INSIGHTS

When inflation is high and costs are rising, companies with pricing power often prove most resilient.

They can increase the prices they charge to their customers, without suffering any major decline in demand, allowing them to maintain their margins.

Those that can’t do this find themselves absorbing cost increases at the expense of their own profitability. This is reflected in lower earnings and dividends, as well as share prices.

Cost pressures for businesses remain intense. In the latest ANZ Business Outlook survey, a net 88.7 per cent of firms reported increasing costs. That’s extremely high and is well above anything we've seen in the last decade.

These cost increases are coming from a range of areas, in addition to the usual ones like rates, insurance and electricity.

Commodity prices are high, freight and shipping have become more expensive because of the pandemic, government regulation has increased, while our tight labour market has put pressure on wages.

Unsurprisingly, businesses are doing their best to pass this on to customers. The ANZ survey shows a net 66.5 per cent of companies indicating they'll increase prices in the coming months. That's also well above anything we've seen in the last ten years.

This isn't just a New Zealand phenomenon. In the US, the National Federation of Independent Business has said price raising activity has reached levels not seen since the early 1980s.

For the most part, local companies have been able to get away with increasing prices in 2021. The economy has been buoyant, unemployment is at extremely low levels, and many consumers are in good heart.

House prices have been strong, which makes people feel wealthier, and there is still a lot of pent-up savings due to closed borders and ongoing lockdowns.

Having said that, if costs keep pushing steadily higher into 2022 and beyond, we might see some businesses struggle to keep raising prices without losing customers.

If that coincides with a slowdown in the economy, consumers could become a bit more frugal, compounding the situation.

Companies with pricing power tend to be those with high barriers to entry, competitive advantages, unique products, a loyal customer base, and strong brands.

Those with high margins in the first place are usually better positioned, as they tend to be more dominant in their markets with more room to move if they do need to adjust prices.

Bigger companies often have more pricing power than smaller ones too.

A recent survey by the Federal Reserve Bank of Richmond in the US showed that 85.2 per cent of large companies were passing through larger than normal price increases to customers, compared with just 73.8 per cent for small firms.

The annual inflation rate here in New Zealand is the highest since 2008 at 4.9 per cent, while in the US it’s closer to seven per cent, the highest in 30 years.

Some of these inflationary pressures are pandemic related and will subside over the next six months, although I’ve got a sneaking suspicion that inflation might remain higher than many believe, and that it could last a little longer.

Competitive advantages, high margins, and strong brands are attributes share investors should always be targeting, regardless of the backdrop.

However, as we look ahead to 2022 and beyond, these things could be even more crucial for investment success.

This article was also published on the New Zealand Herald website under the title "Mark Lister: Higher prices on the horizon, but at what cost?" on 11 December 2021.