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Asymmetric Wholesale Pricing Theory & evidence

Asymmetric Wholesale Pricing Theory & evidence -...

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Vol. 25, No. 2, March–April 2006, pp. 131–154 issn 0732-2399 eissn 1526-548X 06 2502 0131 inf orms ® doi 10.1287/mksc.1050.0138 © 2006 INFORMS Asymmetric Wholesale Pricing: Theory and Evidence Sourav Ray DeGroote School of Business, McMaster University, 1280 Main Street, Hamilton, Ontario L8S-4M4, Canada, [email protected] Haipeng (Allan) Chen Department of Marketing, University of Miami, Coral Gables, Florida 33124, [email protected] Mark E. Bergen Department of Marketing and Logistics Management, Carlson School of Management, University of Minnesota, Minneapolis, Minnesota 55455, [email protected] Daniel Levy Department of Economics, Bar-Ilan University, Ramat-Gan 52900, Israel, [email protected] A symmetric pricing or asymmetric price adjustment is the phenomenon where prices rise more readily than they fall. We offer and provide empirical support for a new theory of asymmetric pricing in wholesale prices. Wholesale prices may adjust asymmetrically in the small but symmetrically in the large, when retailers face cost of price adjustment. Such retailers will not adjust prices for small changes in their costs. Manufacturers then see a region of inelastic demand where small wholesale price changes do not translate into commensurate retail price changes. The implication is asymmetric—a small wholesale price increase is more profitable because manufacturers will not lose customers from higher retail prices; yet, a small decrease is less profitable, because it will not lower retail prices; hence, there is no extra revenue from greater sales. For larger changes, this asymmetry in the behavior of wholesale price vanishes as the price adjustment cost is compensated by the increase in retailers’ revenue resulting from correspondingly large retail price changes. We present a formal economic model of a channel with forward-looking retailers and cost of price adjustment, test the derived propositions on the behavior of manufacturer prices using a large supermarket scanner data set, and find that the results are consistent with the predictions of our theory. We then discuss the implications for asymmetric pricing, channels, and cost of price adjustment literatures, as well as public policy. Key words : asymmetric pricing; asymmetric price adjustment; channel pricing; cost of price adjustment; menu cost; wholesale price; channel of distribution; retailing; economic model; scanner data History : This paper was received February 10, 2003, and was with the authors 13 months for 3 revisions; processed by Subrata Sen. 1. Introduction Asymmetric pricing or what is also known as asym- metric price adjustment is a phenomenon where prices rise readily but fall slowly. Frequent reports in the popular press lament the fact that prices are asymmetric. It is not uncommon to read headlines about prices “rising like rockets (but) falling like feathers” ( Octane Week 1999); retail pork prices not coming down even if hog prices do ( New York Times 1999); and government subsidies to dairy farmers not lowering dairy products prices, even if a hike in the price of industrial milk paid to farmers, raises such
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