Strategic Movements May 2022

Tying Arrangement at Peloton

Peloton will raise its price from $39 to $44 per month for subscriptions to metrics, live-streaming and on-demand courses starting June 1.  Concurrently, Peloton will drop prices on durable equipment such as bikes and treadmills.  For example, the lower priced bike will drop from three hundred dollars; from a total of $1,495 to $1,195 plus a $250 delivery fee.

In Tying Arrangements, the cost of the durable is low, near variable costs, while the cost of the consumable is high, far above variable costs.  Classic examples include razor-razorblade model of Gillette, printer-and-ink model of HP, and gaming-console-and-video-game model of Xbox, PlayStation, and Nintendo.  These models usually work best when customers are more price sensitive to the durable than to the consumable.  Given HP’s success in pricing printers low and ink high in contrast with Kodak’s low market penetration with reasonably priced printers and low-priced ink; many expect this approach to work well in comparison with the approach of Peloton’s competitors such as NordicTrack, Bowflex, etc.

What does this imply for Barry McCarthy, CEO of Peloton? The increase reliance on subscription revenue over durable goods profits should improve the market valuation of Peloton since many investors value companies by the number of subscribers and average revenue per user (ARPU), and the move will postpone the day of reckoning when investors evaluate Peloton by the old metric of earnings.  Buying time to deliver a positive outcome is a smart move for many growth-firm CEO’s.

PTON (Peloton Interactive Inc.) fell from 24.5 to 17.0 in weeks following the announcement.  Twenty twenty-one revenue of $4.0 billion with negative 2021 margins but positive P/E ratio of 170.

Terlep, Sharon (2022, April 15). Peloton to Cut Bike Prices, Raise Fees. Wall Street Journal, B1.

Bundling at Warner Bros. Discovery

Chief David Zaslav of Warner Bros. Discovery laid out his vision for the newly created media giant formed when AT&T Inc. spun WarnerMedia out and the new entity merged with Discovery.  Warner Bros. Discover incudes Warner Bros. movie studio, HBO, CNN, TNT, Food Network, HGTV, and more.  Zaslav’s vision:  bundling.

“We don’t want to go to eight places.  We want to go to one place, and we want to see everything we want to see.” Said Mr. Zaslav.  “When we put it all together, we are much more successful.

In price bundling, two or more distinct offerings serving distinct market segments are sold as one offering at a price below the sum of that of the distinct offerings but above that of any individual offering within the bundle.  Classic examples include Microsoft Excel, Word, and Outlook in Microsoft Office, Season Tickets to Operas and Sporting events that include the sale of several distinct performances in the sale of the single bundled season ticket, or simply fixed-priced luncheons at restaurants.  Price bundling improves profits when the marginal costs to deliver are low and the fixed costs are high.

Streaming video of news, films, series, and reality shows and their respective target markets have the characteristics that would make bundling a highly profitable and market attractive strategy for Warner Bros. Discovery. As such, this strategy should play well for David Zaslav.

WBD (Warner Bros Discovery Inc.) fell from 24 to 19 in the weeks following the announcement.  2021 revenue of $12.2 billion with 16% margins and a P/E ratio of 9.5.

Flint, Joe (2022, April 15). Zaslav Wants CNN to Steer Clear of Advocacy. Wall Street Journal, B1.

Good-Better-Best Versioning at Netflix

Currently, Netflix offers the U.S. market subscriptions at $9.99, $15.49, and $19.99 which differ by the number of simultaneous screens and video quality, all with no advertisements.  Recently, Reed Hastings, CEO of Netflix, raised the possibility of launching a new, lower-priced, version that would be ad-supported.

Versioning improves profits by increasing the sales overall through penetrating the market better with the lower-priced version which simultaneously cannibalizes profits that would have been earned on sales of the higher-priced version.  If penetration profits exceed cannibalization profits, launching a new lower-priced version is sound pricing strategy.

As the market for streaming has passed into early maturity with heavy competition from many media and tech giants, the market has expanded to include many low-priced, ad-supported subscription offers.  For Netflix, launching a new low-priced, ad-supported version would be aligned with the market evolution pattern and timing.

Both the market penetration dynamics and market maturation dynamics indicate launching an ad-supported version should improve profits and market valuation of Netflix under Mr. Hastings.

NFLX (Netflix Inc.) fell from 348 to 188 in the weeks following this and other announcements.  2021 revenue of $29.7 billion with 25% margins and a P/E ratio of 18.

Flint, Joe and Jacob, David (2022, April 20). Netflix Explores Cheaper Service with Ads. Wall Street Journal, A1.

