Cross subsidization definition

What is Cross Subsidization?

Cross subsidization is the practice of funding one product with the profits generated by a different product. This means that one group of customers is paying for the consumption of other customers. This situation arises when the public transit fares in densely populated areas are set somewhat higher in order to pay for artificially low transit fares in less-populated areas where the government is trying to encourage the use of public transit.

Cross-subsidization can be useful in the private sector when a business wants to use the profits from an established product line to fund its development and sale of a new product. This is especially common when it will take some time to establish the new product in the marketplace, so the company is willing to fund it at a loss for an extended period of time.

Example of Cross Subsidization

Jeff, George, and Harry order meals that cost $20, $25, and $30, respectively, and are then charged $75 for the three meals on a single bill. If each one of them pays $25, Jeff is cross subsidizing Harry for $5, since Jeff is paying $25 for a meal that cost $20, while Harry is paying $25 for a meal that cost $30.