Uber’s surge pricing shouldn’t just be about ‘good’ economics

uber

Vivek Kaul

The two most basic laws in economics are the law of demand and the law of supply. The law of demand basically states that all other factors being equal the price and the quantity demanded of any good or service are inversely proportional to each other. The law of supply states that an increase in price results in the increase of the quantity of the good or service supplied.

These two laws are the heart of the business model of Uber. The price of the taxi-service goes up when the demand is higher i.e. more people want to use Uber cabs in an area than the number of cabs available at that point of time. The company calls this “surge pricing”.

On the face of it this pricing practice sounds normal. It is often compared to airline ticket prices where the prices during weekends, summers, festivals and end/beginning of the year tend to be higher because the demand is higher. Along similar lines Uber prices go up when the demand is higher. Nevertheless, the comparison is not so straightforward.

When the demand is high, the price charged by Uber starts to go up. There have been cases when the price has gone up many times the normal price charged by the company. A December 2014 article in the Time magazine puts the highest multiple ever recorded at 50 times the normal price. This happened in Stockholm, Sweden.

When terrorists took over a café in Sydney in December 2014, the price went up four times its normal rate. A similar thing happened in Toronto, last month, during a massive subway disruption in the city.

The company has a standard explanation for this—the law of supply is at work. Travis Kalanick, the CEO of Uber explained it on his Facebook page once: “We do not own cars nor do we employ drivers…Higher prices are required in order to get cars on the road and keep them on the road during the busiest times. This maximizes the number of trips and minimizes the number of people stranded.”

How good is this argument? As Richard Thaler writes in Mishbehaving: The Making of Behavioural Economics: “You can’t just decide on the spur of the moment to become an Uber driver, and even existing drivers who are either at home relaxing or at work on another job have limited ability to jump in their cars and drive when a temporary surge is announced.”

Further, “one indication of the limits on the extent to which supply of drivers can respond quickly is the very fact that we have seen multiples as high as ten”, writes Thaler. If drivers were actually responding to surge pricing quickly that wouldn’t have been the case.

Research carried out by Nicholas Diakopoulos of the University of Maryland (which was published in the Washington Post) suggested that: “surge pricing doesn’t seem to bring more drivers out on the roads”. What it does instead is that pushes drivers already on the road towards areas with higher surge pricing.

Also, in most cities which have taxi-cabs people are used to paying a fixed rate. Uber is trying to challenge that notion. The trouble is that while it is doing that it ends up with a lot of bad PR, during tough situations(like terrorists entering a city, weather disasters, transport strikes/disruptions) when the surge pricing tends to kick in. While “surge pricing” follows economic theory, what the company needs to realise is that they are charging the consumer more, when he or she is in a spot of bother anyway.

So what should they do? Thaler has the answer: “This insensitivity to the norms of fairness could be particularly costly to the company…Why create enemies in order to increase profits a few days in a year?…I would suggest that they simply cap surges to something like a multiple of three times the usual fare.”
Now that sounds like a sensible thing to do.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column appeared in the Bangalore Mirror on July 8, 2015

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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