Pricing Power is Divine
Or 6 ways the reformation could have been avoided
The now iconic Spot the Dog Beanie Baby retailed for under $5 in 1993. By 1999 Beanie Babies cost $10. Did the cost to make a Beanie Baby double in the span of six years? Of course not. It’s a cloth bag of PVC pellets. If anything, production costs must have plummeted as Ty Warner, owner of Beanie Babies, gained economies of scale and began using Furbies as factory line workers. Warner realized that customers would be willing to pay more, so he exercised his pricing power - he raised prices. At a $10 sale price, Warner would make $5 in additional profit off each sale. Around 100 million Beanie Babies were sold per year in the late 90s. That means in one year, raising prices likely increased profits by $500 million.
Every company would love to raise prices and magically increase profits. Few companies can get away with it. Most of the time, higher prices mean fewer sales. That’s because most products have substitutes. Duracell is replaceable with Energizer, Dasani is replaceable with Avian, Denny’s breakfast is replaceable with swamp water. None of these have meaningful pricing power. Companies have pricing power when their product or service is exclusive. That can mean actual exclusivity, like patented life-saving medical devices, or something perceived as exclusive, like the sugared cow urine sold under the Mountain Dew label. With exclusivity, customers have a low elasticity of demand, meaning when prices go up they decide they have no choice but to pay.
Nobody can raise prices forever. No matter how bad people need something, they will reach a point where they simply cannot or will not pay more. French peasants cut off Marie Antoinette’s head, T-Swift set her fans loose on a record label, Samuel Adams and his gang dumped $18,000 of tea into the Boston harbor. All of these people felt they were being overcharged.
The most curious example of pricing power in the history of humankind occurred in 1517 when Martin Luther decided to speak out against indulgences. The Ninety-five Theses were of course about more than money just as the Revolutionary War was about more than taxes, but this being a newsletter about money, we will treat this moment in history as the ultimate test of pricing power. On one side is the seller, God, widely believed to be creator of the universe and maker of destinies. On the other side are humans, who quite like the idea of immortality but would rather not overpay for it.
There’s two takeaways from this epochal moment. First, consumer behavior is baffling. People pay Kanye West $500 for rubber sneakers but God can’t charge 25 Florins for everlasting glory? Which one of these is the omnipotent being? Second and more importantly: nobody, not even God, can raise prices forever. The good news, at least for these companies, is that there are ways to express pricing power without raising prices. This sounds counterintuitive, but it’s true. Companies can transform their pricing power into market power and then use that market power to increase their profit. As proof, here’s 6 ways the Catholic Church could have leveraged its pricing power without actually charging more for indulgences:
Switch to a recurring revenue model: Why charge 25 Florins one time when you could charge a Florin a month in perpetuity? MoneyLemma’s post on Judge Judy covered the appeal of a recurring revenue model and in this case the Roman Catholic Church could have made the transition seamlessly.
Pass-through higher costs: Do you ever notice that fancy restaurants charge “market rate” for their fish? Paying market price is a way to disguise price increases. Customers accept the higher prices because it’s not the restaurant’s fault, it’s just a tough fish market. Instead of simply raising prices for indulgences, the Catholic Church should have blamed higher costs. “The spoils of the Crusades are running low and we’re about to go broke.”
Long-term commitments: Regulated monopolies like cable companies are legally limited in their ability to raise prices. Instead, they force customers to sign up for long-term commitments. Netflix billing month-to-month but Comcast Internet a 12-month commitment with an early-cancellation fee. Comcast doesn’t need customers to commit to long periods. They just know they’ll make more money that way. The Church could have not raised prices, but required that everybody commit to buying indulgences for future generations (with a small deposit upfront).
Lower Inventory & Scarcity: When launching the Model 3, Tesla collected $1,000 non-refundable deposits from over 400,000 people. That’s $400 million! Most of those cars were delivered (or the orders canceled) two years later. If Tesla invested $400 million in the market for those two years then they would have made $100 million profit. That’s $100 million in free money. LIkewise, the Catholic Church could have announced that indulgences had to be bought one generation in advance. Who wouldn’t pay up now to avoid extra purgatory time? The Church could pull future revenue forward then invest it. Maybe they speculate a bit, fund an expedition to the New World.
Shared Scale: Amazon and Costco are two companies that never raise prices. Their business model is actually to lower prices over time. It’s called shared scale. As these companies buy in larger bulk and spread their costs over a larger base, they share the cost savings with customers. That’s why they are unbeatable on price. They make less on each product sold but sell way more products and therefore end up with a higher profit. The Church had massive scale in the 16th century. Had they shared that scale by slashing prices, other religions would simply be unable to compete. That’s how religion works, right?
Payment terms: A company can increase profit simply by changing the terms of payment. A great example is refunds. The New York Times estimated that up to 10% of online apparel purchases are refunded. That means that these companies end up losing 10% of their profit. By contrast, has anyone ever gotten a refund from their electrician? Another example is credit card or shipping & handling fees. Could the Catholic Church have layered in some hidden fees?
Pricing power is one of these business terms that gets thrown around a lot but is often misunderstood. Just because a company doesn’t raise prices doesn’t mean it can’t, and it also doesn’t mean that pricing power is untapped. The best businesses approach pricing tactically: they know they have a suite of different pricing tools at their disposal and they make the smartest decision after considering the political, strategic, and regulatory context.