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More on How Firms Make Capital Decisions

by Andrew White  |  October 17, 2018  |  1 Comment

I was stuck up the mountains (willingly, I might add) and watching the early morning mists roll back and a dark orange sun slowly emerge from the gloom, as I sat with a coffee and engaged my September’s copy of The American Economic Review. I spied a particularly interesting paper among the offerings: How Do Firms Form Their Expectations? New Survey Evidence, by Olivier Coibion, Yuriy Gorodnichenk, and Saten Kumar. The article posited that many firms do not take account of inflation when taking important business decisions.

It turns out that much energy in economic circles has been spent on surveying consumer preferences, beliefs and expectations about recent past and future inflation. But it seems little data is collected about firm expectations on the topic. There are things like the Purchasing Managers Index which does provide some input regarding expectations of a key role in many firms, but there are few other examples like this for all roles.  As firms actually set prices in their respective industry, you would think that inflation expectations might play a role, given the implication of inflation on prices. According to this research paper of firms in New Zealand, this is not the case.

More interestingly the authors find that some firms can be thought of as ‘informed’ and some others as ‘misinformed’. In the case of informed firms, they seem to have a fairly good understanding of recent inflation levels and also of publicly available data on near-term inflation expectations. Those firms that start out as misinformed about recent past expectations remain as misinformed about future expectations. As a result, some firms have the knowledge that would contribute to smart decisions about changing market conditions; some firms lack that information.

The survey was executed in multiple waves and each asked a range of questions about such as prices (of the firms’ products or services), employment, investment, unit cost, wage and sales changes over the next six months prior to being informed of updated inflation data. The same firms were asked, six months later, for the outcomes of those same variables. The differences might be impacted by the firms use, six months before, of that time periods inflation expectations going forward.  There were control groups to baseline such behavior independent of the inflation data.

More generally the survey reported that about 60% of firms do not track inflation at all, and 21% of firms reported not tracking even GDP. 32% of firms reported tracking unemployment and GDP. For those firms tracking multiple variables, 90% try to synchronize the acquisition of them.

I found the paper and its findings fascinating. Given much information about inflation and GDP expectations are widely available, is it the case that many firms use too little of this data when making their most important decisions? Typically competitor pricing of products and services is a key decision taken from time to time; in some cases dynamically.

Is it that inflation and GDP don’t really matter? Are the analytics too broad?  Would it be more useful to look at inflation at an industry level?  Again, there are such things as “factory gate pricing” and producr prices and more, often provided by organizations like the Bureau of Labor and Statistics and others.  Each of these plays a roll in “feeding into” inflation while also reflecting inflation from previous steps in the supply chain.  And therein is another complexity – everything is connected: one firm’s sales price is another firms’ purchase price.  It really is quite interesting to think of the factors that inform business decisions.

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Andrew White
Research VP
8 years at Gartner
22 years IT industry

Andrew White is a Distinguished Analyst and VP. His roles include Chief of Research and Content Lead for Data and Analytics. His main research focus is data and analytics strategy, platforms, and governance. Read Full Bio

Thoughts on More on How Firms Make Capital Decisions

  1. […] in May about Where You Spend Your Firms’ Capital Matters.  I blogged again the other day too: More on How Firms Make Capital Decisions.  I am exploring an idea that intrigues me.  Some firms are more successful than other firms; […]

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