(Bloomberg) -- Companies from automakers to hoteliers keep on sacrificing sales volume – sometimes by design, sometimes by necessity – in favor of higher prices, a dynamic that will test the Federal Reserve’s efforts to rein in inflation.
The latest set of earnings showed that businesses aren’t likely to walk away from a strategy Corbu LLC’s Samuel Rines calls “price over volume” adopted by certain industries at the height of the pandemic, when supplies and labor were both hard to come by.
Ford Motor Co. said this month it is aiming to maintain robust sticker prices, even if that means rolling fewer cars off its assembly lines. Lodging giant Marriott International Inc. has focused on increasing room rates, especially for corporate accounts. Southwest Airlines Co. is among US carriers that are pulling in record revenue as tight flying capacity is helping to keep fares higher.
With peak tourism season around the corner, this reliance on pricing power isn’t going anywhere. And it may be apparent in Wednesday’s consumer price index report, which economists surveyed by Bloomberg estimate will show the annual inflation rate was unchanged at 5% in April after falling for nine straight months.
“It is going to prove much more sticky, prevalent and problematic for the Fed over the summer than people anticipate,” said Rines, an economist and managing director at Corbu.
Auto prices are not far off record highs and the average monthly payment for a new car in March was $754 amid rising interest rates, according to Cox Automotive. That’s almost one sixth of the median post-tax income for US households. The price crunch will likely get more acute as carmakers push to convert their fleets to more expensive electric models.
The pricing tactics reflect lessons of earlier phases of the pandemic: When Ford and its rivals struggled with a chip shortage, they saw running with a thinner backlog of cars had profit upside.
Unlike Ford, which is intentionally limiting manufacturing output, some airlines can’t fly at full capacity because they don’t have enough trained pilots and are seeing delays in receiving new aircraft and parts. Southwest, for example, has said it could have operated as much as 8% more flying capacity in March if it had enough pilots.
The capacity constraints, coupled with strong demand, are allowing the industry to command high prices, especially for flights overseas. Round-trip fares to Europe are averaging $1,032, or 35% above last year and 24% higher than pre-pandemic, according to travel search engine Hopper Inc. International fares should reach their highest levels in five years this summer, the Hopper data show.
The lodging industry, meanwhile, has changed its playbook for the current consumer environment. Prices at US hotels increased by more than 10% in the first quarter compared to the year before, according to data from STR, a Costar Group company. Over the same period, though, occupancy rates increased by only about 6%.
One reason is the demand mix has changed, with leisure travelers returning faster than business travelers, concentrating demand on weekends. But owners also acclimated to running hotels at lower occupancy, a model that helps reduce costs because there are fewer rooms to clean.
“In the pandemic, the industry lost a lot of staff, and gained a lot of pricing power,” said Jan Freitag, national director for hospitality analytics at CoStar.
These service businesses are courting consumers who have been conditioned to put up with price increases after pandemic-related supply chain snarls drove up the cost of everyday staples.
Case in point: Kimberly-Clark Corp., the Dallas-based maker of Huggies diapers and Kleenex tissues, raised prices by 10% across all its categories last quarter. Sales volumes did fall by 5%, but its gross margin rose to 33% from about 30% a year ago.
“If the price goes up on bath tissue, it generally doesn’t mean you’re going to use the bathroom less, right?” Chief Executive Officer Michael Hsu said on its earnings call last month.
Rines, the Corbu economist, says that backdrop has led investors to expect companies to raise prices to become more profitable.
“What we’ve seen is companies across the board do that,” he said. “And if companies can’t do that, they’re getting hammered.”
Still, price-hike strategies can only carry service-sector companies so far. Consumers might balk, and some politicians and economists, including Rines, have already characterized the moves as opportunism because profits have risen alongside prices.
Diana Gomes, a Bloomberg Intelligence analyst who covers consumer goods, said that for all the companies she follows, gross margin is still below what it was in 2019 – a signal their price hikes are largely only offsetting rising commodities and supply-chain costs.
Going forward, prices for services like travel and hotel stays are the biggest concern for the Federal Reserve.
That in part reflects that services companies rely more heavily on workers than manufacturers do, so they’re more affected by wage growth. And those gains have been relentless, up 5.1% year over year among private-sector workers, according to the Bureau of Labor Statistics.
For the Fed, the challenge is to cool off a hot labor market while simultaneously sapping companies’ pricing power, said Kathy Bostjancic, chief economist at Nationwide Life Insurance Co. She sees consumers scaling back on spending a bit once they scratch their travel itch this summer, given rising costs.
“It needs to be seen if companies can continue this pricing power,” she said. “My sense is that it fades.”
©2023 Bloomberg L.P.
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