7uNew Years Eve has come and gone and with it the annual discussion regarding whether Uber’s ‘surge pricing’ is justifiable (for example, here is Slate and here is an excellent set of points from Tim B. Lee at Vox.  For the uninitiated, ‘surge pricing’ occurs when Uber’s algorithms automatically raise the price of rides to consumers by multiples (2, 4 and even 7 times) over their normal price. Not surprisingly, consumers hate this while drivers love it.

Previously, the argument has been about transparency. The price spikes seemed to happen without warning and with variable magnitudes. For those who headed out for a night on the town, they might find themselves with unexpected costs of getting home. Uber (and the response of many economists I might add) is that at least with this they could get home. However, Uber did receive the message and this year was at pains to inform its customers that price spikes were likely. Moreover, they allowed people to receive an estimate of just how much they might pay. Suffice it to say, transparency was achieved.

Of course, this hasn’t really hit at the argument. Planning helps but as airlines have found, consumers really aren’t happy about price variability. In one sense, it is hard to dismiss their distress. When Sydney faced a hostage crisis recently, Uber’s algorithms initiated a surge. There was outrage that Uber was exploiting a fearful situation and Uber, itself, did not appear to intend that and quickly made all fares out the city free. But economists were concerned that such moves may yield to worse outcomes. After all, the point of surge pricing is to encourage more drivers to work and in doing so help in a crisis. But as Tim Sullivan wrote, few (economists included) would teach their kids to demand more from people who are desperate, and so we should not be surprised when people react negatively to these price spikes.

The issue is that the fundamental problem of supply being outweighed by demand continues. Price surges are one way of getting the balance right and, indeed, when there is lots of transparency and little uncertainty these 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 drivers? Consumers pay more on average per ride but are insured against price spikes. Drivers are still paid the same. In that situation, there is a loss in static efficiency (due to consumers demanding more during peak periods and less otherwise) but the consumers get insurance. Moreover, Uber could offer price stability as an alternative product. Then surely it is the consumer’s own fault for not purchasing it; blurring the moral lines somewhat.

Such schemes have not been tried because they can be inherently difficult to manage. Then again, the current system is no picnic so surely experimentation is warranted.

But there is a final wrinkle. When there is surge pricing in effect, some consumers who remember what it is like not to get a ride, would surely be happier than before. Yet this doesn’t seem to be the case (of course, maybe there are some but, apart from economists, I haven’t seen much evidence of it). This suggests to me that the moral outrage is different from the one Sullivan is suggesting. It is not about the “right” thing to do but, instead, that during surge price times, drivers are earning returns about their opportunity cost. That, of course, is the point. But what they are getting is a bonus and the bonus has to (and I don’t have time to get into the full economics here) pay them more than a normal return. In other words, the system is designed not to pay drivers to just do their job when they would be at a party but instead to give them more in order to ration demand. It would not surprise me at all if we had instinctual emotional reactions to situations where the power has shifted against us and that power is being exercised.

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One Response to The morality of price spikes

  1. hhoran says:

    Your post raises issues that appropriately challenge the Tim Lee “surge pricing is spectacularly wonderful” nonsense. If the economics were so powerful and pro-consumer, why hadn’t any other urban transport provider attempted them before? But I think if you dig deeper into the huge differences between Uber surge pricing and airline revenue management, it is easier to put these problems into sharper focus.
    Airline fare options are published in advance and are100% transparent, and tickets are firm contracts; Uber fare discrimination is not transparent and Uber consumers have no contractual protections. The “fairness” issue is not “high fare vs low fare”; it is whether fare options are completely transparent, equally available to everyone, and whether consumers are fully protected from last minute gouging/travel disruption. Airlines publish both their cheap restricted fares and their higher last minute fares in advance; customers know the exact fares on offer well in advance of making their travel plans and at any point in time the exact same fares are available to everyone. Uber itself does not know when demand surges will drive fare surges (especially given the uncertainty of rain), and does not allow customers to lock in specific fare levels in advance. If you buy a cheap fare to LA for travel in April you have 100% price certainty; if you go out for the evening, you have no idea what you might have to pay to get back. If United underestimates demand for Friday night’s flight, it can’t sell more $700 tickets by involuntarily kicking $200 passengers off the plane. There’s nothing to stop Uber driver from cancelling $20 fares when it starts raining in order to get some of those $80 surge fares.
    Variable airline pricing maximizes capacity utilization because of the specific nature of airline demand and operations; Uber demand and operations preclude similar efficiency gains. A significant portion of long-distance airline demand is not locked into specific travel times, and with advance info about big discounts can be induced to shift travel away from peak periods. Peak demand for intra-urban travel is either driven by weather or by fixed-in-time commitments (work, doctor appointments, concerts, etc). Consumers can easily shift the trip to Orlando from August to October but will not shift their Saturday night dinner date to Tuesday morning. Airlines also control 100% of the factors affecting capacity utilization (fares, schedules, staffing, fleet mix) although optimizing efficiency requires staggering complex systems. Airlines could not maximize revenues and load factors if pilots were “independent suppliers” like Uber drivers, who might show up if fares surge, but might not. Full fare airline tickets directly pay for airplanes and pilots. Uber surge pricing is just a sudden short-term windfall. It would certainly induce a few more peak drivers but since Uber doesn’t own or control its capacity (cars/drivers) it can’t ensure that an optimal long-term level of peak capacity and (more importantly) Uber’s business model severs the link between short-term revenue surges and long-term capacity costs.
    No other form of urban transport has been able to achieve any of the efficiency advantages of airline variable pricing because the economics are totally different. One could establish rush hour rates for the Long Island Railroad or Lincoln Tunnel tolls that were 4X the midday rates and 7X the late night rates, but this would destroy the value that this transport infrastructure creates for the rest of the economy. Taxis are a critical part of most urban transport systems. They serve a lot more than rich people going out on the town on Saturday night. No urban transport service of any importance operates on an Uber-like unregulated, laissez faire basis in any developed country anywhere in the world.

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