In my experience, there are two types of businesses on the ASX: price-takers and price-makers. Here’s why it’s important to know the difference and some examples of each…
The Price-Taker
A price-taker is a business that is unable to dictate prices for the goods or services it produces. Meaning, a price-taker must accept the market price. Think of the prices of new model televisions, or coffee from a cafe that has five identical cafes next door. If prices are set too high, consumers will go elsewhere for a cheaper alternative.
There are many reasons a company may be a price-taker.
Strong competition tends to result in competitive pricing and a “race to the bottom” begins. The prices of products fall continuously until no business in that space can make a decent profit. This is common for retail businesses like Harvey Norman Holdings Limited (ASX: HVN) and JB Hi-Fi Limited (ASX: JBH).
Other times, product prices are determined by external factors like commodity prices.
For example, despite the sheer size of a company like Rio Tinto Limited (ASX: RIO), it can’t control iron ore prices — its number-one product. Fluctuations in commodity prices can severely impact the profitability and, therefore, the share price of a business like Rio Tinto.
This is why price-takers don’t make ideal long-term investments, in my view. Ultimately, they have little to no power to consistently increase their prices and profits.
Wouldn’t you prefer a company that could consistently increase prices and still retain their customers?
The Price-maker
A price-maker is the exact opposite of a price-taker. They have some sort of advantage that allows them to dictate the market price of the goods or services they provide.
A common example is a monopoly. If one company controls an entire industry, they’re able to increase prices without losing customers because there are no competitors providing alternative services. Fortunately for consumers, there are few true monopolies.
One example of a company that can raise prices and still retain customers is REA Group Ltd (ASX: REA). REA is the company behind realestate.com.au, the go-to website in Australia for buying, renting or selling a property. It also has stakes in several other international property sites in the US, South East Asia and India. You can read more about REA in this Rask Media article.
Although there are competitors, REA dominates the space and is able to raise prices because of the amount of traffic their website generates. As the website continues to grow in popularity, they will be able to continue charging higher prices.
It Won’t Last Forever…
Although REA looks great now, they might not be able to raise prices forever. Jobs portal Seek Ltd (ASX: SEK) used to have similar market power to REA until other sites like Indeed.com and Jora came along. An increase in competition could reduce REA’s market power and turn them into a price-taker.
Summary
Price-makers are difficult to find because truthfully there are very few of them. If you can find one on the ASX you might have a great investment opportunity on your hands.
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Disclaimer: At the time of writing, Max does not own shares in any of the companies mentioned.
