Breadcrumb

Pros and Cons of Cross Subsidizing Products

Written by

The GoCardless content team comprises a group of subject-matter experts in multiple fields from across GoCardless. The authors and reviewers work in the sales, marketing, legal, and finance departments. All have in-depth knowledge and experience in various aspects of payment scheme technology and the operating rules applicable to each. The team holds expertise in the well-established payment schemes such as UK Direct Debit, the European SEPA scheme, and the US ACH scheme, as well as in schemes operating in Scandinavia, Australia, and New Zealand. See full bio

Last editedDec 20222 min read

Devising a sensible pricing strategy involves research into your customer demographic, competitors, and market conditions. Yet within this framework there’s room for maneuver. One pricing strategy to try is cross subsidization – but what is cross subsidizing and how does it work? Find out when it’s beneficial below.

What is cross subsidization?

The cross subsidization definition is the strategy of funding one product with the profits of another. With this type of pricing strategy, a business intentionally prices one product above its market value. This extra profit covers any losses derived from pricing a separate product below its market value. Customers purchasing the higher-priced product subsidize the group that purchases the lower-priced product.

How does cross subsidization work?

This strategy is often used by businesses that want to increase the sale of a specific product, whether it’s new to customers or they simply have excess inventory. Offering the product at a lower price point attracts more sales. By charging more than market value for another product, the extra profit covers any losses.

There are many ways to employ cross subsidization, both with goods and services. The specific pricing will depend on your goals as well as market trends, including the law of supply and demand. Ultimately, businesses need to take in sufficient profit to cover expenses and maintain a positive cash flow.

Cross subsidization examples

The cross subsidization definition is useful across multiple industries and situations. Here are a few typical cross subsidization examples in practice:

A. The city government wants to encourage locals to use its public transportation system. It charges higher fares for the central business district, which is densely populated. Fares are kept lower on the outskirts of town with less population density. The central, higher fares pay for the cost of offering reduced fares in less-populated neighborhoods.

B. A women’s boutique located next door to a gym sells its activewear at a competitive, artificially low price. It pulls in a roaring trade over the summer months with its swimwear, which it sells at higher prices to cross subsidize the lower cost of year-round sportswear.

C. Three friends go out for dinner together. Mark’s meal costs $30, Stanley’s meal costs $35, and Tom’s meal costs $25. The total price is $90, which they split three ways to pay $30 each. Stanley is essentially cross subsidizing Tom’s meal by $5 to keep the bill even.

The pros and cons of cross subsidization

There are both advantages and disadvantages to this type of pricing strategy. Benefits of cross subsidizing include:

An increase in sales driven by the lower product cost
Publicity for your brand due to special deals
Attractive offers let you stand out from the competition

At the same time, there are some disadvantages to consider as well, including:

Loss of market share for the overpriced product
Customer confusion due to the imbalance in product pricing
The need to raise your product prices once sales drop

To avoid these problems, it’s important to carefully monitor pricing and sales trends. You don’t want to turn off your core customer base with erratic price fluctuations.

Is product cross subsidization right for you?

Whether you’re launching a new product or need to offload stale inventory, cross subsidizing could be a useful strategy. Sustaining lower prices attracts a new set of customers while enticing your existing ones. In a competitive market, attractive pricing can make your product stand out from the crowd. Follow this up with great customer service and you’ll be able to grow your business.

Make sure you’re not losing customers at the final hurdle by offering a smooth checkout process. GoCardless is suitable for both one-off and recurring payments, pulling funds directly from a customer’s bank account using direct debit. It’s easy to set up, low in cost, and convenient for both customer and merchant alike.

We can help

GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.