Pricing Power

What is pricing power?

Pricing power is a company's ability to raise price without losing enough volume to offset the gain. It is not a claim about brand or quality. It is a measurable proposition: after a price increase, revenue per customer rises by more than customer count falls, and retention holds.

The test, stated as arithmetic

A price increase is worth taking whenever the revenue gained on retained customers exceeds the revenue lost to the customers who leave. Because a price increase adds almost nothing to cost of revenue, the gain lands nearly whole in gross profit, which makes the bar lower than intuition suggests.

Three numbers settle it, and all three appear in public filings.

• Average revenue per user or per account, before and after.
• Customer count, before and after.
• Retention, split into gross retention, which counts customers or dollars kept, and net revenue retention, which also counts expansion and contraction inside the retained base.

The split between gross and net retention is the part that gets skipped. Gross retention tells you whether the price increase pushed customers out. Net revenue retention tells you whether the survivors kept buying more, and a price increase can protect the first while damaging the second.

A worked example from a filed price increase

Backblaze announced price increases to its Computer Backup and B2 Cloud Storage offerings in the third quarter of 2023, effective in the fourth quarter. Its annual report for that year disclosed both the outcome and the caveat: there was some incremental decline in the rate at which customers increased storage during the fourth quarter of 2023, but the company did not experience any material impact on customer retention as of December 31, 2023.

The Computer Backup metrics for December 31, 2023 against December 31, 2022 show what that looked like.

• Annual average revenue per user rose from $124 to $140.
• Customers fell from 436,080 to 431,745.
• Annual recurring revenue rose from $53.4 million to $60.0 million.
• Gross customer retention rate rose from 90 percent to 91 percent.
• Net revenue retention rate fell from 108 percent to 100 percent.

Now the arithmetic, step by step.

• Revenue per user change. $140 less $124 equals $16, and 16 divided by 124 equals 0.129, or a 12.9 percent increase.
• Customer change. 436,080 less 431,745 equals 4,335 customers lost, and 4,335 divided by 436,080 equals 0.0099, or a 1.0 percent decline.
• Revenue change. $60.0 million less $53.4 million equals $6.6 million, and 6.6 divided by 53.4 equals 0.124, or a 12.4 percent increase.

Re-check each. 140 - 124 = 16 and 16 / 124 = 0.129. 436,080 - 431,745 = 4,335 and 4,335 / 436,080 = 0.0099. 60.0 - 53.4 = 6.6 and 6.6 / 53.4 = 0.124.

That is pricing power on the measure that matters: a 12.9 percent price-led increase in revenue per customer cost about 1.0 percent of the customer base and produced 12.4 percent revenue growth on a base that was shrinking in units. It is also pricing power with a visible limit. Net revenue retention falling from 108 percent to 100 percent means the retained dollars stopped growing, and the company attributes that particular decline primarily to customer churn rather than to the price increase.

The contrast is a business whose retention runs above 100 percent without needing a list-price change at all. CrowdStrike reported a dollar-based net retention rate of 123 percent as of April 30, 2018 and, in preliminary unaudited estimates, 137 to 141 percent a year later, attributing the rate primarily to expansion of endpoints within existing customers and cross-selling additional cloud modules. That is expansion-driven pricing power, where the customer buys more of the same product rather than the same amount at a higher price.

Where the evidence lives in documents

For a public company, four places.

• Key business metrics, where net revenue retention, gross retention, customer counts and average revenue per user are tabulated. Backblaze reports these separately for each of its two product lines, which is what makes the price increase legible.
• The definition attached to the retention metric. Backblaze defines its overall net revenue retention rate as a trailing four-quarter average, dividing recurring revenue in the current quarter from accounts active at the end of the same quarter of the prior year by recurring revenue in the corresponding quarter from those same accounts, and notes that calculations of similarly titled metrics differ across companies. CrowdStrike's definition compares current-period annual recurring revenue from a cohort against prior-period annual recurring revenue from the same cohort, excluding revenue from new customers and from its incident response and proactive services.
• Risk factors, which is where management concedes what it does not yet know. Backblaze wrote that it might not yet have realized the full impact of the price increases, which could cause it to lose existing customers unwilling to renew at higher prices.
• Management's discussion of gross margin, since a price increase that holds shows up as margin expansion within a quarter or two.

For a private company, ask for the same four things in a data room, and insist that retention be reported both gross and net, per cohort, with the definition written down.

Common mistakes

Citing net revenue retention as proof of pricing power without splitting it. A 120 percent net revenue retention rate driven entirely by seat growth in a fixed-price product tells you the customer is growing, not that you can charge more per seat.

Reading a retention split without its stated cause. In Backblaze's case gross customer retention improved a point while net revenue retention fell eight, and the company attributes that net decline primarily to churn. The split tells you which instrument to look at; management's own explanation tells you what moved it.

Measuring too early. Subscription price changes reach customers at renewal, so the first quarter after an increase reflects a minority of the base. Management's own language about not yet realizing the full impact is the honest version of this.

Confusing pricing power with high gross margin. A high margin often reflects a low cost structure rather than any ability to raise price. The only evidence of pricing power is what happened to volume and retention when price actually moved.

Treating a discount-driven win rate as neutral. A company whose sales team closes on price concessions has negative pricing power, and the symptom appears in realized average revenue per user rather than in list prices.

How it relates to adjacent terms

Net revenue retention is the single most useful instrument for this term, and the reason is that it nets expansion against contraction inside the retained base, so it captures a price increase and its side effects at once.

Price sensitivity is the demand-side mirror. Pricing power is what the seller has; price sensitivity is what the buyer exhibits, and they are the same fact described from opposite ends of the transaction.

A competitive moat is the usual explanation for durable pricing power, but the ordering matters. The moat is a hypothesis about why price can rise; the retention and revenue-per-customer numbers after a price change are the test of it.