Nestle Passes Through Costs Increases

For Q1 2022, prices at Nestle rose 5.2% and volumes increased 2.4% leading to an overall 5.4% increase in revenue to $23.4 billion.

Mark Schneider, CEO of Nestle, remarked on the “sustained consumer demand” that he expects further price increases during the remainder of 2022 in response to inflation and the war in Ukraine.

The significance of this pricing data point is the variation in ability of some companies to raise prices and keep customers while others find demand shrinking quickly with moderate price increases.  Nestle, which makes small indulgences such as coffee and chocolate along with other consumer staples and pet food, is weathering this inflationary moment well.

NSRGY (Nestle SA) was relatively unchanged hovering between 132 and 126 in the weeks following this and other announcements.  2021 revenue of $95.7 billion with 19.4% margins and a P/E ratio of 19.5.

Chaudhuri, Saabira (2022, April 22). Nestle Sales Rise as Shoppers Shrug Off Higher Prices. Wall Street Journal, B3.

Journelle Passes Through Costs Increase in Lingerie

Journelle is raising its price on the Natalie Underwire Bra to $98 from $68 on June 1, 2022.  The driver:  cost inflation from energy to shipping and across many components.  “We think many of these price increases are here to stay” said Guido Campello, CEO of Journelle.  Note: some retailers have chosen to stop carrying the brand but Campello expects sales to remain somewhat steady and was unwilling to lower the quality of the Natalie bra.

Elsewhere in the lingerie industry, Lively raised the price of its bras to $45 from $35 in late 2021.  Victoria’s Secret raised the price of the “Wear Everywhere” bra to two for $54 from two for $52.

This story highlights two key issues for pricing today:

1. Though it is reasonable to expect inflation to be reduced in the latter half of 2022, it requires a special kind of magical thinking to expect sharp inflation to be followed by sharp deflation. Historically, inflation is generally not followed by a reversing of the price increases.  Instead, prices generally settle, and inflationary rate is simply lowered but not reversed.
2. Journelle, a luxury lingerie brand, accepted the tradeoff of fewer sales through some channel partners with the expectation of robust sales online, at flagship stores, and through other retailers.

Kapner, Suzanne (2022, April 25). Increasing Costs Hit a Lingerie Maker. Wall Street Journal, B4.

Coca-Cola Embodies Pricing Power

Organic revenue is up 18% for Q1 2022 driven by volume, mix, and price improvements.  That is a trifecta for James Quincy, CEO of Coca-Cola Co.

From a short-term, profit-optimizing viewpoint, this performance implies prices should increase further at Coca-Cola Co to maximize profits.  Mr. Quincy however responded with “We certainly aren’t looking to take price increases just because we can. We want to earn them as a brand, and we want to make sure we can recover the cost over time.”  This is a clear example of Warren Buffett’s definition of pricing power and a good business: “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.”

KO (Coca-Cola Co) was relatively unchanged hovering between 66 and 63 in the weeks following this and other announcements.  Twenty twenty-one revenue of $38.7 billion with a 25.3% margin and a P/E ratio of 27.2.

Feuer, Will (2022, April 20). Coca-Cola Posts Increase in Sales as Costs Climb. Wall Street Journal, B1.

Unilever Embodies Pricing Power

Unilever raised prices in Q1 2022 by 8.3% and plans further price increases over the remainder of the year.  Revenue increased by 7.3%.  Volumes declined only 1%.

Digging deeper, Beauty and Personal Care achieved a 7.4% price increase with only 0.3% volume decrease, Homecare achieved a 12.5% price increase with only a 2.9% volume decrease, and Food and Refreshment achieved a 7.1% price increase with only a 0.6% volume decrease.

All these numbers imply Unilever is still operating with inelastic demand. That is, Unilever can raise price profitably in the short term.

Unilever may not be in Warren Buffett’s portfolio today, but we can see clearly why he made a bid for it in 2017.  Unilever has pricing power.

Alan Jope, CEO of Unilever, appears aware, stating: “You will see pricing accelerate through the rest of the year.“

UL (Unilever PLC) was relatively unchanged hovering between 44 and 46 the weeks following this and other announcements.  Twenty twenty-one revenue of $62 billion with a 11.5% margin and a P/E ratio around 16.

Chaudhuri, Saabira (2022, April 29). Unilever Increases Prices over 8%, Hurting Demand. Wall Street Journal, B6.

McDonald’s Untapped Pricing Power

On average, McDonald’s raised menu prices by 8%, while overall sales grew by 3.5% same-store sales grew by 11.8% in Q1.  These are strong results.

Kevin Ozan, CFO of McDonald’s, indicated that the 8% price increase was at the menu translated into a 5.5% price increase to the franchises and was associated with 1% fewer transactions and 1% reduction in revenue through trade-downs (poor mix).

