December 13, 2019

I’ve written previously about Warren Buffett and his comments on pricing power. Buffett made a comment on the importance of pricing in evaluating a business which is frequently quoted by investors and folks like me who do work in pricing:

The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business.

The quote, powerful on its own, is even more insightful when you look at it in context. Buffett’s comments on pricing power came out of testimony he gave to the Financial Crisis Inquiry Commission (FCIC). This Commission was a Congressionally-appointed body charged with investigation the causes of the financial crisis of 2007-2010. One of the targets of their investigation was Moody’s Investors Service, one of the dominant players in the business of rating securities. Ratings agencies Moody’s and Standard & Poor’s had conferred AAA ratings on mortgage-backed securities and other instruments which turned out to be a major source of financial losses during the crisis.

Buffett’s Berkshire Hathaway held 15% of Moody’s shares when it went public in 2000. By 2008, its ownership had risen to 20%; by 2010, Berkshire Hathaway and three other investors owned over 50% of Moody’s shares.

When the role of Moody’s in the financial crisis was examined by the FCIC, therefore, Buffett became a source of interest. He was questioned by FCIC counsel Brad Bondi, and Buffett discussed the rationale for his Moody’s investment:

BUFFETT:   . . . . basically, the single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.

BONDI: Now, you’ve described the importance of quality management in your investing decisions and I know your mentor, Benjamin Graham--I happen to have read his book as well--has described the importance of management. What attracted you to the management of Moody’s when you made your initial investments?

BUFFETT: I knew nothing about the management of Moody’s. The . . .I’ve also said many times in reports and elsewhere that when a management with reputation for brilliance gets hooked up with a business with a reputation for bad economics, it’s the reputation of the business that remains intact.

If you’ve got a good enough business, if you have a monopoly newspaper, if you have a network television station--I’m talking of the past--you know, your idiot nephew could run it. And if you’ve got a really good business, it doesn’t make any difference. . . .

Very few of us will ever develop a business with a dominant position like Moody’s. The point Buffett is making about Moody’s, though, applies to all businesses, large and small:  how you price your product or service is critically important to the success of an enterprise. If you get your pricing right, it will overcome a lot of your mistakes in other areas of the business.

Maybe your operating processes aren’t optimal. Your lead conversion might be off. Your expenses can be higher than they should be. There’s a lot that can go wrong in a business, but excellence in pricing covers a lot of errors, even the mistake of putting your “idiot nephew” in charge.

And there are days when you are in charge and you feel like you’re a mess. (I have those days myself.) Don't worry, I suspect Buffett would tell you. Focus on your pricing, get that part of your business right, and you don’t have to be brilliant.

You can even be the idiot nephew.

 

©Ray Business Advisors, LLC and John Ray

Image Credit:  freeimage4life on Flickr

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About me:  I’m enthusiastic about how changes in pricing strategy can significantly change profitability for a business and enhance life choices for business owners. I live this passion through Ray Business Advisors, my outside CFO and business advisory practice, in which my pricing is exclusively value-based, not hourly. I work with business owners on how they can change their pricing not just to increase their profits, but better serve the wants of their customers. Click here to learn more or call me at 404-287-2627.