Uber’s Dynamic Pricing Model

We talked about Uber from the perspective of becoming a driver back when they announced deals to help get new drivers financed. The company is top of mind for me again after listening to the latest Planet Money podcast episode: Why Paying $192 For A 5-Mile Car Ride May Be Rational.

First, let’s circle back to their news back then and some of the details we mentioned: An Uber driver can gross upwards of $100,000 a year per car. Another little bullet point mentioned in the podcast is that Uber takes a 20% share of the revenues. So that means a net of $80,000 (or more) minus car payments, maintenance, gas and other expenses. But keep in mind that all of that is tax deductible as business expenses. It seems to me that an Uber driver can probably do fairly well for themselves striking out with their own car, with effectively no education requirements (Depending on the service offered, you may be required to have a commercial driving license, or be licensed by the city in which you’d like to operate).

In that press release they announced a partnership with car manufacturers to help secure cheaper leasing for the vehicles that make up their fleet in an attempt to help sign on new drivers. All of this is a result of Uber attempting to help grow their business. The simple problem here is one of supply and demand – they need to increase their supply of drivers to help meet the demands of their growing customer base. Which brings us to the other way the company is addressing this mismatch: dynamic or “surge” pricing. That’s the basis of that new Planet Money podcast.

Surge Pricing

The idea is very simple, but one we rarely see in practice for many goods and services in our lives. And in fact, depending on the circumstances, it can actually be illegal and deemed “price gouging”. When demand increases dramatically and supply is limited, the natural response would be to raise prices. That’s exactly what Uber does with it’s “surge” pricing that causes the price to become multiplied. It can result in multiples that become outrageous in comparisons to the normal fares: two, three, even seven times the original rate. The idea is to entice drivers to extend their shifts if they were planning on heading back home, or to put out a call for drivers to get on the road when they may not have planned to. Or even to get drivers to shift the area they are serving.

The question becomes whether or not the company will thrive long term with such a pricing policy. The podcast gave many counter examples of stores such as Home Depot or Lowe’s  keeping prices of road salt, shovels and snowblowers constant even as they sell out immediately in advance of snow storms. They could easily ramp up the price since people are clamoring for these items and they are literally selling out as new shipments arrive. But they don’t. Why not maximize the profits per item? Because “they’re in it for the long term” and people feel cheated or taken advantage of when they feel a price increase like this. In fact, I can recall a number of cases where we’ve had storms in New York and the Governor or Senators call for investigations into business like gas stations where people reported “price gouging” during events like Sandy. The business was trying to maximize it’s profit off the limited supply of gasoline it had – and in this case it was seen as illegal!

Where do we draw the line with regard to prices that actually reflect a sudden increase in demand? It feels like taking advantage of consumers if the increase is due to a natural or personal disaster – or if the good in question is a staple or “need”. Yet we tolerate it to some degree with hotels and flights around big events or holiday weeks. Restaurants and florists on Valentine’s.

And to make the point further, when prices aren’t elastic and don’t fluctuate to meet a limited supply we can actually see “scalping”. Clearly this is very common for concerts and events. Everyone’s aware of ticket scalpers. But it also happens for other items: game consoles just after launch – people will buy up the limited supply and resell at a much higher price. It even happens for the road salt, shovels and snowblowers around storms. People will buy them up and then re-sell them on Craigslist.

The point seems to be that we expect a long term or reputable retailer to hold steady on prices for us, or else we’ll feel cheated and won’t repeat our shopping there. But for short-term or one time transactions we’re grudgingly willing to pay the true market price for an item while gritting our teeth.

Can Uber become a long-term service that still dynamically prices?  If they’re open and transparent about the pricing model, will that be enough? Time will tell.

 

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