East Bay Times

Corporate America is testing the limits of its pricing power

Alexander MacKay coleads the Pricing Lab at Harvard Business School, a research center devoted to studying how companies set prices.

Since the pandemic, he has watched how businesses have become more willing to experiment with what they charge their customers.

Big companies that had previously pushed through one standard price increase per year are now raising prices more frequently. Retailers increasing­ly use digital price displays, which they can change with the touch of a button. Across the economy, executives trying to maximize profits are effectivel­y running tests to see what prices consumers will bear before they stop buying.

Huge disruption­s to supply chains pushed up corporate costs during the pandemic and forced many companies to think more creatively about their pricing strategies, MacKay said. That supercharg­ed a trend toward more rigorous pricing, and showed many companies that they could more boldly play with prices without chasing shoppers away. The experiment­ation continues even as costs ease.

“We may have prices changing more quickly than they have before,” he said. That could mean up or down, though companies are generally more eager to raise prices than cut them.

Firms are trying to figure out how to protect the profits they have built since the pandemic. For big companies in the S&P 500 index, the average profit margin — the percentage of profit relative to revenue — soared in late 2020 and into 2021, as government stimulus and the Federal Reserve's emergency interventi­ons stoked consumer demand. At the same time, companies raised their prices so much that they more than covered higher costs for energy, transporta­tion, labor and other inputs, which have recently started to come down.

Corporatio­ns as varied as Apple and WilliamsSo­noma recently reported their highest-ever margins for the third quarter, while Delta Air Lines said its internatio­nal routes generated record profitabil­ity over the summer.

Margins eased somewhat last year, but have recently recovered to levels that would have set records before the pandemic. Average margins in nearly every sector in the S&P 500 are running near or above 10-year highs, according to Goldman Sachs.

“Companies are maintainin­g or even expanding margins because they are not passing these cost cuts on to consumers,” said Albert Edwards, a strategist at Société Générale, who called recent moves in margins “obscene.”

Now, companies are trying to figure out how to set prices to protect profits at what could prove to be a turning point. High interest rates and waning savings are making some — though by no means all — shoppers more price sensitive.

Many companies may be able to protect profits just by holding prices steady as their own costs come down. But some are still thinking about whether they can push prices up further as demand cools and overall inflation abates.

“I don't think companies have the monopoly power to just willy-nilly raise prices,” said Ed Yardeni, president of the research firm Yardeni Research.

There's a focus on margins over market share.

Many corporatio­ns are talking on earnings calls about how they are prioritizi­ng profit margins — even when that translates into less growth.

Take Sysco, the food wholesaler. Its local market business has turned slower recently, Kevin Hourican, the company's CEO, said on an October earnings call.

But “Sysco is not reacting by leading with price to win share,” he said, referring to the tactic of cutting prices to gain more customers, which is commonly used during downturns. “Instead, we are focused on profitable growth.”

Lennox, a heating and air conditioni­ng company, is working to perfect its pricing strategy based on years of data, Alok Maskara, the firm's CEO, said at an investor event this summer.

People in the industry are “margin-dollar focused versus revenue-dollar focused,” he said, implying that fewer, more-profitable sales are preferred to many, less-profitable ones.

That's sometimes a shift from post-2009 practice.

The focus on higher margins — even if it means selling less — is in some cases a shift away from the convention­al wisdom in the years during and after the 2009 recession. Back then, some executives felt compelled to compete on price for cost-sensitive shoppers. For hotels, that meant a focus on filling every room.

“If you remember back in the Great Recession, there was this view of let's just drop rates until we get people to heads in beds,” Leeny Oberg, Marriott's chief financial officer, said in a September meeting with investors. She added that “it wasn't necessaril­y the right strategy all the time.”

Now “the industry has clearly learned some lessons,” she said. Over the past few years, the company has aimed for more of a balance between maximizing revenue and profit, she noted.

Retailers, which have been caught out by shifting consumer tastes in recent years, are talking more lately about “inventory discipline,” or keeping less product in stock, so that they can avoid selling things at clearance prices. The logic is that it's better to sacrifice a few sales by running out of products than being forced to slash prices in a way that hits the bottom line.