During the last 5 chapters of Cowen’s book “Inner Economist” I discovered the term “cross subsidy”. Many of us at one point or another have enjoyed the benefits of paying too little or not paying at all for a good or service that costs too much money to give away or substantially discount. You might think why, or how is this company turning a profit? How many times have you questioned what is really going on? Do you realize that you are indeed paying?
Cowen uses Las Vegas to explain how “cross subsidy” works. When I was a child I lived in Las Vegas, and we would frequently go to Casino’s to dine at the “great” buffets, and I remember my family thinking the buffets to be so cheap. As a child I had no idea what was going on, but always remembered that food is cheap in Las Vegas. Years after my family moved back to Colorado, I visited Las Vegas again. I suggested that we eat at a buffet, since they are so cheap, and to my surprise the buffet was not cheap but actually in my opinion a bit overpriced. Granted you get shrimp, crab legs and a slew of other items, but I was expecting a $2.50 not $12.50. Was it inflation? No, as Cowen explains the primary patrons of Casinos buffets used to be the gamblers. The buffets could charge a next to nothing price because the money spent gaming made up for the difference. This is as Cowen states: the classic example of a “cross subsidy”. One service (gaming) “cross subsidized” the production of another service (food). However once locals figured out that they could go into a casino and enjoy a buffet on the cheap, without gaming, the casino starts to give more than they gain. You are not getting cheap food because you are really paying for it through the money you are loosing to the games. Just as I experienced, this is no longer the case. Instead we see commercials advertising the great shopping, unique restaurants and spectacular shows, not to mention the spas, golfing and other activities that are probably now cross subsidizing the gaming.
“Cross subsidy” is prevalent all over. For instance if you travel much you can apply it to your hotel. Since I manage a hotel it is easy for me to explain how this works. The biggest point between hotels for competition is amenities, i.e. free breakfast, free happy hour, free internet, free business center, free shuttle and so on. It is probably no surprise that the hotel pays to supply these amenities. The hotel room is the cross subsidy of the other free items. This really works to the benefit of the hotel since we can present it to you as a free service which conveys better value than the hotel across the street that charges $9.99 per day for internet, and $10.95 for breakfast buffet and so on. You are not really saving the money it is built into your hotel room price. It works, because guests perceive free amenities as better value, only because it seems cheaper since it is not broken down line by line.
As you might have noticed by now, key phrases really strike my curiosity as I decide the principle behind them are important to remember for the purpose of applying them in all situations possible. This application makes me stop and analyze what might be going on. I will be on the lookout for other areas where “cross subsidies” may be prevalent.