Richmond Fed, Report: How Well Do Firms Retain Customers After Price Increases?

“The impact of price on firm value can be understood through two main channels: level of profit per customer and customer base dynamics. In other words, the price influences the mass of customers buying from the firm in the current period, as well as the future customer base. Therefore, setting the optimal price requires balancing the marginal benefit of a price increase (more profit per customer) with the cost (decrease in the customer base).”

“Our price-setting model provides a comprehensive framework for understanding the relationship between customer and price dynamic in equilibrium, with heterogeneous production and search costs. Empirical evidence from a large U.S. supermarket chain shows that increasing the price of a good is associated with a higher customer attrition rate. If firms are concerned about customer retention, the price pass-through of cost shocks will decrease. More productive firms offer higher continuation value to customers by charging lower prices. In contrast, higher prices are associated with a higher propensity for customers to search, resulting in higher demand elasticity. An increase in demand elasticity leads to firms reducing markups, amplifying the effect of demand shocks on consumption.”