Motley Fool Hidden Gems Investing - The Art of Pricing Power

Episode Date: January 20, 2022

Both Amazon and Costco are expected to increase their membership fees this year. Will they surprise customers (and investors) by increasing their fees by more than they have in the past? Maria Gallagher analyzes what’s expected and why pricing power is harder for entertainment businesses like Spotify, Netflix, and Disney+. She also discusses the expansion of McDonald’s partnership with Beyond Meat, the anticipated IPO of Impossible Foods, and why she’s not as bullish as others on the plant-based protein industry. Plus, Jason Moser and Matt Frankel dig into Shift4 Payments and share why it’s more than simply a payments processing business. To get a free copy of our Investing Starter Kit go to www.fool.com/StarterKit. Stocks: AMZN, COST, WMT, NFLX, DIS, SPOT, MCD, BYND, UL, FOUR, TOST, SQ Host: Chris Hill Guests: Maria Gallagher, Jason Moser, Matt Frankel Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. Today on Motley Fool Money, we'll get into why we love pricing power and why we have questions about the business of plant-based proteins. All that and more coming up right now. I'm Chris Hill and joining me from the financial capital of the United States of America, Motley Fool Senior Analyst, Maria Gallagher. Thanks for being here. Thanks for having me. We've also got Jason Moser and Matt Frankel coming up with a closer look at a payments company a lot of investors don't know about, but let's start with a conversation about pricing power. The thing that Warren Buffett has said, he loves to see most of all in a business,

the ability to raise prices over time. If history is any guide, Maria, both Amazon and Costco are going to raise the price of their membership fees this year. The last time Amazon did this with Amazon Prime was four years ago, and the time before that was four years prior. With Costco, it was on five-year cycles. They raised the price of a Costco membership five years ago and then five years before that. Let me start with this. If you're a shareholder of either company, first of all, congratulations. These are great businesses that have rewarded shareholders for a long time. But if you're a shareholder, you have to be hoping that they are going to follow suit and in fact, raise the price of membership. Yeah, especially during today's

inflationary environment. That's something that I think people are going to be looking for. So we're about, they say likely eight to nine months away from a likely membership fee increase for Costco. I'm thinking maybe August or September thinking it might go up about $5 for their gold Starfita $65 and their executive membership up $10 to $130. What's really interesting though, is that Costco has really consistent track records and such a loyal following. So they have a really high member renewal rate of 91% in the US and Canada and 89% worldwide in 2021. So what you see is as these price increases happen, you see that these members are so loyal to these companies that they say, okay, well, what I'm getting from this membership is really worth it for me. So I'm

going to keep paying that. And I think you see that with Costco and you definitely see that with Amazon because Amazon, you know, touches every part of our lives, even if we don't realize how much of our lives it touches. So even if you don't use Amazon prime that much, you maybe want to watch the Amazon prime TV shows, or you want to get whole foods delivery, or you want to get good deals on audible audio books. So all of these things make it worth it. All of the benefits of those memberships make it worth it for the consumers? I'm sure there are Wall Street analysts who, on this next set of earnings calls for these two companies, assuming that membership fee increases are not announced, they're going to ask about this. And they're

probably going to, and we've seen this for decades with Costco, they're probably going to ask, why aren't you raising it more? Because Costco raises it $5 at a time, which seems, and I'm not a Costco member, but it seems like they could go bigger if they wanted to. Amazon kind of done the same thing. They started at $79, they raised it to $99, then they raised it to $119. My expectation as a Prime member and an Amazon shareholder is that when they announce a price increase, it'll go to $139. I guess my question, Maria, is, is it the smart move for these two businesses to keep going at this expected clip when, certainly in the case of Costco, they could go higher? They could raise it $10, and I think that people would be fine, the overwhelming majority of those

members would be fine going from $60 to $70 a year. It's a great question, and I'm sure there are a lot of people doing this math internally to see what that inflection point is, is bringing the price too high so that you see consumers getting outraged. You don't want to jack it up so much that so many people leave that it ends up not being profitable, but you don't want to do it too little. And then that doesn't increase profitability the way investors and consumers want to see it. So I think it's all about finding the perfect balance. And I think Costco specifically has always really tried to be so consumer focused and consumer forward that they want to do the best thing for their consumers and they want to increase it just a little bit as much as they can

