[This post originally appeared in HBR blogs on 24th August 2012]

Over the last year, a new app has been changing the way people get limos in some major cities in the US. Uber — founded by Garrett Camp, Oscar Salazar, and Travis Kalanick, and launched in 2010 in San Francisco — allows people to get and pay for taxi rides easily. Here’s how it works: after you have signed up for an Uber account, you can launch the smart phone app and instantly find limos or town cars equipped with the service. One click hails them, and the nearest driver comes and picks you up. At the end of the journey, your driver charges your account. No standing in the rain trying to hail a cab. No grabbing for cash or fiddling with credit cards.

Uber has positioned itself for the time-sensitive rather than price-sensitive consumer. Its rates are higher than you would find for regular taxi, but the fast response drives value for consumers. On the technical side of things, Uber works well. Its challenge now is to get both customers and drivers signed up. But doing so involves a delicate balancing act, one faced by every startup that fancies itself a “platform.”

A tirade of a blog post by Bill Gallagher this week shows just how delicate the balancing act really is. Taxi rides have fees that vary with the length and time of the journey. People are used to that. But Uber, to encourage more taxis into a busy area, has implemented what economists call “dynamic pricing.” With dynamic pricing, when supply gets tight, prices rise. We see this all the time with hotels and airlines. Uber implemented it to reward those drivers who joined the service; drivers who service busy areas get paid more. In that way, dynamic pricing also helps to direct drivers’ attention to where they are needed most, which helps users. If you want to ensure that supply for Uber users isn’t tight when it is for everyone else, you pay suppliers more during busy times.

Put that way, it all sounded reasonable. But for consumers like Gallagher, it meant confusion. Gallagher, for instance, saw that his airport ride might cost him 1.5 times the usual amount, but there was a miscommunication with his Uber driver, who misquoted the price. Uber has tried to be responsive to Gallagher’s expression of ire, but one gets the sense that in this one case there was some fragility in the customer relationship.

If this were a one-time mishap, we could set it aside. But sticker shock has actually turned out to be a ongoing issue for the company. This was demonstrated most clearly in New York on New Year’s Eve, a night that should have been a triumph for the start-up. Because of high demand and the accompanying ever-higher prices, Uber’s supposedly simple and straightforward transaction became complex. Consumers saw that their ride home could be seven times the price of their ride into town. Consumers who were used to easy clicking missed the notice and became (reasonably) upset when the bill arrived. Either way, they weren’t happy. Basically, to satisfy one side of its market — the taxi drivers — Uber upset the other side — its customers.

One possible reaction to this issue is to conclude that dynamic pricing is a pipe-dream, fundamentally inconsistent with what consumers want. That, however, would be short-sighted. After all, if consumers want timely service, especially during peak times, surely they will have to pay for it. Uber doesn’t own the cars, so it must rely on the market to procure them. That means that when the competition heats up, prices will rise.

The problem is not that the consumers paid but how they paid. It was the surprise over the unexpectedly high price that disrupted the relationship. In light of this, Uber could offer consumers the option of an account with some price assurance. One extreme would be that the consumers’ prices were fixed but slightly higher than the average dynamic price. Uber could still pay taxis more when there was peak demand but the cost of that would be spread over consumers at all the times they grab cabs. Basically, Uber would offer their consumers insurance over a fluctuating cab price and then use the premiums to pay for the peak procurement. More to the point, this option would allow the company to shield consumers to the full brunt of their supply management challenges.

Such an approach would require a more delicate balancing act on Uber’s part. It cannot rely on consumers to self-mediate the peak times. But then again that is not its mission. To encourage intensity of use, which is where Uber makes its profit, it needs both consumers (who value simplicity and certainty) and taxi drivers (whose other option is to go it alone). That means it has to offer each side what it wants even if it results in a more problematic management and financial balancing act for the company itself. But that too will rely on having lots of customers with diverse preferences.

Uber will succeed or fail based its ability to generate a virtuous cycle — which is why platform establishment is easier to say than to do.

(For my part, I’ve used Uber several times and really like not only the convenience but the beautifully designed receipts.)

6 Responses to Uber and the delicate business of creating a platform

  1. Tony Healy says:

    Personally, I think Uber has the right approach, and I’m also pleased to see their CEO defending it.

    Taxi rides are one market where customers are strangely protected from demand-driven pricing, and they shouldn’t be. In this case, the reporter was clearly notified of the surcharge but chose to disregard that notice in favour of an unclear verbal communication.

  2. Will G says:

    I haven’t used Uber, but based on the link provided and Uber’s site http://blog.uber.com/2012/03/14/clear-and-straight-forward-surge-pricing/ it doesn’t tell the consumer the exact fare before the user accepts. I feel this problem can be resolved by providing the consumer exact rates BEFORE they accept, instead of just estimates + surcharges.

    I love dynamic pricing, but I feel like the consumers are acting with incomplete information in this case.

  3. […] Uber and the delicate business of creating a platform – Digitopoly […]

  4. taxiguy says:

    This business model will not work. For it to work he has to deregulate the entire industry. He will be regulated in DC where they were caught lieing to a councilwoman. When the facts come out that this is a skimming operation stealing rides from taxi cabs and running an on demand sedan service it will be shut down. They have a good PR machine but that will not over take the fact they are a rouge app operating illegally in most places they operate. This company will be sued by employees because they control the driverrs by contract and fire their drivers, ADA because they discrimminate and don’t follow regilations regarding taxi companies, underserved communities will sue them because you have to have a cell phone and credit card and taxi cab companies have to provide service to everyone. This will be a class action night mare.

    This will end just like red swoosh. The legal operators will prevail and one more bankrupt company that claims technology that is nothing new but a way to break the law.

  5. […] are worried that large price increases represent gouging and create uncertainty. (Of course, again economists suggest that some forward price contracts could assist here but Uber has yet to rise to that […]

  6. […] work to do so without large fluctuations. The other way is to have excess capacity. As I wrote in HBR a few years ago, what if there is a guarantee of price stability for consumers but Uber uses prices to still induce […]

Leave a Reply

%d bloggers like this: