WHO HAS THE PRICING POWER?
27 October 2010 by Cullen Roche
2 Comments
One of the many unintended consequences of QE appears as if it will be margin contraction. As input costs surge in recent weeks it will become even more important than ever to maintain pricing power in a world of weak end demand. The analysts at Credit Suisse recently highlighted US sectors and companies who are likely to maintain pricing power in this environment as well as those that will see their pricing power deteriorate. Among the industries with pricing power:
- Rails
- Tobacco
- Paper/paclaging
- Fertilizer
- Investment Banks
- Capital goods
- Hardline retailers
- Software
- Food producers
(Right click for larger image)
Those with little pricing power include the following:
- Consumer discretionary
- Machinery
- Steel
- Electrical equipment
- Chemicals
- Homebuilding
(Right click for larger image)
Source: Credit Suisse
I was actually going through the same though process before I read this article.
See below:
First, consider that at the commencement there is no transmission mechanism unless there is potential for loan demand. Without consumer demand because of increasing desires to save, there is no transmission mechanism.
Commodity Prices
You do, however, create a necessary increase in commodity prices, because the price of global inputs rises as your currency declines. Your currency declines, of course, for two reasons: a. yields fall in your country, because the excess cash has to go somewhere, and b. if there are simply more dollars those dollars must be worth less globally. As a result, your input prices increase. While these price increases are definitely passed along to corporations, they do not necessarily make it all the way to consumers, because consumers cannot tolerate price increases: an increase in price will lead to a decline in demand unless the market is extremely inelastic (gasoline and food).
For those producers who have a high commodity input cost as a percentage of their output cost but are in elastic markets, this will lead to a decline in profits. For those producers who have a high commodity input cost as a percentage of their output cost but are in inelastic markets, they should be able to maintain margins. This would theoretically result in price increases in inelastic markets where there are no wage increases, leading to a decline in the standard of living (negative real wage growth).
To the extent processing of raw materials occurs elsewhere, however, this should not lead to price inflation or compression of domestic margins, but should rather lead to a decline in foreign margins. If the market simply cannot bear any increase in prices, then prices will remain low and foreign margins will be compressed. To the extent capital costs are low relative to prices, they may choose not to operate at these lower prices because all of their margin could be eliminated. To the extent they have a high capital investment component they will likely continue to operate at the same output level. In industries where capital costs are low, it may be possible for domestic competition to emerge if foreign producers abandon the market or shrink their supply, stimulating labour demand in the domestic market.
So you have a few major effects:
1. Margins are compressed for domestic firms utilizing global commodity inputs with elastic end-markets.
2. The standard of living declines where prices increase faster than wages for commodity-like products with inelastic end-markets.
3. Margins are compressed for foreign firms, which may or may not cause them to reduce supply and potentially stimulate domestic competition.
So in other words those hanging on to us curency are screwed–buy gold!!!
I think that all the well written explanation s are lovely but as a bottom line guy, just tell me the bottom line or at least tell me the bottom line at the end of the articulate explanation.