These numbers imply McDonald’s is operating in the inelastic demand domain. That is, from a short-term, profit-optimizing viewpoint, McDonald’s should increase prices further to maximize profits.

Christopher J. Kempczinski, CEO of McDonald’s, responded however with “… our mindset is about stealing share, and that’s what we’re seeing in the numbers, both on sales and on traffic.”

This is yet another example of Warren Buffett’s definition of pricing power, albeit one of untapped pricing power.

Also, McDonald’s is currently hiring for a Global Pricing Director, Strategy and Transformation.

MCD (McDonald’s Corp) was relatively unchanged hovering around 250 in the week following this and other announcements.  Twenty twenty-one revenue of $23.2 billion with a 32.5% margin and a P/E ratio around 26.5.

Haddon, Heather (2022, April 29). McDonald’s Price Increases Help Boost Sales in the U.S. Wall Street Journal, B3.

AT&T’s Quiet Price Increase

AT&T Inc. plans to lift the rates on older wireless “Unlimited” and “Mobile Share” plans by $6 to $12 per month starting June 1, 2022.

Given that the U.S. wireless industry has only three major carriers: AT&T, Verizon, and T-Mobile, and given that AT&T has the dominant market share, expect the competitors to follow this price leadership move.

T (AT&T Inc.) was relatively unchanged hovering around 20 in the week following this and other announcements.  Twenty twenty-one revenue of $169 billion with a 11.9% margin and a P/E ratio around 8.5.

FitzGerald, Drew (2022, May 4). AT&T to Increase Rates on Older Cellphone Plans. Wall Street Journal, B3.

Beer Inelasticity During Inflationary Periods

Anheuser-Busch InBev SA stated it sold 2.8% more beer at 7.8% higher prices in Q1 2022.  Heineken NV, Carlsberg A/S, and Molson Coors Beverage Co. also reported higher Q1 prices and higher volumes.

That would place these brewers in the inelastic demand domain where higher prices would drive higher profits.

Commenting on historic trends, Michel Doukeris, CEO of AB InBev, stated “When inflation goes up and demand gets constrained, usually beer trades up not down.”

BUD (Anheuser Busch InBev SA) was relatively unchanged hovering around 54 in the week following this and other announcements.  Twenty twenty-one revenue of $54 billion with an 8.6% margin and a P/E ratio around 27.5.

Chaudhuri, Saabira (2022, May 6). Bud Brewer Buoyed by Pricier Beer. Wall Street Journal, B6.

Kellogg’s Untapped Pricing Power

With a double negative, Steve Cahillane, CEO of Kellogg Co. stated “… we aren’t going to be able to just not pass prices through to consumers.”  In simpler terms: Kellogg’s is going to raise prices.

According to a price, volume and mix analysis, Kellogg’s has increased its profits from price & mix improvements more than profits decreased from volume reductions across North America, Europe, Latin America, and APAC Africa and Middle East.

This data would place Kellogg Co. in the inelastic demand domain where higher prices would drive higher profits.

Cahillane however appears to be more motivated by market share than profits alone.  Worker strikes and a factory fire hampered production leading to a 10% volume loss in the U.S.  Cahillane stated “We aren’t at all complacent and we aren’t underestimating the challenge of rebuilding our business.”

K (Kellogg Co) rose slightly to 73 from 70 in the week following this and other announcements.  Twenty twenty-one revenue of $14.2 billion with a 10.5% margin and a P/E ratio around 16.

Gasparro, Annie and Seal, Dean (2022, May 6). Kellogg Expects Prices to Increase. Wall Street Journal, B6.

Goodyear

Excluding foreign currency impacts, revenue per tire at Goodyear increased 17%.  Darren Wells, CFO of Goodyear Tire and Rubber Co, reported price, volume, and mix all improved for Goodyear’s legacy business in Q1 2022.  A trifecta for Goodyear.

Mr. Wells went on to state: “We’ve got to acknowledge that we’ve got major competitors who have announced two or three price increases during calendar ’22.  And Goodyear – North America has announced one increase of up to 12% on January 1. …. But our market analytics indicates that since the beginning of 2021, the average selling price of Goodyear product in the market has increased over 16% compared to a competitive range of 9% to 12% in North America.”

GT (Goodyear Tire & Rubber Co) fell slightly to 11.3 from 12.3 in the day following this and other announcements.  Twenty twenty-one revenue of $17.5 billion with a 4.3% margin and a P/E ratio around 4.1.

Feuer, Will (2022, May 7). Goodyear:  Price Rises Offset Higher Expenses. Wall Street Journal, B3.