Cross subsidy

The subsidy Cross is a strategy that involves raising the price of a product or service to a customer group. In this way, the company generates a surplus that allows it to reduce the rate of the same good for another economic segment.

Typically, with this subsidy, people with higher incomes pay a higher price. Thus, the company can charge individuals with lower incomes less without reaching losses.

In other words, through cross-subsidization, wealthier consumers indirectly finance those who receive lower wages. For state companies, this is an alternative to direct subsidy , when it is the Government that pays with its funds part of the service or merchandise offered.

Another type of cross subsidy

Another type of cross subsidy is one that consists, first of all, in increasing the price of one of the goods (tangible or intangible) that the company markets. This, in a market where the firm holds a dominant position .

With these higher revenues, the entity is able to lower the rate of another of its products or services. Thus, with more competitive prices, it will enter a market in which it seeks to gain participation.

In conclusion, cross subsidy is a way to finance a low price strategy. This, when the organization has opted for business diversification .

Advantages of cross subsidy

Among the advantages of cross subsidy are:

  • It allows companies to enter the lower income segments.
  • It is useful for (usually state) water and electricity companies. With this strategy, they can pay for the services offered to sectors that demand a greater initial investment. For example, when located in an area very far from the country or the city. In exchange, they increase prices to another group of the population.

However, there are also some downsides:

  • This kind of subsidy can be used to carry out a predatory pricing strategy . This implies reducing tariffs below the cost of production. Thus, it seeks to eliminate competitors and achieve a monopoly on the market.
  • Some consumers may misrepresent information or move to access subsidized prices. Consequently, the effectiveness of the measure is reduced because some people who are outside the group that is sought to protect end up benefiting.

Cross subsidy example

An example of a cross subsidy is that applied by the Lima Drinking Water and Sewerage Service (Sedapal), in Peru, which classifies consumers according to their income level based on data collected by the National Institute of Statistics and Informatics ( INEI). Then, differentiated rates are charged as we observe in the following table:

 

Category Consumption range(Cubic meters per month) Rate

(Peruvian soles per cubic meter)

Residential
Social 0 to more 1,227
Subsidized domestic 0-1010-20

20-50

50 or more

1,2271,368

1,445

5,239

Unsubsidized domestic 0-2020-50

50 or more

1,4452,051

5,239

Non-residential
Commercial 0 to 1,0001,000 or more 5,2395,621
Industrial 0 to more 5,621
State 0 to more 3,445

It should be noted that, according to Sedapal, to provide the potable water service in Lima, 3.66 Peruvian soles per month per cubic meter must be invested. In other words, most users pay a price below cost, with some consumers being more subsidized than others.

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