Mix Stickiness Under Asymmetric Cost Information

In most organizations, the agent has superior information about the relative costs of different products or activities. This handicaps the principal when the principal seeks to adjust the product mix. Our main conceptual finding is that there is “mix stickiness.” The agent’s superior information about the relative costs of different products or activities leads to an advantage for the status quo; that is, there is inertia (or stickiness) in the mix of products or activities pursued. The historical mix has an advantage because the asymmetric information about relative costs has less of an impact when the mix does not change. If the mix changes, the producer can extract information rents by claiming high costs on the least reduced or most expanded products. Only in the case of larger shifts in the environment will the mix change. Changing the mix comes with the advantage of making rationing cheaper. Our analysis gives new insight into several business practices. It suggests, for example, that for moderate downsizing, a reinforcement approach of proportionally cutting all activities (lawn mowing) is optimal. When more dramatic downsizing is called for, a reorientation approach of eliminating certain activities (divesting) is optimal. It also suggests that outsourcing may come at the cost of reduced adaptability, and it may help explain why most, if not all, healthcare systems struggle to control cost. This paper was accepted by Rajgopal Shiva, accounting.