so that they can continue to give the best offerings to their consumers. And I think you see it with other entertainment companies as well. So you saw more pushback when Netflix raised its prices and people saying, well, I'm just going to leave because I'm only getting one thing from Netflix and I can get it lots of other places. So understanding also the dynamics of the switching costs too, of will people be more interested in getting a Walmart Plus subscription if Amazon Prime increases too much or getting into more Sam's Club if Costco raises their prices too much. So it's all about, I think, finding that balance of understanding the competitive dynamics, what they're offering to members, and then what members are willing to pay

to stay a part of this corporation as opposed to moving to an easy switch. I'm sure there is some testing that these businesses do, whether it's sort of focus testing with their members to see what they're willing to stomach. But it does seem like there's a decent amount of art that goes into raising prices. And I'm glad you mentioned the entertainment companies, because one of my thoughts when I was sort of looking over the history of Amazon and Costco raising prices is that it seems to me anyway, like it might be a little bit easier for them in this regard. Membership of Prime, membership of Costco is a pathway to buying more stuff. And this is something you touched on. Everybody does math in their head when it comes to

paying fees. We do it, whether it's Netflix, Spotify, anything we're paying for, we're doing the math in our head. And the math always comes down to the same thing. Is this worth it? And And with Amazon and Costco, it seems to me it's a little easier because part of the math people are doing in their head is, well, how much am I spending every year on Amazon.com? How much is my family grocery bill every month or every year at Costco and all the home goods that I'm buying? Yeah. Therefore, it's worth it for me to pay $60 or maybe when they announced the increase

$65. Is it harder for Spotify and Netflix and HBO Max and all these others? Because it's not a pathway to buying more things and spending more money. It's simply a comparison against the experience itself. Spotify raising prices, by the way, am I right, they've never raised the price of their monthly fee? They've never raised their premium. They've raised some other parts and it depends on what part of the world, but for the most part, no, Spotify hasn't really increased prices. Why is that? I know people who use Spotify and love Spotify. And if they kicked it up a dollar a month, I'm sure they wouldn't blink.

I think they should. So I think this is such an interesting question and kind of an interesting thing to think about. I think so much of it too, is I wonder if it's about understanding what type of goods you're getting from these, right? So I would argue that Netflix, Spotify, all of these entertainment services are seen more as a luxury because you're getting something. Whereas if I'm going to Costco to buy toilet paper and I'm buying headphones on Amazon Prime, these are things that you need that aren't necessarily these things that give you that much joy in the same ways that I think is kind of an interesting dynamic and seeing, well, you're getting so much from a Costco membership. I looked up what the most expensive things sold on Costco are and somebody bought a

$600,000 diamond at Costco. So you have a real range of things you can buy at Costco. You have a real range of things you can buy on Amazon Prime. There's a poster of Dracula being sold on Amazon for $1.2 million. Whereas if you go to Netflix, if you go to Spotify, you know what you're getting. You're getting music, you're getting TV shows. And somehow even with Netflix, you see a lot of the TV shows you came to Netflix for are maybe leaving Netflix. New Girl's leaving Netflix. The office has left Netflix. So understanding the value the customers get. And I think part of it is it feels more like a luxury getting these TV and entertainment things into your home because you don't necessarily need them the way that you need toilet paper and you

need food or you need these things that you're getting from Costco and Amazon. So I think it's all about understanding that mental math people are doing and what they're willing to pay for it. You talked about Netflix and their raising prices in the past. It does seem like the initial price point that these businesses set gives us as investors an indication of how the businesses are planning to execute what they're delivering and their intentions to raise prices over time. If you think about Apple coming out with Apple TV and pricing it at $5 a month and it's Apple, they've got all the money in the world. They could have made it $3 if they wanted to, but setting that intentionally low price point because

they just wanted to get as many people in the door as possible and build it up over time. You could probably say the same thing about Disney Plus. When they first came out with that streaming service, I was surprised at how low they priced it until you and other people on the Motley Fool analyst team pointed out to me like, well, yes, it's much lower per month than Netflix. They also have a hell of a lot less content to offer than Netflix does. So that's why they're pricing it in such a way. Same sort of strategy almost though, right? Where let's price this low, get people in the door. And then as we're already seeing with Disney+, yeah, we're going to tick that price up over time. And I think also the low price point comes

