Cost Stability and the Periodic Review Cycle

Abstract

This paper investigates the relationship between a firm's cost stability and the frequency with which it acquires data in planning its operations. We first consider a benchmark model of a profit maximizing monopolist whose marginal costs follow an AR(1) process over time. The firm uses forecasts based on historically observed costs for its production decisions and must determine how often it should collect cost data to update its forecasts. We explore the relationship between the frequency of forecast updates and the stability of cost data over time. In the benchmark model, we show that decreasing cost stability leads to more frequent data collection.

We then examine the impact of product market competition on the firm's cost data collection choices. The firm is assumed to compete as a Cournot duopolist in its product market. We show that when the cost shocks are common to the industry, competition decreases the frequency of plan updates. Finally, we examine the impact of inventory by allowing a monopolist firm to "smooth" the cost shocks by holding inventory. We show that inventory introduces a non-monotonicity into the solution. Decreasing cost stability need not lead to an increase in the frequency of data collection.

JEL Classification: M40, M46, D80, L13