Pricing Power Beats Good Management

Warren Buffett is known for buying companies for billions of dollars (case in point – Burlington Northern Santa Fe railroad which was bought last year for $26.5 billion). Many times people ask him: What is the most important thing he looks at before buying a company?

His answer: Pricing power.

“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 10 percent, then you’ve got a terrible business.”

An extraordinary business does not require good management, he says. A dominant position in your market can survive for quite a long time with bad management, but eventually it will catch up with you.

Buffett singles out and praises managers from Berkshire’s more than 70 companies and leaves them alone to conduct their business. But they have to deliver.

“If you have a dominant position in the market, you can survive for quite a long time with bad management, but eventually it will catch up with you”, says Benjamin Hermalin, professor of economics at the University of California Berkeley’s Hass School of Business.

Terry Connelly, dean of Ageno School of Business at Golden Gate University in San Francisco concurs. “Good management can’t do anything with a bad case” he says. “In the short run good management can make a stock pop but I follow what Warren’ saying, especially because his point of view looks at the fundamentals. Good management can’t do anything with a bad case.”

Read more about it here and here.