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Working Paper

Generalized Long-term Price Effects: Are They Asymmetric, Nonmonotonic, and Time Dependent?

Shijin Yoo and Koen Pauwels, 2008 [08-108]

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In this study, Shijin Yoo and Koen Pauwels develop a generalized model to measure the long-term impact of price changes, testing for asymmetry in positive and negative changes, nonmonotonicity in the magnitude of changes, and time variance. They employ a threshold vector autoregressive (VAR) model in which sales response depends on the magnitude of the pricing change, from which they derive generalized impulse response functions. They apply this methodology to a rich data set covering the marketing mix for five frozen-entrée brands in 18 U.S. city markets.

The results offer new insights into long-term price effects, which are found to be both nonmonotonic and asymmetric, but not time variant. First, the authors find that long-term sales performance is much more sensitive to a price rise than to a decline in price, with elasticities about 5.5 times larger for price increases than for decreases, although that difference varies substantially across brands. Second, the sales response is nonmonotonic for price increases, becoming bigger when the price change is larger. It does not hit saturation until around a 30% threshold—twice the size of the saturation threshold estimated in other studies for short-term response to a price increase. Finally, the authors find that their results are not time variant, although sales response does depend on past price and sales performance. For example, if sales decrease in the current period as a result of a price increase, this negative effect continues in the next period as well.

The authors find that conventional VAR models greatly underestimate sales reaction to price increases for all analyzed brands and markets. (Interestingly, conventional VAR models are fairly successful, on average, at estimating the sales reaction to declines in price.)

These results caution managers against implementing price hikes based on recommendations from symmetric, monotonic models of long-term marketing effects.

About the authors
Shijin Yoo is Assistant Professor at Korea University Business School. Koen Pauwels is Associate Professor of Business Administration at the Tuck School of Business, Dartmouth College.

Included in the following collections:
Executive Director's Letter 08-002
MSI Reports 2008

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