For those of us in the land of the living (and working), the latest Office for National Statistics (ONS) wage and inflation data has been a long time coming. After four years of seeing inflation outstrip average earnings, finally September recorded wage growth of 1.3% versus inflation of 1.2%¹. Perhaps the “cost of living crisis” is finally over. Unfortunately the same cannot be said for the cost of dying crisis, the subject of this post.
Question: Which national consumer facing company generates the highest operating margin? No, it isn’t Dunelm, the market leader in soft furnishings. No, it isn’t Howden, the market leader in kitchens. It isn’t even Next, the market leader in homeware and clothing. The answer is Dignity², the market leader in funeral services. Dignity generates operating margins of 30%, which compares to Next/Howden/Dunelm with 20%/17%/16% respectively. Dignity is the most profitable national retailer by a significant margin.
The key reason for Dignity’s high margins is the pricing power it has over its customers. This pricing power is, in my opinion, a function of the distressed and infrequent nature of the sales of funeral services, rather than a differentiated product. A potential customer often has little idea about price, and little desire to shop around. Furthermore, the cost is often born by the deceased’s estate. This means that demand on a local level is almost completely insensitive to price. Even on an industry level demand is not sensitive to price because there is a given quantity of deaths each year, all of which must be provided by a funeral.
As you might expect of any company which operates in an unregulated market, and demonstrates exceptional pricing power, Dignity raises its prices each year. These price rises are well above underlying cost increases, and the consumer price index. In 2005, the average Dignity funeral cost £1700 (arrangement of funeral services and supplies). By H114 this had increased to £2700.
I find it interesting that utility companies, which generate low margins and operate in a regulated market, receive such a pounding from politicians and the media for rising prices, something which they are pretty much forced to do merely to cover their own input cost increases. Meanwhile the funeral service industry which makes very high margins, and raises prices regardless, receives hardly any bad publicity.
In more rational markets, high margins would attract new lower-priced entrants, or an existing participant would lower their prices in an attempt to gain market share. In both case margins would fall. However in the funeral services industry because demand is insensitive to price, trying to gain market share by cutting prices is a pointless exercise.
Dignity would argue that their customer satisfaction remains at very high levels, with expectations for 99% of their customers either met or exceeded. However, given the distressed state of the customer, and infrequent nature of the sale, are customer expectations the right benchmark to use? Should Dignity be allowed to continue to increase prices and margins as long as their (uninformed) customer doesn’t complain?
As an investor Dignity presents a dilemma. Sustainable pricing power is an attractive characteristic of a company. However, ideally pricing power should be a function of a truly differentiated product/service which is hard to replicate, not a result of the fragile nature of ones customers base. It is difficult to see how the status quo changes though, unless the regulator decides that consumer interests are no longer being served… and that is what Dignity shareholders will worry about the most.
1. Source: http://news.sky.com/story/1371766/cost-of-living-pay-rises-outpace-inflation
2. This is no recommendation to buy or sell any particular security