Markups Dynamics with Customer Markets

We study a model where customers face frictions when changing their supplier, generating sluggishness in the firm's customer base. Firms care about expanding their customer base and this affects their pricing strategy. We characterize optimal pricing in this model and estimate it using data on the evolution of the customer base of a large US retailer. The introduction of customer markets reduces average markups, more markedly for less productive firms. We use the model to perform a counterfactual exercise and investigate the cyclical behaviour of markups in response to both aggregate supply and demand shocks.