market structure and competitive positioning.
- In highly competitive markets firms are price takers; returns cycle but over the long run approach the cost of capital. Only a sustained low-cost producer can earn more.
- Competitive markets show little differentiation, low entry barriers, substitutes, weak loyalty and low switching costs. Markets often become competitive over time through commoditisation.
- Firms with pricing power (monopolistic competition, oligopoly, monopoly) show differentiation, entry barriers, few substitutes, switching costs and loyalty.
- Evidence: compare prices with costs. Raising prices 3% while costs rise 5% is not pricing power. Rising margins over time are the key sign.
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