A healthy margin proves nothing about pricing power on its own. What proves it is a margin that held, or improved, the last time the business tried to raise prices and a customer had the choice to say no.
Key takeaways
Pricing power is the ability to raise a price without losing the volume behind it. A business can carry a strong margin today for reasons that have nothing to do with that ability — a legacy contract signed years ago, a supplier concession that is about to expire, a market that has not yet given customers an easy alternative. None of those tell a buyer what happens the first time the new owner tries to move the number. The only reliable evidence is a documented history of actual price changes and what happened to volume and retention afterward.
A stable, well-explained margin is reassuring. An unexplained one is a flag. Among deavo's own red-flag list for reading a target's financials: “margins that move significantly from year to year without an obvious explanation” sits alongside related-party pricing — “including rent paid to a property the owner also owns” — as a pattern worth chasing down before it is accepted as pricing discipline. A margin that moved because a related-party lease was quietly below market is not evidence of pricing power; it is evidence the seller was subsidizing the number, and that subsidy ends at closing whether the buyer priced for it or not.
A margin question and an asking-price question are closer together than they look. Deavo's own list of mistakes that lower a sale price includes “an unrealistic asking price — pricing based on what the owner needs rather than on how comparable businesses have actually traded,” and the same source notes that customer or supplier concentration issues typically “surface partway through due diligence, after a buyer has already spent time and legal fees getting to a signed letter of intent, which is exactly when a seller has the least room to walk away.” A margin that has never faced a real pricing test and an asking price built on the owner's retirement needs are frequently the same underlying problem told from two different angles — both assume the market will simply accept what the seller has decided the business is worth.
The earnings base a margin is measured against is itself a judgment call, which is exactly why it needs checking rather than accepting. “A multiple applied to SDE is not directly comparable to a multiple applied to EBITDA for the same business, since the earnings base itself is calculated differently,” and converting between the two is “imprecise and should be treated as directional only.” Aggressive or unsupported add-backs are “one of the more common points of pushback during due diligence,” and for good reason — a margin built on a generous add-back schedule can look identical to a margin built on real pricing discipline until someone reconstructs the earnings line by line and asks how consistently the add-backs were applied year over year.
Pricing power reads differently depending on what the business sells and to whom. Deavo's retail hub puts it plainly: “foot traffic, sell-through and supplier terms tell a buyer more about next year than last year's sales do,” and its wider outlook note makes the same point at the market level: “two businesses with similar revenue can trade at noticeably different multiples depending on how much of the earnings depend on the departing owner, how documented the operations are, and how concentrated the customer base is.” A margin propped up by a handful of concentrated relationships carries a different pricing-power story than one earned across a wide, price-sensitive customer base, even at an identical percentage.
Evidence a margin is pricing power, not luck
A dated record of an actual price increase, with volume and customer-count data from before and after it.
Confirmation that any related-party pricing (rent, management fees, supplier arrangements with the owner) is at arm's length, not subsidized.
A consistent add-back methodology across years, not a schedule that grew more generous as the sale process approached.
Customer concentration behind the margin — a small number of accounts can hold a headline price while masking real fragility underneath it.
A target shows a stable 34% gross margin across three years and a clean SDE add-back schedule. Digging into the general ledger, the margin held steady because the company's largest supplier contract — 40% of cost of goods — was locked at a fixed price for the full three-year window and expires four months after the deal's expected close. There has been no price increase to customers in that period; the flat margin is a function of a flat cost, not tested pricing power. Once the supplier contract resets to current terms, the same 34% margin requires either absorbing a real cost increase or passing it to customers who have never been asked to accept one — a genuinely untested event that the historical margin gives no evidence about either way. It is the same reason a margin figure and a pipeline figure should be diligenced together rather than separately, and why a growth projection that assumes the margin holds needs its own evidence, not a borrowed assumption from the historical trend.
Not by itself. A stable margin is consistent with real pricing power, but it is equally consistent with a fixed input cost, a subsidized related-party arrangement, or an add-back schedule that has quietly grown more generous. The margin trend needs a documented cause before it counts as evidence either way.
Because the margin a buyer is evaluating is only as reliable as the earnings base it is measured against, and converting between the two earnings measures is directional, not precise. An inconsistent add-back methodology can make an untested margin look like a proven one.
A dated record of an actual price increase to customers, with volume and retention data from before and after it. Absent that specific event, a margin history describes what happened to cost, not what customers were willing to accept.
It's worth treating as a related question rather than a separate one. Deavo's own framing of a common seller mistake — pricing based on what the owner needs rather than on how comparable businesses have actually traded — and an untested margin often come from the same place: an assumption that the market will simply accept the number the seller has already decided on.
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