Asking About Prices: A New Approach to Understanding Price Stickiness

Chapter 14: Hierarchy

Chapter 14 Hierarchy The big firm is always in danger of becoming ... an elaborate hierarchy, in which every decision requires the consulting of this man, the referring to that man, the permission of a third, the agreement of a fourth, so that decisions become endlessly delayed. -E. A. G. ROBINSON The Hierarchical Structure of Large Firms The hierarchy theory attributes price stickiness to delays in getting a large, hierarchical organization to act. If many people are required to "sign off" on a price change, prices may be incapable of changing rapidly in response to changes in the firm's environment. This theory is the only one of the twelve examined in this book that was not culled from the economic literature. Rather, it was suggested by a businessman. As noted in chapter 3, six executives volunteered to help us pretest the questionnaire. At the end of each of these six interviews, we asked whether we had omitted any factor that was important in slowing down price adjustments. One respondent , who was responsible for pricing in a large manufacturing company, suggested hierarchical delays. It struck us as preCisely the sort of phenomenon that might be empirically important in big companies, and yet totally ignored by economic theory. There certainly is plenty of anecdotal evidence that large companies sometimes move ponderously. Indeed, one standard explanation of the limits on economies of scale invokes organizational sluggishness and the difficulty of managing larger and larger firms.! Large corporations devote considerable attention to-and management consultants reap considerable income from-devising organizational strategies to keep decision making flexible and responsive. So the notion that hierarchies may slow down price changes does have the ring of plausibility. 254 Asking About Prices Hierarchy could be considered a theory of either nominal or real price rigidity. On the one hand, even raising prices to stay in line with overall inflation requires an affirmative decision on the part of the firm. On the other hand, the firm could decide to index its price automatically, in which case an affirmative decision would be necessary only if the firm wanted to change its real (relative) price. Of these two scenarios, nominal rigidity seems more likely, as explicit indexing in the real business world is quite rare. Survey Results on the Validity of the Theory The precise question asked of firms was: B9. Some people think that price changes are slowed down by the difficulty of getting a large, hierarchical organization to take action. How important is this idea in explaining the speed of price adjustment in your company? Responses to this question were summarized in chapter 5 and are repeated for convenience in table 14.1. Briefly, the theory performed extremely poorly. Of the twelve theories, hierarchy ranked next to last. While it is possible that many executives are reluctant to admit that their firms are plagued by hierarchical delays, we were generally impressed by the respondents' high level of candor. The importance of hierarchy in explaining price stickiness is low in every industrial sector, although it ranks considerably higher in the transportation, communications, and utilities (TCD) sector than elsewhere (see table 14.2). The mean score in TCD is significantly higher (at the 10 percent level) than the mean score in either trade Table 14.1 B9. How Important Is Hierarchy in Slowing Down Price Adjustments in Your Company? (n = 199 Responses) Code Response 2 3 4 Totally unimportant Of minor importance Moderately important Very important Mean response = 1.41 Rank = 11th Percentage of Firms 78.9% 7.0 8.3 5.8 Hierarchy 255 Table 14.2 The Importance of Hierarchy in Slowing Down Price Adustment, by Sector (n = 199) Percentage of Finns Transportation, Construction Cornmuand nications, Code Response Manufacturing Trade Services Mining and Utilities 1 Totally 77.1% 89.2% 75.5% 95.5% 52.9% unimportant 2 Of minor 4.3 9.5 7.5 0.0 20.6 importance 3 Moderately 11.4 1.4 10.4 4.5 8.8 important 4 Very 7.1 0.0 6.6 0.0 17.6 important Mean response 1.49 1.12 1.48 1.09 1.91 Sample size 70 37 53 22 17 Rank 10th 12th 10th lith 7th or construction and mining, the two industries in which the theory scored the lowest. Even within the TeD sector, however, more than half of the firms rated the hierarchy theory as "totally unimportant ." The...