Netflix (NFLX -3.92%), Amazon.com (AMZN -1.64%), and Chipotle Mexican Grill (CMG 0.40%) have several things in common. The three of them are exceptional growth companies led by inspiring and innovative leaders. In addition, the three companies will be raising prices soon. Pricing power is of utmost importance when it comes to generating returns for shareholders in the long term, so investors need to pay close attention to these price increases and the subsequent reaction from customers.
Netflix and the ghost of past price increases
Netflix announced on Friday that it will be raising prices by $1 a month in the U.S., so new subscribers will be paying $8.99 a month versus the previous fee of $7.99. However, the price of $7.99 a month will be maintained for existing subscribers for two more years.
Source: Netflix.
Wall Street analysts and investors have been concerned over the possible consequences of a price increase on Netflix's subscriber base. This is understandable considering that Netflix made a huge mistake back in 2011, when it tried to excessively raise prices, infuriating customers and losing many of them in a decision that was later reversed.
However, make no mistake: The recently announced price hike is very different. A price increase of 12.5% may sound like a lot in percentage terms, but it's still only $1 per month, so hardly a game changer for most customers.
In addition, Netflix has materially broadened its content library over the last few years, including huge hits like the original production House of Cards. When considering the quality of the service in comparison to its price, subscribers have strong reasons to pay $1 extra for a growing collection of highly desirable tittles.
Besides, the fact that it will be generously grandfathering current customers shows that Netflix has learned its lesson from past mistakes, so it looks like the company should be able to successfully implement the recent price increase without suffering much damage in terms of subscriber growth.
Amazon is primed for sustained growth
Amazon Prime is a huge strategic asset for the company. The program is very valuable in terms of customer loyalty, competitive strength, and overall demand in the savagely competitive discount retail industry.
Source: Amazon.com.
A report from Consumer Intelligence Research Partners estimates that Prime members buy from Amazon at double the frequency of non-Prime customers. In addition, the study claims that Prime members spend twice as much, with an average purchase amount of $1,340 per year versus $650 per year for non-Prime customers.
Amazon has recently raised the price of its Prime membership from $79 a year to $99. The company says it has "tens of millions" of Prime members, so a $20 increase in price per member won't probably move the needle by much in terms of revenues for a company that made $19.74 billion in sales during the first quarter of 2014 alone.
However, most of that increase will probably flow directly to profit margins since there are almost no costs attached to this price increase.
On a positive note, management is quite confident based on the initial reaction from customers during the latest earnings press conference. "In terms of Prime, it's early, but we are encouraged with what we see so far. Just over the last several weeks, our Prime subscribers continue to grow week over week," said CFO Thomas Szkutak.
Chipotle's delicious growth and spicy food costs
Chipotle announced a huge sales increase of 24.4% to $904.2 million during the first quarter of 2014 on the back of a 13.4% growth rate in comparable-store sales. However, rising food costs are negatively affecting profit margins, so the company has decided to raise prices "somewhere in the mid-single digits" over the coming months.
Source: Chipotle Mexican Grill.
The restaurant business is notoriously competitive, so it's important to watch prices and their possible impact on demand. However, a 5% price increase in an $8 burrito means an extra $0.40 for customers, and this does not sound like too much considering that it's the first price increase Chipotle has implemented over the last three years.
Chipotle has always faced competition from lower-priced alternatives such as Taco Bell and many others, and this has not stopped the company from producing extraordinary performance over time.
Considering that demand for its burritos has been booming over the last several years, the company should have enough pricing power to get away with a reasonable price increase to compensate for rising food costs.
Bottom line
Pricing power says a lot about a company, its competitive strength, and its ability to generate attractive returns for investors over time. Netflix, Amazon, and Chipotle Mexican Grill are testing their ability to increase prices, so investors need to watch these developments closely. Fortunately, the three companies look strong enough to successfully raise prices without losing too many customers in the process.
