Pricing power

Pricing power is what determines whether inflation is a problem for a business or an irrelevance. Inflation raises nominal revenue and input costs at the same time, so the question is never whether costs rose, it is whether the company could pass them on. A business that can hold its margin through a cost cycle has it. A business whose margin compresses every time inputs rise does not, whatever its management says.

You test it with evidence rather than assertion. Look at gross margin through a period when input costs moved sharply and see whether it held. Look at contract structure: annual list price increases that customers accept are pricing power, while long dated fixed price contracts are the opposite, since they lock the revenue and leave the cost floating. Look at how large the product is as a share of the customer's total cost, because customers argue hardest about the lines they notice.

The concept explains why the same inflation number is good news for one company and dangerous for another. A branded producer facing low price elasticity keeps its absolute margin per unit. A producer selling a commodity into a globally set price cannot raise it at all, and absorbs the entire increase.

It is also usually what a high multiple is paying for. A business that can reprice with inflation has cash flows that hold their real value, which is precisely what makes a long duration valuation defensible. Where practitioners disagree is how much of it survives a genuine downturn, since pricing power measured in a benign period frequently turns out to have been market growth wearing a disguise.