Megabus’ Marginal Cost Pricing Strategy

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedIn

Have you ever wondered why the cost of airline tickets or bus fare is prone to change depending on when you buy your ticket or the date you are traveling? These businesses are usually operating on a marginal cost pricing strategy.

One company that is practicing a marginal cost pricing strategy and succeeding is Megabus.com, a low-cost bus service that offers incredibly low fares. For example, a Megabus round trip route from Des Moines to Chicago might typically cost around $19, while the same Greyhound route could run upwards of $90. Some internet specials have even offered city-to-city fares for as low as $1. The Des Moines Business Record explored the Megabus.com strategy in detail in their May 10, 2010 issue.

According to company president Dale Moser, who was interviewed by Business Record editor Chris Conetzkey, Megabus.com can afford to offer such low fares based on the principle of supply and demand. The company has taken the natural “peaks and valleys” of travel habits into account to create a pricing structure that is dependent on the customers’ timing and the demand for a specific route. This means that while some customers may pay $1 for their seat, other customers will likely pay more. These drastically low rates might mean that on a day-to-day basis, the company will see losses. But  with the large amount of tickets sold, Megabus.com wins in the long run.

Of course, there are other factors in play that allow the company to do business using this marginal cost pricing strategy. Megabus is part of the Stagecoach Group, an international public transport company. Moser says that because Megabus is part of one of the largest public transportation companies in North America, there isn’t much additional overhead or infrastructure to worry about. Then, the company does much of their business online, which means no storefront costs.

Marginal cost pricing succeeds for this type of service because the marginal cost of having someone be a passenger is much less than the incremental cost that is charged. In other words, even if a Megabus customer pays only $10 for their ticket, the cost for the company of having them as a customer on a bus that is already traveling is significantly less. When this cost is figured in over several customers, with some paying very low rates and others paying higher rates, it’s easy to see how Megasbus.com has become successful. While a company that sells products has to consider the marginal costs of producing a product, Megabus will be sending a bus to its destination no matter how many passengers are on board. It is therefore in their best interest to sell as many seats as they can.

Other businesses can incorporate this system if the following conditions are met: 1. The business must have some sort of monopoly power. 2. The business’ customers differ in their willingness to pay. 3. The customers aren’t able to hide this difference. If your business could benefit from this type of strategy, perhaps look to Megabus’ great example for some inspiration.