into that idea of kind of forget subscriptions, right? I accidentally paid for a stars plus subscription for four months because I wanted to watch Good Will Hunting and it was only on stars. So I paid, I thought I did a week trial. I thought I canceled it. I didn't, but months went by and I didn't notice that I was still paying for it. You see that with gym memberships or you're saying, oh, I'll go next month. I'll just pay. It's only $10 a month. So having that very low price point saying, oh, well, it was only $5. I watched a couple episodes of Ted Lasso. Maybe I'll keep it for another month. And then you just keep going. So there is a point where that gets too high. I would say $15 with Netflix. It's too high for a forget me type of subscription. That's a

noticeable amount of money. If you're in a $5 range, I think that that gets into that kind of forgetting mentality where people are like, oh, I kind of watched it this month. I'll just keep paying for it. So that's an interesting thing, I think, too, with streaming is figuring out how many people can kind of pay for it and only use it sometimes versus how expensive does it have to be for you to say, well, if I'm going to pay this, I want to watch it every day, or I want to be watching Netflix, or I'm going to pay up for HBO Max because everything they do is so good and I'm obsessed with Succession or whatever the show is. Last thing before we move on, there's not really any reason for us as investors to expect that Amazon and Costco are going to break from

tradition, right? I mean, if we could bet on this at a sports book in Vegas, overwhelmingly, the odds are Costco is going to increase their membership later this year by $5 and Amazon's going to do it by $20. That's, I mean, anything else would be a real surprise, wouldn't it? Yeah, I think that you can, it's been kind of consistent, like you've said. And I think, especially in this environment, especially with these inflationary pressures, they want to anyway. So it's a good kind of time for them to do it. And both it's about time and also it's a good time. McDonald's is expanding its partnership with Beyond Meat starting on February 14th. The McPlant Burger will be available at 600 locations in two major

metropolitan areas, San Francisco and Dallas-Fort Worth. I get how some people would look at this news as a win for Beyond Meat, I kind of think it's long-term potentially a bigger win for McDonald's, both in terms of what they offer. But if this thing becomes a hit, doesn't it give McDonald's slightly more negotiating leverage with beef producers? Well, I'm sure McDonald's is probably getting a great deal with Beyond Meat with the potential. They have over 14,000 locations. So that's a huge market for Beyond. So I think that McDonald's has lots of power in all of these negotiations already, but I agree definitely it could increase their power. I think it's also interesting. So this is a part of a three-year partnership. Beyond Meat has some

of these other partnerships with Pizza Hut, with their Beyond Sausage Crumbles, KFC with their Beyond Fried Chicken. That's at only about 10 KFC restaurants for a limited time. So you see a lot of these fast food chains are really testing out the consumer appetite in the U.S. and Canada for these types of offerings. And so I think it's interesting. I think it's an important space because you see a lot more people are looking for less meat options, but essentially I think beyond specifically, it's a product that it's not that different. It's not that special veggie burgers. I'm sure I can get pushback from this, but most veggie burgers kind of taste the same. Some people will disagree, but most people for the most part will say they're kind of a commodity,

they're kind of commoditized. So the competition is only going to get more intense. So I think the rhetoric in this space about the excitement with Beyond Meat, the excitement with all of these offerings is a little bit different from the reality of if it's not Beyond Meat, it could be somebody else. Or if you go to a grocery store, if you're picking Beyond Meat, you're really just looking at Beyond Meat, Impossible, the Whole Foods brand, whatever it might be, you're kind of just picking the cheapest option or the option that looks pretty good. This is a good opportunity for me to point out that our email address is podcastsatfool.com for anyone who wants to push back on Maria's comment about veggie burgers. Impossible Foods is expected to go public later

this year. I'm sort of torn, Maria, because I believe in the future of this industry, plant-based alternatives. And yet, I have not yet seen anything in the business of Beyond Meat, and I don't expect I'll see anything in the business of Impossible Foods when they go public to make me want to jump in as an investor. Is this an industry whose future for investors is going to be less about individual businesses like this and more about larger businesses that have a plant-based division? And by the way, one way that happens is some large company just buys Beyond Meat. Yeah, I would expect some consolidation in this area. I would expect maybe Tyson's or you have these bigger conglomerates saying, this is a space that's interesting.

