Surge Pricing- Economics or Greed?

Surge Pricing- Economics or Greed?

Surge Pricing- Economics or Greed?

Uber’s surge pricing during Delhi’s Odd-Even traffic decongestion campaign and Kejriwal government’s quick decision to ban the same stirred a hornets nest. Uber cried foul, claiming it to be a world wide standard practice. Kejriwal called it pure blackmail. Customers, though, had no say and the rest pitched in depending on which side of political spectrum they occupied.

Pure Economics

Uber claimed its dynamic pricing policy, popularly known as surge pricing, is based on pure elementary economics. Price is simply determined by supply and demand. Their pricing algorithm automatically detects situations of high demand and low supply and hikes the price in increments, depending on the scale of the shortage. So that is their theory and apparently quite plausible. However, they preferred to omit some other elementary economics.

It is true that as a rule higher demand or lower supply will lead to higher prices but there is always a small suffix ‘ceteris paribus’ (everything else remaining the same). In this case, many things changed when Delhi government introduced the Odd-Even traffic decongestion scheme. The most important of these changes was the fact that there was significant improvement in travel time and this suddenly creates a lot of additional capacity (supply) without any cost to Uber or drivers. So let us examine its impact vis a vis what Uber is claiming.              

Let us start with a conservative assumption that travel time improved by 20%. Using simple mathematics, Uber drivers would be able to increase their trips by same percentage from 8am to 8pm, which accounts for most of their business. So using same elementary economic principals, it will cause a rightward shift in supply curve and lead to higher supply at lower prices.

Uber completely ignored the boost on supply side and merely looked at shift in demand curve. It is no surprise that such a projection will cause a price increase. However, if we take into consideration the ground reality of higher supply and higher demand, we come up with two scenarios. In the first scenario, price will remain unchanged if increase on demand side matches increase on supply side, with one key outcome i.e. at new equilibrium point, more cabs will be available at the original price. In the second scenario, higher increase in demand as compared to supply side will eventually lead to more number of cabs being made available at a higher price.

Finally, even if increase in demand does outstrip the increase in supply and the price does increase, what kind of increase is justified? Uber claims surge pricing is a standard practice and surge is automatically calculated by computer algorithms. However, the fact is that it is Uber’s standard practice and algorithm have also been authored by them. Why should a customer accept an increase in price up to 700% just because of a heavy shower?

By Uber’s own admission, surge price trips account for less than 10% of total trips. So going back to our drawing board, let us try to decipher total impact of Odd-Even campaign on Uber. Going with our original projection of 20% increase in supply due to improved travel time, earning potential of Uber and its drivers increases by same percentage across the board, including their major chunk of business at base price. On the downside, they have to incentivise the drivers to come out during the surge period. Why should they not fund this incentive from the gains they make on their bread and butter business due to 20% free capacity. As they say you win some and you lose some. In any case surge price of up to 8 times can’t be justified by pure economics, as claimed by Uber.

So is it greed

Delhi Chief Minister Kejriwal equated Uber’s surge pricing during operation of Odd-Even scheme as daylight robbery. He was not the first to challenge Uber. There have been many instances in past as well.

Uber faced a huge backlash for surge pricing immediately after Australian Hostage situation in Sydney on December 15, 2014. Prices surged up to 4 times in the aftermath of massive evacuation of surrounding shops and offices. Uber’s first response was “Fares have increased to encourage more drivers to come online and pick up passengers in the area” Massive public protest forced it to retract its earlier position and to offer free rides to people affected by this situation. However, even then they still tried to justify the surge pricing. So it may not be pure greed but Uber is certainly opportunist. It is in its DNA. Its business model is quite unique. It calls itself a “Market place” and its drivers as “Partners”. It doesn’t own any cars. It keeps about 20% of total revenue from cab rides and drivers get the balance.

 It is not driven by profit but by market share which is increasing at a very fast pace, notwithstanding considerable financial losses. It has managed to raise over $10 billion and is the only startup company valued over $50 billion. However, underlying vision is clear, put competition to bed and then use monopoly power to force customers to pay what and how it likes.

How much is too much?

It is clear that surge pricing is key to Uber’s survival. It makes losses while undercutting competitors and tries to make up some of these losses through opportunist surge pricing. It may temporarily suspend it in emergency situation capable of causing public wrath but won’t change course otherwise.

In current day and time, industry watch dogs and regulators are pretty much the norm even in capitalist countries. So there is no reason as to why Uber or any other market leader  or player is not subjected to same regulation to ensure some fairness based on economic principles and aligned with public interest. After all we are past  laissaz-faire.
Uber owes Kejriwal a thank you card for free additional capacity.

(The author is a management consultant and a chartered accountant based out of New Delhi)

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