As most consumers assume, typical product pricing relies on the basic rules of supply and demand. But you may sometimes pay more or less for a product because the company that produces it has implemented different, highly strategic pricing tactics. One of these tactics is called product-cost cross-subsidization.
How It Works
Product-cost cross-subsidization is the strategy of pricing a product above its market value to subsidize the loss of pricing a different product below its market value. For instance, if you have a sporting goods business, and you’re hoping to increase the sale of baseballs, you might price these below your own cost. Instead of taking a loss on the balls, you cross-subsidize the cost by pricing your baseball bats well above their actual market value. The extra profit you make on the bats will essentially cover any losses you take on the balls.
Determining Basic Product Cost
To cross-subsidize your products, you’ll need to have a good idea of how the product should be priced prior to cross-subsidization. While there is a plethora of pricing strategies that businesses employ, your pricing will depend on the goals of your business and the market. Because your profits will need to cover all of your expenses, your pricing will need to reflect your product cost, operating expenses, rent, site maintenance, payroll costs and loan interest fees, along with many other factors.
Benefits of Product-Cost Cross-Subsidization
When you use a product-cost cross-subsidization strategy in your pricing, you may see a big bump in business because pricing is a primary driver for consumers who are considering a purchase. If the quality of your product and your customer service are on par with your competitors, an underpriced item may be enough to convert indecisive buyers. For this reason, product-cost cross-subsidization can be a good strategy to use for new products on the market or products that fall into a highly competitive market segment.
Disadvantages of Product-Cost Cross-Subsidization
Cross-subsidizing the cost of your products can lead to pricing problems down the road. For example, when you lower the price of one product and boost the price of another, you may quickly lose market share for the overpriced product because your competitors will be able to beat you in price, likely while still remaining profitable. You will likely see greater business for the underpriced product, requiring you to focus more of your operational time and resources into the product, which could further reduce sales for your overpriced product. As these sales dwindle, you’ll be forced to raise the price of your underpriced product, and possibly lose customers in the process. Diligence in monitoring and adjusting prices and marketing can help temper this cycle.
- George Doyle/Stockbyte/Getty Images