SIMON BROWN: Price-takers vs price-makers

Whatever industry a business operates in, it’s ultimately selling a product or service, and how much it can charge, the cost of customer acquisition and the retention of customers matter — a lot.

Some, such as Apple, can command a premium price, whereas others, such as miners, are price-takers in that the market sets the price for the mineral or commodity they mine.

Being a price-taker means all you can manage is the cost and quantity of production. Then you wait for the price of the commodity to rise, hoping you can keep costs low and boost production and, ultimately, profits.

Premium is a great place to be, as the business can charge a higher price and earn better margins. In some cases it really is premium, but it can also just be a perceived premium. I visited a rum distillery in Mauritius recently and while the rum was completely average, the fancy packaging and bottles meant they were selling at a way higher price than the quality suggested they should be. This works, but you have to be able to maintain the façade or the business is over.

In some industries it depends on where the power lies. You may make an excellent fast-moving consumer goods product, but all the power lies with the retailers, and even the large listed producers don’t have a lot of power over the retailers.

Further, while the retailer relies on very slim margins, it uses bulk to make its profits substantial. The producers, on the other hand, are nearly always being squeezed — so it is usually a better investment to own the retailer rather than the producer.

Switching costs can also make a difference. For example, my keyboard just told me its batteries are getting low and need replacing. What brand will I buy? Whichever is on special at my local retailer; there is zero switching cost between batteries, which all largely give the same operational life.

Switching between different retailers is also largely frictionless, which is why we’ve seen such an increase in loyalty cards. Checkers has taken it a step further by printing on each receipt how much I have saved and the Sixty60 service now also has a flat monthly fee for unlimited deliveries. Both work, but only as long as I remain confident their prices are best.

We’ve seen even printers and coffeemakers struggle. The plan was to sell you a cheap printer then charge over the top for the ink. Ditto Nespresso and the coffee pods. But the printer companies had to resort to putting chips in the ink cartridges to prevent people using generic ink and customers then just moved to friendlier suppliers.

Convenience also matters a lot. I buy petrol from the nearest fuel station as I need; brand loyalty is pretty much zero.

Price and quality are the things that keep a customer coming back; so, as an investor, when we start to see either slip, we should be concerned.