Cross-subsidization is a pricing strategy where the sales of one product or service subsidize the sales of another. This typically involves charging higher prices for one product or service in order to charge lower prices for another, often with the goal of gaining market share, promoting a new or less popular product, or achieving other strategic objectives.
Cross-subsidization can occur within a single company or across different companies in a conglomerate. It’s commonly seen in a variety of industries and scenarios:
- Telecommunications: A telecommunications company might charge more for landline services to subsidize the costs of providing affordable mobile services.
- Public Services: Public transportation often involves cross-subsidization, with profitable routes subsidizing the costs of less profitable but necessary routes.
- Retail: A supermarket might sell some popular items at a loss (known as loss leaders) to attract customers, while charging higher prices for other items to make up for the losses.
- Pharmaceuticals: A pharmaceutical company might charge higher prices in wealthier countries to subsidize lower prices in poorer countries, or it might charge more for branded drugs to subsidize the costs of developing new drugs.
While cross-subsidization can have benefits, such as increasing affordability or promoting innovation, it can also raise concerns. For example, it can potentially lead to anti-competitive behavior if a company uses profits from a market where it has a monopoly to subsidize prices in another market where it faces competition. Regulatory bodies often scrutinize such practices to ensure they don’t harm competition or consumer interests.
Example of Cross-Subsidization
Let’s take an example from the streaming services industry.
Suppose there’s a company called StreamCo, which offers both streaming music and streaming video services. The streaming video service is highly popular and profitable, while the music service, which is newer, is still gaining its footing and currently operates at a loss.
In this case, StreamCo might decide to use some of the profits from its video service to subsidize the music service. This could involve lowering the price of the music service to attract new subscribers, investing in more content to make the service more appealing, or enhancing the technology to improve the user experience. The goal would be to grow the music service to the point where it becomes self-sustaining and profitable.
In this way, the successful video service is cross-subsidizing the less profitable music service. This is a strategic decision by StreamCo to invest in the growth of the music service, with the expectation that it will pay off in the long run.
It’s worth noting that while this kind of cross-subsidization can be an effective growth strategy, it also involves risks. For example, if the music service doesn’t catch on as hoped, StreamCo could end up losing the money it invested without gaining the anticipated benefits. And if the video service’s profits decline for any reason, it might not be able to continue subsidizing the music service.