On Uber's surge pricing

4 minute(s)

Context

Uber received significant media coverage in the past few days as storms drew attention to their surge pricing model. Heated discussions around its merits & morality crowd the web; in terms of economic theory, the model makes perfect sense, but it makes people furious.

We did more trips because of our approach, not fewer. We gave people more options to get around, and that is the whole frickin' goal.

Travis Kalanick

Uber charges more when the demand for their services increases. During rush hour, Uber's algorithm increases prices to incent drivers to get on the road, maximizing the number of rides completed (as well as Uber's profit). This makes sense, but what if the reason demand increased is a snowstorm? Prices have gone up more than 7x base fare under extreme scenarios. Kalanick says that increasing prices ensures that anyone who wants a ride and can pay for one will get one, and delivers on Uber's core value: reliability. Economic theory is on his side - when demand increases, prices need to increase to encourage an increase in supply until the market clears (and in a free market, this would also maximize Uber's profit). Technically, the flexible pricing mechanism means greater market efficiency.

The core issue

However, economic theory also points to the Big Tradeoff: there is a trade-off between efficiency and equality. And this is the core of the problem: Uber's pricing model targets efficiency over equality, and the surge fees price certain people out of the market. Tied with the fact that demand for taxi services correlatives positively to extreme weather changes, some see it as an example of price gouging (which is illegal in most states).

This is where black and white turn to grey. The lack of a price-finding mechanism means the model could be considered gouging; in a real open market, the demand has the opportunity to bid, but this power is ceded to Uber's proprietary algorithm. The calculation is a black box, so we have no idea what's really going on, and for all we know it's not actually efficient. But on the flipsite, for price gouging to truly exist Uber needs to be a monopoly (or demand would switch to a competing product rather than pay the outrageous price). There's a variety of other options and Uber doesn't control the prices set by those alternatives. Even in times of extreme weather, it's unlikely that Uber is the only option available.

Ultimately, Uber is a private company with no legal/moral responsibility to service people they don't want to service. They probably still want to do something to address the negative publicity, especially as they simultaneously face increased regulatory scrutiny and backlash from traditional cab companies. For me as a user, Uber has been cheaper, more convenient, and an overall better experience. The economics for drivers isn't yet proven but at a glance it looks like most stakeholders (except for traditional cab companies) are better off with Uber around.

Recommendations

If I was in charge of Uber's response to this backlash, I'd do two things:

• Increase transparency on the algorithm
• Take Uber's fee off base price, not surge price

This would have three key benefits:

• Better optics: Uber wouldn't be seen as profiting off natural disasters and other emergencies, and help sway users in favour of Uber and a dynamic pricing model.
• End-user prices would be lower. A $20 ride suring might clear at $40, and Uber's commission would be $10 (25%). Taking only the base fee ($5) means the clearing price would be $35. Driver income would be unchanged and rider surge would be 1.75x insted of 2x.

This would truly deliver on Uber's core value of reliability, and the slightly lower income is well worth the cost of the negative press, damage control response, etc.

Overall, I think variable demand-based pricing is a great idea and one that we should see more often, as long as the right checks and balances are in place to comfort users.