"Customer Capital: Theory and Evidence"

Trustees Of Boston University, Boston

Investigators

Abstract

This award funds development of a macroeconomic model that incorporates frictions arising from consumer search for information about product characteristics. Firms spend substantial resources on marketing and sales costs. These expenses are evidence of frictions in product markets; firms must spend money to attract new consumers. These frictions imply that customers tend to remain with the same firm for some time. Therefore, a firm can view its existing customer base as 'customer capital', a valuable firm asset. This research examines the implications of this kind of market friction and customer capital for macroeconomics. The investigators develop a simple and parsimonious general equilbrium model incorporating this search theory based customer capital. They then analyze the model to answer three different questions. First, they demonstrate that firm-level investment behavior depends on these customer based product frictions. Second, this kind of market friction results in more accurate predictions of macroeconomic time series. For example, the hump shaped responses of macroeconomic aggregates to total factor productivity (TFP) shocks result because firm expansion is slowed down by the expense of attracting new customers. Incorporating product market frictions also means that the model demonstrates how a news shock can generate an economic expansion as firms build up their customer base in advance of increased productivity. Third, the model provides a new tractable framework for analyzing both firm price-setting decisions and markups. Concerns about maintaining the costemr-base make prices insensitive to firm-specific cost shoks, as well as somewhat insensitive to aggregate cost shocks. Finally, customer capital explains the value premium widely documented in financial markets. Firms with more customer capital may have lower systematic risk, thanks to the flexibility of customer capital. This project incorporates insights from business management and industrial economics into macroeconomic modeling. The results will be useful for policymakers and forecasters.