Pricing power: measures, trends and influences on firm value

Abstract

Pricing power is highly prized by investors, pursued by managers and almost totally ignored by marketing academics. One potential reason may be a lack of validated measures of pricing power. In this study, we examine two pricing power metrics: a new enterprise-level measure of price elasticity and the industry-adjusted Lerner Index. Both measures can be estimated across companies and time from readily available financial data. The enterprise-level estimates of price elasticity are consistent with those reported in meta-analyses of results from product-market level models. We find that the average absolute price elasticity for publicly held firms in the US has been increasing (becoming more negative) since the late 1980’s. In contrast, the average Lerner Index (across industries) has been increasing over the same period. Therefore, pricing power for publicly held firms appears to be both increasing and decreasing over time. Finally, we show that both measures of pricing power have positive effects on firm value through their influence on future cash flows and cash flow variability. Valuation Insight: Price setting power in general is a key determinant of firm value. This paper measures pricing power alternatively by price elasticity and by the percentage of price above marginal cost (the Lerner index). These measures empirically are found to be quite distinct, moving for instance in opposite direction in historical data, and represent different dimensions of pricing power. Each contributes significantly to shareholder value.