Internet Industry, Product Management

The Problem With Uber’s Surge Pricing

Uber’s surge pricing causes a ton consternation among for its customers and while surge pricing is a theoretically correct economic response to a shortage, in practice it makes for service that doesn’t meet the all the needs that Uber is trying to fulfill. The idea behind surge is pricing is sound on paper: when there’s more demand than supply, the price should rise so that market clears. The alternative is a shortage which would mean long waits for an Uber, similar to how its difficult to get a taxi in a period of high demand. The problem with surge pricing is that it forces the customer to be in a spot market for transportation. A spot market is where a transaction is made for immediate fulfillment or in simpler terms, an Uber ride can only be bought when you need it and the price fluctuates so there’s no way of knowing in advance (say a day or even an hour before) how much you’ll pay.

Consumers do not like spot markets in general and most of the time, their transportation needs are predictable rather than of the moment. The number of commodities that the average consumer buys at spot prices is quite small. Ones that come to mind are gasoline and food products like milk, fruits, vegetables, and meat. The amount of complaining when gas prices rise is a good indicator of how much people dislike spot markets. There’s less complaining about food because there are many of substitutes. If the price of beef is high, one can always buy chicken or pork instead.

When it comes to transport, people avoid spot markets. When was the last time you walked into the airport and bought a ticket for plane departing in an hour? The problem with walking into the airport and buying a ticket is that the price could be very high. If there are few seats left, a flight that is usually $400 could be $1000. Since most of us rarely need to fly on short notice, we avoid the spot market and make a reservation in advance. If fares are high the weekend we want to fly to Vegas, maybe we go the next weekend or decide to take a road trip instead.

With Uber, we have none of these options since we don’t know what the price is going to be till right when we need the service. Say I bought an airline ticket for 4 weeks from now. I know 4 weeks in advance that I need transportation to the airport on a particular day and time, but if I want to take Uber, I have no idea what that will cost. If I open the Uber app and see it’s 3x surge pricing, I likely don’t have enough time left to take the bus instead. The same problem exists if I need to be a work at 9am tomorrow and my plan is to take is to take Uber. For much of most peoples transit needs, they know in advance when they will need transportation. That foreknowledge should be useful in making sure that supply and demand are balanced but with Uber, it’s not used at all.

With Uber, the riders are only one-half of the equation. If surge pricing worked as intended, drivers would see the high prices, start driving and increase the supply. For the supply to meaningfully increase, the number of drivers has to be elastic meaning that high prices need to actually significantly increase the supply. Uber drivers have a similar problem to riders in that they don’t know what the rates will be in advance. If an Uber driver is sitting at home in their underwear and watching re-runs on TV then 3x surge pricing might motivate them to put on some pants, get in the car and starting driving. However, if they made other plans or just decided to sleep in, then 3x surge has no effect on their willingness to provide rides. If they had known that it was going to be 3x surge pricing maybe they would not have agreed to go to brunch or stayed out late the night before but with Uber’s current system it’s all guess work. An experienced driver might know when surge pricing is likely and plan accordingly but if it’s unpredictable (either in time or amount), then potential increase in supply is limited to drivers who happen be sitting around doing nothing.

I don’t have access to data on how surge pricing affects supply. Uber certainly has this data but even under heavy criticism, they’ve never (to my knowledge) made any specific claims about how effective surge pricing is at increasing the number of drivers. Even without the data one could presume that if surge pricing was effective at bringing in drivers that surges above 1.5x would be rare as most people would not pass up the chance to earn 50% more than usual. In some geographies, 2x and greater surges are a common event.

New Year’s Eve is surge pricing at its most extreme. On NYE 2013, some riders were paying $500 for rides. Every business that is part of people’s New Year’s Eve festivities, especially bars and restaurants, raises prices on New Year’s Eve which makes sense because demand is so high and supply is fixed so it certainly makes sense that an Uber ride will cost more. Personally, I’m not a huge fan of New Year’s Eve and there’s an amount of income that would at least get me to consider driving for Uber on NYE. However, with the current surge pricing system, I don’t know what I’d make. While some revelers wouldn’t want to pre-plan what time they go home, I suspect many would prefer to book their ride in advance especially if it gave them certainty on the cost. I’m not going to give up my NYE’s because the earning potential might be good but is unknown and I suspect there are many people like me. Predictability would increase supply and make consumer better off.

Allowing reservations and still keeping an element of dynamic pricing so that supply and demand balance isn’t an easy problem. However if ride-sharing services are going to fulfill their vision of enabling people to not own cars, Uber or its competitors will need to create a method where prices are known in advance for transport needs known in advance. While surge pricing might be economically efficient in a purely economic view, that’s too narrow a way to look at the problem. From a product point view, there are customer needs not being met. If Uber can’t figure out how to tell people what it will cost them to get from point A to point B a week now, somebody will come into the market and meet that need.