News: Analysis & Commentary
THE POWER TO RAISE PRICES
Even with near-zero inflation, some companies get more for what they sell. Why that's good
The contrast is striking. The folks who make personal computers--including Compaq, IBM, and Hewlett-Packard--are slashing prices to move inventory. Yet online-service giant America Online Inc. is going in the opposite direction. On Apr. 1, it raised its monthly fee for unlimited usage by 10%, from $19.95 to $21.95. And there's no sign of increased account cancellations, says Barry Schuler, president of AOL Interactive Services. "Nobody loves a price increase," says Schuler. "But from our perspective, it has gone over well."
Assuming that the rate increase sticks, AOL will join a select group--the pricing power elite. Although core inflation is running at a meager 2.1%, some industries--including airlines, mutual-fund houses, sellers of mainframe software, and entertainment companies--are able to boost prices far faster. Their secret: products that customers want and are not easily matched by competitors. In contrast, companies outside the elite are forced to survive on stagnant or falling prices.
This tremendous divergence in pricing power is a new thing. In the 1980s, prices marched upward in lockstep across the economy. From 1985 to 1990, for example, the 4% overall inflation rate was matched by similar hikes in diverse categories such as haircuts, air fares, new vehicles, entertainment, rent, clothing, and food. Only a few, like health care and college tuition, could beat this norm.
Today, prices are far more sensitive to supply and demand in individual markets. Federal Reserve Board Chairman Alan Greenspan and other economists have long hailed this change as a key benefit of low inflation. When the overall inflation rate is high, price hikes mainly reflect economy-wide trends. But with low inflation, price changes contain more information about market conditions in specific industries. The economy benefits since investment flows into high-price industries where demand exceeds supply."LOCKED IN." Eventually, companies with pricing power see their edge wiped out or substantially reduced as competition increases. But until that happens, the pricing power elite can enjoy the benefits.
Consider transportation. In the 1980s, the price of flying rose only a bit faster than the cost of a new passenger vehicle. Now, the airlines are showing major pricing clout: Typical domestic business fares rose 9% in February from the previous year, reports American Express Travel Related Services Co., as carriers benefited from strong demand, little capacity growth, and a lack of low-fare competition. According to the Bureau of Labor Statistics, ticket prices soared at a 37% annual rate in the first quarter.
Meanwhile, thanks to inexpensive imports and overcapacity, U.S. carmakers are being forced to swallow price cuts in the form of bigger rebates and cut-rate financing on most models. At General Motors Corp., for example, incentive costs rose to an average of $1,305 per vehicle in the first quarter, up 52% from a year earlier.
This difference in pricing clout shows up within the software business as well. Prices for many PC applications are falling sharply. Average retail prices for PC games, for example, are down 12% in the first two months of 1998 compared with a year earlier, according to market researcher PC Data. Prices for business-application software are off 17%.
But at least one PC software company has enough pricing power to hold the line in computer stores. Microsoft Corp. announced on Apr. 20 that it will price Windows 98 upgrades at $109--the same suggested retail price as Windows 95--even though the price of a home PC has fallen by a third in the past two years. PC makers ask for price cuts all the time, observes Microsoft Chief Financial Officer Gregory B. Maffei. But Microsoft isn't planning on offering any discounts.
At the same time, the price of mainframe software continues to soar. Software makers charge higher prices when users upgrade to more powerful computers--even though the software stays the same. At U.S. Bancorp, the license for one CompuWare Corp. package jumped from $1 million to $4.5 million when the company upgraded its mainframe. "We're not getting greater business value out of the software," says Mark Sobotka, vice-president for technical services. But, in a lot of cases, Sobotka concedes, software makers "have us locked in."
In financial services, too, some companies have the power, while others don't. For example, more and more people looked for help this year to cope with the spiraling complexity of tax forms. This greater demand enabled H&R Block Inc. to increase its average charge for doing a return by 8%. And the explosive growth of sector and international funds--which tend to charge higher fees--helped push up typical mutual-fund fees by 5.4% in 1997, based on data from Lipper Analytical Services Inc.
Surprisingly, banks don't seem to have the same clout. True, automated teller machine fees have gone up. But according to new government figures, checking-account fees rose at only a 1.6% annual rate in the first quarter. The recent merger wave, however, might help banks regain pricing leverage.
Of course, the market for some services is so hot that the sky's the limit. Take computer services. Nieto Computer Services, a three-year-old Houston computer- and network-services company, has raised service fees two years in a row without a whimper from customers. "We raised hourly rates and lost one or two clients out of 130," says co-founder Scott Mt. Joy. When the company started in 1995, it charged $35 to $50 an hour for contract work. Today, rates are $75 to $150. The increase, Mt. Joy says, reflects the scarcity of experienced programmers and sky-high demand.CROWDED CINEMAS. With disposable income surging, entertainment businesses, too, are able to charge more without cutting into demand. Ticket prices for sporting events are up sharply, for example. And despite movie-ticket price hikes averaging 7.8% last year, filmgoers still crowded into the cineplexes.
The latest example of entertainment pricing power: In early April, Walt Disney Co. announced an estimated 6% increase in ticket prices at Walt Disney World in Orlando. The hike also comes just in time for the opening of the company's much-ballyhooed $800 million Animal Kingdom theme park. Nearby Universal Studios Inc. and Sea World of Florida are matching Disney. "Obviously, if someone else raises prices...then that gives you a window," admits Victor G. Abbey, executive vice-president and general manager of Sea World. But Abbey notes that visitors will get more for their money: Park owner Busch Entertainment Corp. has more than doubled Sea World's size.
Finally, there's the housing market. Nationally, sales prices for existing homes are up 5.2% over the past year--a number that conceals sizable city-to-city disparities. In some areas, such as Miami and Albany, N.Y., prices are stagnant or falling. But in Boston, home prices are up 10.6%.
So, if you experience sticker shock at the baseball stadium or when you hear what that cunning cottage costs, remember that you're rubbing elbows with members of the power pricing elite. Just hope that they continue to be a rare breed in this low-inflation world.By Michael J. Mandel in New York, with bureau reportsReturn to top