Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets

Abstract

We study the price adjustment practices and provide quantita- tive measurement of the managerial and customer costs of price adjust- ment using data from a large U.S. industrial manufacturer and its custom- ers. We e nd that price adjustment costs are a much more complex construct than the existing industrial-organization or macroeconomics literature recognizes. In addition to physical costs ( menu costs), we identify and measure three types of managerial costs (information gath- ering, decision-making, and communication costs) and two types of customer costs (communication and negotiation costs). We e nd that the managerial costs are more than 6 times, and customer costs are more than 20 times, the menu costs. In total, the price adjustment costs comprise 1.22% of the company' s revenue and 20.03% of the company' s net margin. We show that many components of the managerial and customer costs are convex, whereas the menu costs are not. We also document the link between price adjustment costs and price rigidity. Finally, we provide evidence of managers' fear of antagonizing customers. I have no answer to the questionof how to measure these menu change costs, but these (menu cost) theories will never be taken seriously until an answer is provided. Edward Prescott (1987, p. 113)