Among other extraordinary skills, Warren Buffett has a special talent for explaining important investment concepts in a simple and powerful way. Pricing power can be a central variable to consider when making investment decisions, and companies such as Coca-Cola (NYSE:KO), Apple (NASDAQ:AAPL), and Starbucks (NASDAQ:SBUX) have the pricing strength to generate consistent profitability for investors in the long term.
In Buffett's words:
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.
Coca-Cola's sparkling brand value
Coca-Cola is not only one of Buffett´s biggest holdings, but also a paradigmatic example to understand his investment philosophy. The company's brand value, unparalleled distribution network, and abundant financial resources to invest in areas like marketing and product development provide rock-solid competitive strengths for the business, which management translates into superior profitability and consistent capital distributions for shareholders.
The Coca-Cola brand produces more than $1 billion in sales in 19 countries, and the company owns 16 other brands bringing in more than $1 billion in global revenues. Not only that, but Coca-Cola also has a pipeline of 20 more brands generating between $0.5 billion and $1 billion in global sales, many of which will probably become new billion-dollar brands in the middle term.
This level of brand differentiation allows Coca-Cola to charge for its products a substantial premium over generic competitors, which produces superior profitability for shareholders.
Coca-Cola has a gross profit margin of more than 60%, and operating margin is in the area of 22% of sales. By comparison, generic competitor Cott (NYSE:COT) has a gross margin of 12% and an operating margin of only 4%, since it lacks Coca-Cola´s competitive strengths and the pricing power that comes with them.
Apple doesn't care about market share
Apple is the most valuable brand in the world, according to Interbrand. The company is losing market share against cheaper smartphones and tablets operating with Android in emerging markets, where Apple products are too expensive for many consumers and carriers don't usually subsidize the price of the devices as much as in the United States.
But Apple is not about market share. The company is focused on creating high-quality products supported by a deep ecosystem and providing a superior experience for customers, and Apple customers seem to be more than willing to pay premium prices for its products.
According to CEO Tim Cook in the company's latest press conference:
iPhone customers are loving their phones, and continue to produce the highest loyalty rates in the industry. A December survey of U.S. customers by ChangeWave indicated a 96% customer satisfaction rate for iPhone. And based on the latest data provided by Kantar, iPhone customers have a 90% loyalty rate, significantly higher than the competition.
The company will need to reinvigorate product innovation to accelerate growth, but Apple's profitability is not in question, as the company has an operating margin above 28% of sales and generated more than $22.6 billion in operating cash flows during the last quarter alone.
Starbucks sells much more than coffee
Starbucks sells much more than just coffee. The company provides, first and foremost, a differentiated customer experience supported by one of the most valuable brands in the consumer sector.
A comfortable environment providing a third place between work and home, personalized customer attention, and a dynamic policy of permanent innovation are big differentiators for the company, and this means higher prices for Starbucks versus the competition.
Management is moving in the right direction by broadening the company's product offerings with new drinks and food products in order to increase sales and attract a broader customer base in a cost-efficient manner. This bodes well for profit margins, which are already at sky-high levels near 29% of sales.
The company has materially expanded its store base in recent years, but, fortunately for investors in Starbucks, there is no sign of saturation at this stage. Demand remains remarkably strong, with global comparable-store sales increasing by 5% during the last quarter because of a 4% increase in traffic and a 1% rise in the average ticket value.
Pricing power generates superior profitability for investors, and perhaps more important, it's a clear reflection of competitive strengths and healthy demand for the company's products. This means companies such as Coca-Cola, Apple, and Starbucks deserve particular consideration from investors looking for high-quality businesses to hold for the long term. You don't need to take my word for it -- just ask Warren Buffett.