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Micro-responses to shocks: Pricing, promotion, and entry | VOX – CEPR Policy Portal

Studying how firms respond to demand shocks can provide useful insights into firm and consumer behaviour, while revealing important implications for market outcomes and for policy decision making.

Firms can respond to shocks by adjusting prices (intensive margin) and/or their product mix (extensive margin). These decisions may potentially differ for single- versus multi-product firms, for premium-brand versus second-tier manufacturers, and for shocks that are temporary versus permanent; anticipated versus unanticipated; demand-driven versus supply-driven; and positive versus negative.

Understanding the multiple ways in which firms respond to shocks is not easy. While many studies have looked into each one of these potential responses in isolation and yielded valuable insights, less work has been done to document the multi-dimensional response of firms to shocks, and even less on the response of their competitors. For example, a literature focusing solely on the price response to seasonal (and therefore anticipated) demand variation finds that prices are often countercyclical (Chevalier et al. 2003, Nevo and Hatzitaskos 2006) and offers various competing explanations. Research on multi-product firms in international trade finds that adjustments at the extensive margin (change in sales attributed to entry and exit of new products) can be at least as important as changes in the intensive margin (change in sales attributed to goods that exist before and after) – see for example Bernard et al. (2011) and Broda and Weinstein (2010).

In a recent study, we aim to contribute to this work by using very rich micro-level (scanner) data to analyse firm responses to a consumer boycott (Antoniades and Clerides 2018). The natural experiment provided by boycotts is a source of exogenous variation that lends itself to the analysis of cause and effect, as in the recent work of Hendel et al. (2017). Our setting is unique in that the demand shock affects only a subset of the firms in the market. This fact, and the richness of our data, allow us to make a novel contribution by studying the response, both at the intensive and the extensive margins, of both the shocked firms and their competitors.

The large, unanticipated shift in demand away from Danish products and towards non-Danish products provides a perfect setting for studying how firms respond to shocks. Our analysis revealed a notable difference in the response of Danish and non-Danish firms – Danish firms lowered prices moderately and kept the product mix the same after the boycott ended. On the other hand, non-Danish firms kept prices constant but altered the product mix substantially both during and after the boycott by introducing new varieties (barcodes) and new promotional bundles. In other words, we observed that the drop in Danish sales came solely from the intensive margin.

The price trends can be seen in Figure 2, which shows price indices for cheese products calculated in two different ways (varying and fixed weights). There is a decline in the price of Danish products of the order of 5–10% that lasts roughly a year, while there is no discernible change in prices of non-Danish products. The changes in sales are shown in Table 1—the loss of sales of Danish products comes from the intensive margin, while the increase in non-Danish sales from the extensive margin.

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Micro-responses to shocks: Pricing, promotion, and entry | VOX, CEPR Policy Portal.