Cost decisions of supplier firms: A study based on the customer-supplier link

Abstract

We examine the association between the cost decisions of suppliers and their key customers. Using a U.S.-based sample of customer-supplier pairs, we document that an increase in the key customer firm’s cost stickiness in the prior period results in a significant increase in their suppliers’ cost stickiness in the current period. This finding suggests that suppliers observe and incorporate the cost decisions of their key customers into their own cost decisions. Further, we find that this relationship is concentrated in the sub-sample where the likelihood of information frictions in the supply chain is high, the customer firms have a positive future demand outlook, and the customer firms’ managers have fewer opportunities to engage in empire-building activities. This paper contributes to the growing literature on cost behavior and supply chains by documenting the role of cost decisions of customers in mitigating the adverse effect of information frictions in supply chains. This paper also provides industry-related implications by suggesting that an increase in the cost stickiness of customer firms could act as a signaling mechanism for the supplier firms allowing them to prepare for a potential change in future demand.