Beyond already has a foothold, so let's just buy them and make them a part of a larger conversation. I can't think of a food brand that people are so loyal to that has stayed independent in this way. I think the brand I think of that I'm the most loyal to is Ice Cream and Spend and Jerry's and that's owned by Unilever. And it's the power of just a brand selling one thing in one area. I don't think it's as strong as maybe they would like it to be. And still not that many people are vegetarians. I think it's also one of those things with the rhetoric is now nobody's eating meat, but it's only about 5% of U.S. consumers. So it's still a relatively small amount. So maybe you're going somewhere and you want the vegetarian option for your one friend

that's a vegetarian, but I don't think that all of your friends now are going to be getting the Beyond Burger because you have one friend that's a vegetarian. So I wouldn't say I'm incredibly bullish on the space. I would think that there's going to be some consolidation and maybe some of these bigger players are going to pick up some of these more niche players. Maria Gallagher, great talking to you. Thanks for being here. Thanks so much for having me. Shift4 Payments is not exactly a household name. The company went public in the summer of 2020, and while the stock is up 50% since its first day of trading,

Shift4 has largely flown under Wall Street's radar. For more on a business that investors might want to take a closer look at, here's Matt Frankel and Jason Moser. Matt, long-time listeners know that you and I always enjoy talking stocks, particularly in the financial space. I mean, that's what we've done for so long. This week, we're going to take a closer look at a company. It's still relatively new to the Public Markets. The company is Shift4 Payments. Before we get to what you like about this business, what is it that Shift4 Payments actually does? They're a payment processor at heart, but there's so much more than that. They're also

a software-as-a-service company, and they target specific industries. Their bread and butter is the restaurant business right now. They're a big competitor of Toast, if you know that company. They process payments. They have a point-of-sale system. It's actually a whole restaurant operating system. A lot of listeners don't know this about me. I came from the restaurant business. That was my first career another lifetime ago. I took a look at what Shift 4 offers to restaurants, and we had nothing like this when I was in the business way back in the day. It really just automates the whole thing. It provides technology. If you've ever gone to a restaurant where you could scan a QR code and then pay your bill, that's most likely Shift 4

was the company behind that. They power these for some of the biggest brands in the business. Applebee's, IHOP, KFC, Denny's are all Shift 4 customers. They're also big in the hospitality business. Hilton is a big customer of theirs. They try to be very specialized, which is what makes them a lot different from other payment processors. Square is a competitor, but they're not just all-in on restaurants, if that makes sense. Well, that does make sense. I'm glad you said that, because when I was reading about Shift4, it reminded me of, you just said it, toast. Really, it is that exposure to the restaurant industry. One of the things that you like about the business, one of the

things I like about it too, it really feels like this is a one-stop shop. I think you said the key phrase there, operating system. For a restaurant to be able to have an operating system they can rely on. I mean, this is a system that does a number of different things for the restaurant, for the business itself, right? Right. It's a land and expand model. They'll provide one service such as the restaurant software system. One of the big things that differentiates them from Toast is that Toast doesn't have an in-house payment processing option. They'll cross-sell them that payment processing option. They're expanding it to new verticals. Gaming is a big focus of theirs

right now, where they're building out things for gaming. BetMGM was their first big get in that space, where they're the infrastructure behind that. What they do is they provide a host of services for these specific industries, like restaurants, where there are other competitors, but no one provides a comprehensive solution that they do, and that's the secret sauce behind the model. Yeah. You have a comprehensive solution coupled with a large and growing market opportunity, and you have a recipe for tremendous potential success. Let's talk a little bit about that market opportunity, because all-in, this is a massive market opportunity. It's tough to quantify, and companies

throw these trillion-dollar sums around that they're never actually going to get. ShiftForward, they think their current market opportunity, between all the companies they could go after, about $1.1 trillion in annualized payment volume. Pretty big market so far. They're planning on adding more verticals over time. Just to name a few, non-profits are one of the newest things they want to get into. The healthcare business doing healthcare payments and software solutions. Then technology, SpaceX Starlink is actually one of their newest clients. has very high long-term potential for obvious reasons. As they build these verticals, they say their market opportunity is going to grow to about $3.7 trillion in payment volume.

