Definition of cost stickiness and why cost stickiness occurs

In addition to the cost behavior of variable and fixed costs, another stream of research proposes the cost behavior that recognizes the role of managers in adjusting committed resources in response to changes in activity-based demand. Noreen and Soderstrom (1997) find that costs are more difficult to adjust when activities decrease because costs increase more sensitively in response to the increase in activity than they fall in response to the decrease in activity.

Building upon findings by these studies, Anderson et al. (2003) label this cost behavior that the magnitude of the increases in costs associated with an increase in volume is greater than the magnitude of the decrease in costs associated with an equivalent decrease in volume as ”sticky”, and establish an empirical model to test this cost behavior. In their study, they propose the following model:²

, , ,

This model provides the basis for the test of stickiness of SG&A costs. The model is written in ratio to improve the comparability of the variable across firms, and in logarithmic form to reduce the effect of potential heteroskedasticity problem. In this model, the coefficient







2 Anderson et al. choose SG&A costs as their major interest because "SG&A cost can be meaningfully studied in relation to revenue activity because sales volume drives many of the components of SG&A costs "(Cooper and Kaplan, 1998, p.341). CFO magazine also did an extensive analysis of SG&A costs in relation to sales revenue in its annual SG&A survey.

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increase in SG&A costs with 1% decrease in sales revenue. They focus on selling, general, and administrative (SG&A) costs in relation to revenue activity because sales volume will affect many of the elements of SG&A cost. If SG&A costs are sticky, the percentage increase in SG&A costs for an increase in sales revenue should be larger than the percentage decrease in SG&A costs for an equivalent decrease in sales revenue.

Using 7,629 U.S. firms over 1979 to 1998, Anderson et al. (2003) provide empirical evidences that SG&A costs increase on average 0.55% per 1% increase in sales but decrease only 0.35% per 1% decrease in sales. They contend that this kind of sticky cost is mainly derived from the effects of adjustment cost and uncertainty of future demand during periods of rising and falling corporate activities. Cost stickiness occurs as managers deliberately adjust the resources committed to activities. When demand increases, managers commit more resources to meet additional sales. When demand falls and there is uncertainty about future demand and thus, managers may purposely postpone reduction in committed resources until they are more certain about the permanence of a decline in demand. Thus, cost stickiness occurs if managers deliberately retain unutilized resources rather than incur adjustment costs to remove committed resources and to replace the resources as the demand restore. Yasukata and Kajiwara (2011), using the data from Tokyo Stock Exchange, provide evidence that cost stickiness is the result of deliberate decision of managers. They use managers’ sales forecasts as a proxy for managers’ prospect of future sales and find that current level of cost stickiness is associated with the prospect of future sales. Subramaniam and Weidenmier (2003) also show that cost stickiness is the result of managers’ asymmetrical response to large demand changes. They argue that managers will expand capacity of the firm by changing the firm’s committed resources when revenue increases by more than ten percent. However, when revenue decrease by more than ten percent, managers may not want or able to

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change firm’s capacity, causing cost stickiness.

Besides the U.S., cost stickiness is also found in other countries. For example, Calleja at al. (2006) use a sample of US, UK, French, and German stock market to compare the sticky behavior of operating costs in different countries. They find that cost behaviors of firms from the four countries have some common characteristics: costs are sticky but are, in general, less sticky when aggregated over longer periods and when firms suffer larger declines in revenues. They also find that costs of French and German firms are stickier than cost of US and UK firms. They contend that the result is attributable to the differences in systems and managerial oversight.

Some researchers look for the evidences of sticky costs across industry levels. For example, Subramanian and Weidenmier (2003) find that there are inter-industry differences in the cost stickiness behavior of SG&A and COGS costs as well as in the determinants of sticky behavior. They examine the cost stickiness for four different industries: manufacturing, merchandising, service, and financial services. The results show that manufacturing is the “stickiest” industry because of high level of fixed asset and inventory, while merchandising is the “least sticky” due to its highly competitive environment. The other two industries do show some level of stickiness where interest expenses drive stickiness in the financial industry and employee and inventory intensity drive stickiness in the service industry. In addition, merchandise and service firms adjust their cost quickly in response to change in sales revenue due to their low level of fixed asset and the use of temporary help.

Balakrishnan and Gruca (2008), using the data relate to 189 general hospitals from Ontario from 1986 to 1989, investigate inter-departmental variation in cost stickiness They find that costs are sticker in services deemed more central to the hospital’s mission.

They argue that hospital administrators are unwilling to trim costs in core activities

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because of the nature of hospital’s service and because of the adjustment costs associated with changing this capacity. In comparison, it is easier and cheaper to adjust capacity levels in other services. In sum, cost stickiness is a phenomenon that is widely spread across country-level, industry-level as well as department level.