Price Outlook Examples

Consider the balance between demand and capacity, the history of real price increases and industry return levels to estimate whether future prices will tend to rise or fall based on these developments.

Example 1:

In 1995, Assisted Living emerged as one of the fastest-growing segments of the health care services industry due to the increasing elderly population, regulatory constraints on the addition of skilled nursing beds and health care cost containment pressures.

Explanation: The prices in this industry are likely to rise or stay high in the foreseeable future. Demand is increasing with the increase in population and with the redirection of patients from more expensive hospitals. At the same time, capacity is constrained by regulations on the addition of skilled nursing beds.

Example 2:

When GE bought RCA in 1986, it went into consumer electronics. GE planned to use automation and workforce reductions to improve consumer electronics profits. Far Eastern competitors introduced many product innovations along with very low prices.

Explanation: Prices are likely to come under pressure. A major competitor has found cost savings that will increase its margins at the current price. Over time, these costs are likely to be passed on in price savings to the customer because of the press of competition in a market that is not an oligarchy. At the same time, Far Eastern competitors are increasing their presence in the market, with very low prices which apparently are not yet fully matched by the domestic producers.

Example 3:

In 2000, Dell was turning its focus to make servers its No. 1 priority. Dell was concentrating on customers and technologies important to internet infrastructure. They unveiled new low-cost servers for running web sites and a new program to accelerate server deliveries and provide customer referrals to web host firms that used Dell equipment.

Explanation: Dell is a significant and expanding entrant in the market, that alone should put pressure on margins. However, Dell also tends to use low prices to increase its share. So prices in the industry are likely to come under pressure both because of the expansion of competition as well as the tendency of Dell to use price to gain share. This industry can be a high growth industry, however. If that growth exceeds the ability of current industry competitors to add capacity fast enough to meet the growth then prices will rise or remain at high levels.

Example 4:

During 1992's first 3 months, drug prices rose between 3% and 6% on average, down from the 10-12% range prices had risen during the first quarters of the last five years.

Explanation: Prices and margins from a competitive point of view could easily stay high. There are a very limited number of alternatives for these drugs. Prices in the industry are likely to remain under some pressure as large drug buyers react against high levels of real (that is, inflation-adjusted) price increases. Government pressure could decrease demand enough to cause the companies to reduce their prices in order to satisfy this Very Large customer. However, since capacity in any proprietary drug is controlled by its producer, individual drug prices may continue to rise faster than inflation.

Example 5:

American Greetings' price increases from May 1994 to August 1996 averaged 3.3% per quarter or 13% annually.

Explanation: Prices in real terms are rising very rapidly in this industry. Prices should get weak under the press of the expansion of lower-cost competition or a decline in demand as consumers resist. American Greetings, as one of the leaders in the industry, has raised prices in real terms and has increased its margins significantly. These high prices either allow new competitors to enter the industry or may depress demand from consumers.

Example 6:

Some low-priced cigarettes are selling for as little $1 a pack, compared with an average retail price of more than $3 for big-name brands, such as Marlboro. To feed the market for inexpensive cigarettes, tiny factories, with antiquated second-hand equipment, are popping up across the country.

Explanation: There are new low-cost competitors entering the market under the price umbrella of the brand names. Prices should come under pressure in this very profitable market.

Example 7:

Over the past decade, industry leaders, particularly General Mills Inc., have jacked up the cost of a box of branded cereal to as much as $5. But while prices have gone up, demand has gone down.

Explanation: This industry has seen several years of real (inflation-adjusted) price increases. Returns and prices are both high in this industry. These prices should come under pressure because of declining consumer demand and the growth of substitute products.

Example 8:

An entrepreneur took over some Evelyn Wood Reading Dynamics franchises and began raising prices above their $195 level. Sales increased as prices went up until market resistance appeared at $395.

Explanation: In the next 2 to 3 years, industry prices may remain firm. The industry has limited capacity because of the lack of brand name substitutes. At the same time, price increases reached high levels before product demand dropped faster than prices increased. The industry is likely to be able to maintain the new high price levels for some time because of the lack of alternatives. However, these high price levels may provide an price umbrella for future new entrants into the market.

Example 9:

In 1987, mail-order pharmacies, like Medco's National Pharmacies, JC Penney's Thrift Drugs and Health Care Services, promoted generics and offered drugs at prices from 20-30% cheaper than drugs at conventional retail outlets.

Explanation: The drug manufacturing industry's prices should come under pressure as mail order pharmacies depress demand for the proprietary drugs and increase demand for generic substitutes. Demand is falling and new low cost capacity is increasing.

Example 10:

In 1996, the business intelligence software market grew at more than 70% a year.

Explanation: Pricing should stay stable at a high level because demand is increasing far faster than most companies would normally be able to add capacity. This high rate of demand should have allowed high prices in the industry. The continuation of this rate of demand should allow these high prices to remain in effect until the industry can add capacity as fast as demand grows.