They're currently at about $50 billion, so a very, very small fraction of where they think they could be. I don't see them ever getting into the trillions, at least not anytime soon. But the point is that there is room to 10X this business and still be at a pretty small market share. And it feels like the leadership story here is one that investors should feel really good about. Is that right? Oh, for sure. I mean, I'm a big fan of their leadership team. I honestly had dug into them about a year ago, so I can't remember names off the top of my head right now. But I remember their leadership's highly invested, great compensation structure that really kind of aligns their interests with shareholders. Very shareholder

friendly management is kind of the feel I get from them. Right. And to be clear, we're talking about founder, CEO, Jared Isaacson, I think is who you're referring to. Yeah. I mean, still kind of a young buck, I think, in the CEO world. I have a whole sheet of stats in front of me, but that name wasn't on there. Well, hey, listen, none of us is perfect, Matt. None of us is perfect. But I mean, listen, that's something we always focus on, at least with leadership. I mean, it's never really the solely reason to invest, but it's always nice to know that you have founders involved there with skin in the game, really with the passion to take that business as far as they can. We talk a lot about things we love

about this business. I mean, clearly there are things to keep an eye on there. One thing that I go back to, I started thinking, I like the idea that they focus on such specific markets, but are you concerned that in time, maybe they pursue ancillary markets where they don't necessarily have an edge? I mean, I'm thinking something like a healthcare, for example, where regulatory considerations can be a lot higher than something like the restaurant business. Do you feel like there's that opportunity for diversification, I guess, for lack of a better term? Yeah, there's a ton of execution risk when you're going into new verticals like that. There's a ton of risk involved with just being a specialist, by the way, in, say, restaurants.

Sure. I mean, Shift4's business was much more affected by the pandemic than, say, Square or PayPal, because what happened to restaurants when the pandemic started? So, there's risk both ways. I like Shift4 for their core competencies, which are restaurants, hospitality, the things they do really well. I think there's enough room to grow just in those markets as it is. Like I said, I mentioned their current addressable market's about a little over a trillion dollars in annual payment volume, and they're at about 50. So, there's a lot of room to grow into their markets that they've already proven they can do. Yes, there's a lot of execution risk there, which is why I alluded to take that $3.7 trillion figure with a big

grain of salt, because the healthcare market might not work out for them. Starlink might not be $100 billion annual revenue stream like they think it's going to be, things like that. But as far as their core business goes, you really can't argue with the success they've had so far. No. I'm glad you said success, because I feel like there's a growing gap between the business itself and how the market is treating this company today. The stocks had a tough last 12 months, down around 30% as we're speaking. But generally speaking, when you look at the business, it's growing. Topline is growing, you've got this opportunity for plenty of other markets to reach there. How

do you view this as an investment opportunity for investors? Is this just some other fintech name, or you really got to wait for them to prove their use case, or do you feel like there really is the opportunity, the differentiation that makes this an idea that investors should consider? I'm glad you just mentioned top-line, because that answers the question right there. Shift4 has grown its total payment volume, which is where it derives most of its revenue, at a 37% annualized rate over the past five years. That's higher than Square, PayPal, Visa, or MasterCard. That's a better five-year growth rate than any of those companies. The growth rate is even higher when you look at that core restaurant business,

52% growth in payment volume through their network, annualized since 2017. I do think that the use case is being proven out. I mentioned some of the brands that use them. T-Mobile Arena is one of their new entertainment brands that picked them up. If you go to that stadium in Las Vegas, you're going to be using Shift4. Caesars is a customer of theirs now. Hilton is a customer of theirs. I don't like to just sit here and drop names, But this list of names really shows what the use case is. The fact that these big companies are picking them up over Square or over Toast, it shows that there is a big use case for this platform. I agree. I think there is a lot to be said for that. Those big customers,

they can lead you down a road of picking up a lot of new customers, both small and large. That's good to hear. Matt, it was really great catching back up with you this week. Thanks so much for digging into what really looks like a compelling name in the fintech space. Yeah, it's always great to talk with you. We have to do this again sometime soon. That's all for today, but coming up tomorrow, we'll break down what you need to know about the industry leader you're probably already a customer of, Netflix. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

I'm Chris Hill. Thanks for listening. We'll see you tomorrow.