What Is Product Cost Subsidization? (With Pros and Cons)
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Strategically pricing your products and services can help you grow your business and increase your profits. Product cost subsidization is a pricing tactic that many businesses use to balance their prices across many products. If you're considering implementing a new pricing strategy, learning about the benefits and drawbacks of product cost subsidization can help you determine if it might be a beneficial strategy for you. In this article, we define product cost subsidization, explain how it works, share some pros and cons and offer some tips to help you choose the right pricing tactic for you.
What is product cost subsidization?
Product cost subsidization is a pricing tactic in which a company raises the price of one product to compensate for losses caused by another product. This strategy allows businesses to price a product lower than its market value without losing profits. Commonly, a business adds a small amount to the prices of many products to make up for losses from one noticeably under-priced product.
Product cost subsidization can also be a promotional tactic to drive sales of one specific product. A business might discount a particular item or service to encourage buyers to purchase it and to distinguish themselves from other sellers in the market. To account for the loss the discount might cause, they might increase the price of a different product or service.
How does product cost subsidization work?
If you want to implement product cost subsidization, you can first calculate the market value of the product you're selling. You can find a product's market value by considering supply and demand. Learn how rare the product is, how many people want it and what your competitors might be charging for similar products. After determining market value, you can reflect on your business circumstances to learn what the standard price before subsidization might be. Many factors can influence standard pricing, such as:
Interest on debts
Once you've learned what you can charge to account for your expenses, you can calculate how much to inflate or reduce the price according to your losses. For example, if you lost $800 on a recent theater production, you might make tickets for your next production more expensive to subsidize the loss. If the theater has 100 seats and you plan to run 20 performances, adding 40 cents to each ticket could recoup your $800 after a sold-out run. If you expect smaller crowds, you could raise the price more to ensure you make $800 back.
Pros and cons of product cost subsidization
Below are some benefits and challenges of using this pricing tactic:
Pros of product cost subsidization
Here's a list of pros of product cost subsidization:
Might attract customers
If you want to expand your customer base, you might consider implementing product cost subsidization. For many customers, price is the most important factor that informs their shopping decisions. Offering a popular product at a price below market value can win customers from competitors. Once they've entered your store or explored your services in pursuit of the under-priced product, you can expose them to your other products.
Can raise your profits
Because product cost subsidization can inspire a sudden increase in sales of the under-priced product, it could be a profitable pricing tactic. This method also protects you from losing money when offering a steep discount on a product. By simultaneously recouping losses and increasing sales, you may be able to grow your profits overall using product cost subsidization.
Cons of product cost subsidization
Here's a list of some of the cons of product cost subsidization and ways to mitigate them:
Might affect your workflow
Typically, product cost subsidization leads to an increased demand for an under-priced product because price is a deciding factor for many buyers. Because that particular product is so popular, you might have to dedicate more resources to producing or restocking it to keep up with demand. To ensure you're able to meet customers' needs, build flexible business plans. You might change your budget, assign more team members to work on that product or place more orders with suppliers. If you're adaptable, the changes can be manageable.
Could damage your credibility with customers
You might risk the trust you've built with loyal customers by using artificial pricing strategies. Over time, customers might notice your prices are inconsistent and choose to buy from a competitor who has more stable prices instead. To combat this, try to monitor competitor prices closely and aim to use this tactic within reason. If you price your products near market value, even when compensating for losses, you might be able to retain your customers. Dispersing the price increase across many products might also help you earn back your losses in a way that's nearly indistinguishable to most customers.
Tips for choosing a pricing tactic
If you're wondering which pricing tactic is best for your business, here are some tips you could consider:
Research your target market
Target markets are subsets of customers who you might aim to attract. Target markets typically share common values, lifestyles or demographics, and analyzing these groups might reveal more about their needs. A thorough study of their interests and purchasing behavior might help you understand what matters to them when they're deciding between suppliers, which can help you choose an influential pricing tactic.
Read more: How To Identify Your Target Market
Be flexible in your methods
Remember that different pricing tactics can be successful under different circumstances. As the market transforms and your business needs change, consider switching pricing tactics frequently. You can also combine different pricing strategies at once to help maximize your profits. For example, at a home improvement store, product cost subsidization might help you convert customers from your competitors by offering the lowest price on a popular cleaning solution, while tiered pricing might be appropriate for washing machines to expand your potential customer base to include all budgets.
Monitor your competitors
If you're selling a product in a crowded market, it's vital to stay competitive so you can retain your customers. Perform frequent competitor analyses to stay informed about the other sellers in your market, and study their pricing strategies. Observing how customers react to different methods of pricing can help you learn from your competitors' mistakes and predict what might be popular in the future.
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