Cross Subsidization - Definition, Examples, Working, Advantages, Disadvantages & More

Cross subsidisation is the difference in the pricing strategy for two groups of consumers. It is the practice of paying a set of consumers greater prices to fund reduced costs for another group. Cross subsidisation is the practise of paying for one product using the earnings from another. This implies that one set of consumers is financing the spending of another. This problem occurs when artificially cheap transit fares in less populated regions pay for higher public transportation fares in densely populated areas where the government is trying to encourage public transportation.

Cross subsidisation is one of the most important topics for the UPSC IAS exam. It covers a significant part of the Economy subject in the General Studies Paper-3 syllabus and current events of national importance in the UPSC prelims syllabus.

This article will discuss the work, disadvantages, advantages, and examples of cross subsidisation.

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What is Cross Subsidization?

Cross subsidization involves the strategy of setting different prices for different customer groups. This approach entails charging higher prices from one group to support offering the same product at a lower, subsidized price for another group. The pricing of most products is commonly influenced by supply and demand dynamics. Yet, there are instances where you might encounter products priced higher or lower due to the implementation of distinctive and strategic pricing tactics by the manufacturing company. The technique of cross subsidization is one such strategy employed to manage product costs effectively.

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Cross-Subsidization Price Shifting

When some payers are charged more than full costs to make up for other payers who are paying less than full costs, this method is referred to as cross-subsidization price shifting.

Cross Subsidization Examples

Let’s use an example to understand cross-subsidization better.

• The cost to produce and distribute electricity remains constant, irrespective of the end users.
• However, different tariffs can be assigned to various consumer groups, such as lower rates for residential users compared to industrial users.
• This situation results in a cross-subsidy, where industries subsidize residential customers.
• Over the past decades, the agriculture sector's energy consumption has risen, often with free or heavily discounted electricity in India.
• This led to financial strain on state governments and distribution firms and increased cross-subsidy burden on industries.
• The power industry offers an example of this phenomenon.
• Cross-subsidization is widespread in India across sectors like power, healthcare, aviation, and higher education.
• This approach reduces strategic incentives for cross-subsidization by eliminating traditional predatory practices.

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Working of Cross Subsidization

Cross subsidization is a marketing tactic in which one product is overpriced to compensate for the loss caused by the underpricing of another.

By selling your baseball bats well over their true market value, you cross-subsidize the cost of the balls rather than taking a loss on them. Any losses you incur with the balls will be more than offset by the additional profit you generate on the bats. For example, you might price baseballs below your own cost if you manage a sporting goods company and want to enhance sales.

• Over the past few decades, the energy demand in the agriculture sector has expanded.
• India offers free or very reduced electricity to the agricultural industry.
• As a result, there has been an increase in the cross-subsidy load on industrial and commercial consumers, a loss in the financial health of energy distribution companies, and a considerable financial burden placed on the state governments through direct subsidies.
• The scenario outlined above is one illustration from the power sector.
• In India, cross-subsidization frequently happens in the power, healthcare, aviation, and higher education sectors.

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Advantages of Cross Subsidization

• Pricing is a key factor for customers considering a purchase. 
• Thus, using a product-cost cross-subsidization approach in your pricing may significantly increase revenue.
• Cross Subsidization is also used in Healthcare facilities.
• A low price may be sufficient to persuade consumers who are on the fence to buy if the quality of your product and your level of customer service are competitive with those of your rivals.
• For this reason, using a product-cost cross-subsidization strategy can benefit newly released items or products that are part of a highly competitive market niche.

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Disadvantages of Cross Subsidization

• Cross-subsidizing your product costs could cause issues with pricing in the future.
• For instance, if you increase the price of one product while decreasing the price of another, you risk losing market share for the overpriced item since your rivals will be able to undercut you on price while still likely making a profit.
• The underpriced product will probably see more sales, necessitating you to devote more of your operating time and resources, which could further decrease sales for your costly product.
• You’ll be obliged to increase the price of your low-priced goods as these sales decline, perhaps driving away customers.
• This cycle can be controlled with careful monitoring, monitoring, and changing prices and marketing.

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