Surge This: Ideas and Economics on Uber

The Uber car service’s practice of “surge pricing” garners attention, it seems, at every snowstorm, flood, or other act of God, such as a Jay-Z concert.

Uber CEO Travis Kalanick continues to vigorously defend the company’s policy of charging as much as eight times regular fares during peak times, saying that the higher prices are necessary to bring more cars on the road, which in turn makes for a better Uber experience for more people. And yet the public wails.

“You idiots!” Uber’s defenders scream. It’s Econ 101. When demand outpaces supply, prices rise. Higher prices encourage more quantity supplied, hence Kalanick’s claim to more cars on the road.

The invisible hand at work, dummies. It’s called capitalism.

Jason_Rapp_2013

But, for the same reason that there’s Econ 202, Kalanick’s story deserves a deeper look.

Many businesses see fluctuations in supply and demand, and choose not to charge the clearing price. Uber chooses to raise the clearing price, and the company’s implication that it’s simply for the betterment of the experience is specious.

First, it’s worth noting that the company hasn’t provided data to support its claim that higher prices result in more drivers. Spikes in demand are just that — spikes. They don’t last long. Getting a driver off his or her couch and on the road during a storm takes time.

Further, drivers drive on schedules, often sharing cars, based on average supply and demand. So the notion that there’s excess supply sitting around during snowstorms deserves scrutiny.

But what about the economics? Shouldn’t supply and demand be the laws that matter?

As New Yorkers understand, when you get a cab in the rain, you feel lucky. That lucky feeling is described by economists as “economic rent” — or the excess value derived from a good or service beyond its production cost. Since taxi prices are fixed, a rider who might otherwise pay more for the rainy-day pick-up simply basks in that lucky feeling.

What’s really happening is a determination of who benefits from temporary gaps between supply and demand.

Uber is simply saying that the driver (and the company itself) should derive the economic rents, not the consumer. No problem there, that’s business.

And by using price as the determinant, they reward those customers who are least price-sensitive, i.e., rich people. Uh-oh, here comes the backlash.

The backlash, of course, is the human element that says “Hey, I ride you on sunny days and rainy days. And I’ll pay more in the rain. But don’t gouge me in a storm. In fact, that part of human nature has been codified into anti-gouging laws, which, unlike the laws of supply and demand, are actually written into the legal code.

My friend Mo Koyfman correctly points out that, while the economics makes sense in the books, Uber is digging itself into a massive PR hole.

Further, as the blogger Sarah Lacy recently noted, the opacity of the Uber pricing mechanism is sowing distrust. She worries that perhaps she’s seeing surge pricing not because of quantity supplied or demanded in the aggregate, but rather because Uber knows that she has a history of paying the higher price, so they’re just charging her because they know she’ll pay it.

In economic terms, she fears that Uber knows the slope of her demand curve, or her elasticity of demand, and is charging her accordingly. Perfectly legit, but true gentlemen don’t peek at a lady’s demand curve.

Jumping back out of the econ text, what other systems could Uber use to deal with demand spikes?

Loyalty: Uber could reward its most frequent users by priority placement on a waiting list during periods of high demand. Airlines do this for aisle seats up front. Restaurants do this for prime tables or Saturday-night reservations. They could even charge loyalty points instead of cash as the surge price.

FCFS: Uber could simply queue its requests and show consumers where they stand. First-come, first-served is a time-honored tradition. “We have no cars during this storm, would you like a text message when we do?” Some transparency to the consumer would likely be rewarded.

Tiering: Rather than charge everyone higher prices, Uber could offer the option of surge pricing for immediate service, or normal pricing for waiting. It could even argue that the high prices it offers to rich people for jumping the line helps to lower the overall price for everyone else. Disney does this with its VIP Tour Guide product at its theme parks.

Caps: Like its competitor Lyft, Uber could simply cap the surge price. Price transparency before a transaction is important to consumers for practical reasons. So, knowing that the surge price won’t be more than 50 percent above the base fare will help consumers, but does so at the expense of those economic rents.

In short, Uber’s system is elegant in its pure economic efficiency — but the result is that the richest customers benefit. That’s what makes capitalism great.

But what makes capitalism interesting is that regular consumers don’t want to feel “gouged,” and don’t want to be considered second-class citizens. So they start thinking about competitors, like Lyft, who take a less Keynesian view of fairness.

In the long run, Uber’s price-mechanic may not be as efficient as it seems. But, as Keynes said, in the long run we’ll all be dead, or at least in driverless drone cars.

Jason Rapp (@jasonrapp) is managing director of Science Inc., an early-stage technology holding company in Los Angeles.


Must-Reads from other Websites

Panos Mourdoukoutas

Why Apple Should Buy China’s Xiaomi

Paul Graham

What I Didn’t Say

Benjamin Bratton

We Need to Talk About TED

Mat Honan

I, Glasshole: My Year With Google Glass

Chris Ware

All Together Now

Corey S. Powell and Laurie Gwen Shapiro

The Sculpture on the Moon

About Voices

Along with original content and posts from across the Dow Jones network, this section of AllThingsD includes Must-Reads From Other Websites — pieces we’ve read, discussions we’ve followed, stuff we like. Six posts from external sites are included here each weekday, but we only run the headlines. We link to the original sites for the rest. These posts are explicitly labeled, so it’s clear that the content comes from other websites, and for clarity’s sake, all outside posts run against a pink background.

We also solicit original full-length posts and accept some unsolicited submissions.

Read more »