Mark-up Pricing in the UK

Though I have briefly examined this subject before, much more can be said, given the range of evidence.

In what follows, I review:

(1) Hall, Walsh, and Yates (2000),

(2) Greenslade and Parker (2012), and

(3) finally Downward (1999, Chapter 8).

Hall, Walsh, and Yates (2000) report the results of a survey of 654 UK companies in 1995 carried out by the Bank of England, and mostly of large companies in manufacturing (68% of the survey), as well as some in services (13%), retailing (13%), and construction (6%) (Hall, Walsh, and Yates 2000: 426–428).

The survey found that 79% of firms used time-dependent pricing, and reviewed prices at specific frequencies (Hall, Walsh, and Yates 2000: 432). Furthermore, 28% of companies reviewed their prices only once a year and about 19% only quarterly (Hall, Walsh, and Yates 2000: 430).

About 37% of companies had changed their prices once in the year period before the survey, and about 27% twice (Hall, Walsh, and Yates 2000: 431).

The survey also asked firms if they recognised a specific “pricing theory as being important” for explaining their pricing behaviour. The most important results were as follows:

Theory | Percentage recognition
Constant marginal costs | 53.8%
Cost-based pricing | 47.1%
Implicit contracts | 45.4%
Explicit contracts | 43.7%
Procyclical elasticity | 35.3%
Pricing thresholds | 34.4%
Non-price elements | 24.2%
Stock adjustment | 22.9%
Coordination failure | 22%
Price means quality | 18.5%
Physical menu costs | 7.3%. (Hall, Walsh, and Yates 2000: 436).

It should be noted that the most important of these “theories” are compatible, not mutually exclusive.

Next the firms were asked to rank how important these theories were on a scale of 1 (high) to 7 (low). The rankings from most important to least important can be seen below :

Theory | Placing
Explicit contracts | 1
Cost-based pricing | 2
Coordination failure | 3
Pricing thresholds | 4
Implicit contracts | 5
Constant marginal costs | 6
Stock adjustment | 7
Non-price elements | 8
Procyclical elasticity | 9
Price means quality | 10
Physical menu costs | 11 (Hall, Walsh, and Yates 2000: 436).

It can be seen that cost-based pricing/mark-up pricing was the second most important reason given, though it is perfectly compatible with “explicit contracts” and “coordination failure” (the failure to raise prices because firms fear competitors will not do so, or lower prices for fear of setting off a price war).

Firms are required often to make fixed nominal contracts which generally fix prices for the customer, and this is an important reason as well as cost-based pricing for price rigidity (Hall, Walsh, and Yates 2000: 438).

Also notable in the findings is that UK companies in the survey report constant marginal costs (Hall, Walsh, and Yates 2000: 437).

A minor cause of price rigidity is the idea that “price means quality”: if a firm lowers prices customers may interpret it as a signal that goods have declined in quality. But this seems to be important only in markets for luxury goods (Hall, Walsh, and Yates 2000: 440).

Like so many studies, the New Keynesian idea of “menu costs” received the lowest ranking: it appears to be dubious or, at best, of marginal importance in explaining price rigidity (Hall, Walsh, and Yates 2000: 440).

Most interesting are the results on what is the most common cause of rises or falls in price.

First, what most often causes prices rises? The main results were as follows:

Factor | Percentage of firms
Increase in material costs | 64%
Rival price rise | 16%
Rise in demand | 15% (Hall, Walsh, and Yates 2000: 441).

Only 15% of firms report that demand is a major cause of price rises, and the overwhelming majority attribute price rises to increase in costs of production: a finding that strongly confirms that mark-up pricing is most probably the most prevalent form of pricing in the sampled firms.

Secondly, what most often causes prices falls?

Factor | Percentage of firms
Rival price fall | 36%
Decrease in material costs | 28%
Fall in demand | 22% (Hall, Walsh, and Yates 2000: 441).

Factors (1) and (2) are also consistent with mark-up pricing, since mark-up firms frequent must follow a price leader in setting prices.

What emerges from this is also that rises in production costs are far more likely to cause price increases than cost decreases are to cause price decreases: that is, there is a bias towards upwards – rather than downwards – movements in prices in modern market economies (Hall, Walsh, and Yates 2000: 443).

Firms were also asked: what happens when there is strong demand and this cannot be met from inventories or stocks?

The result was as follows:

Increase overtime | 62%
Hire more workers | 12%
Increase price | 12%
More capacity | 8% (Hall, Walsh, and Yates 2000: 442).

Since increasing overtime or hiring more workers implies that machines or factories will be used to a greater extent than before, then these factors seem to effectively mean an increase in capacity utilisation, which is clearly the main response to booms in demand.

Only a small 12% of firms would increase prices.

This completes the findings of Hall, Walsh, and Yates (2000).

Next, I turn to Greenslade and Parker (2012).

Greenslade and Parker (2012) report the results of a new survey of 693 UK firms (conducted in December 2007 and February 2008) chosen to be representative of the private sector economy of the UK as a whole, including manufacturing, electricity and gas supply, construction, services, and retail trade, but excluding public sector firms or those under regulatory price control (Greenslade and Parker 2012: F13–F14).

An interesting finding is that price rigidity is greater in manufacturing and services than in the trade sector, which has also been found in Eurozone studies (Greenslade and Parker 2012: F4–F5).

When asked how prices for their main product were determined, 68% of firms said that competitors’ prices were “very important” or “important” in determining price (Greenslade and Parker 2012: F9).

The second most important explanation was mark-up pricing, with variable mark-ups (58%) and constant mark-ups (44%) both being important (Greenslade and Parker 2012: F10).

As we have seen, since mark-up pricing industries often rely on a price leader or leaders, the first finding about “competitors’ prices” does not contradict the second finding on cost-based pricing, but is consistent with it.

The main explanations for price stickiness were coordination failure, the need to avoid antagonising customers, and explicit and implicit contracts (Greenslade and Parker 2012: F12).

Finally, Downward (1999, Chapter 8) presents a survey of 283 UK manufacturing enterprises (Downward 1999: 150–151). When asked whether the firm set its prices for its products by means of a mark-up on average costs, 63.7% of firms said either “very often” (29.9%) or “often” (33.8%). A further 17.3% said “sometimes.” Only 7% said “rarely,” and only 8.1% said “not at all” (Downward 1999: 160).

BIBLIOGRAPHY
Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Greenslade, Jennifer V. and Miles Parker. 2012. “New Insights into Price-Setting Behaviour in the UK: Introduction and Survey Results,” Economic Journal 122.558: F1–F15.

Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’ Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.

Lee, F. 1995. “From Post-Keynesian to Historical Price Theory, Part 2,” Review of Political Economy 7.1: 72–124.