Above the Crowd

A Deeper Look at Uber’s Dynamic Pricing Model

March 11, 2014:

New-Logo-Vertical-DarkOver the course of the past year, many writers have offered their perspectives on Uber’s dynamic pricing strategy. Perhaps the only consistency is that people have deeply passionate views on this topic. However, there are still many misperceptions about how the model works, and the purpose of this post is to clarify some of those misperceptions.

I am an Uber investor and board member, and therefore expect that many will dismiss these thoughts as naked bias. But consider that as a result of my role I have access to more information that might enable a deeper perspective. I also have quite a bit on the line, and as a result have spent a great deal of time contemplating the policy as well as the potential alternatives.

Clarifying Certain Specifics Regarding Uber

Before diving into Uber’s dynamic pricing model, it is important to clarify some of the key elements of how Uber is structured and operates.

1) Uber is a marketplace and Uber’s drivers are all independent agents. Uber’s drivers are independent agents that are either self-employed, or work for someone who owns multiple cars. Uber does not own cars and does not employ drivers. Each day, and each hour for that matter, these drivers decide whether or not to open the Uber application and accept requests for rides from Uber customers. These drivers are not bound by exclusivity. Many of them work on multiple services, and many have “regular customers” that they engage off the Uber platform.

2) The majority of Uber fares go to these independent drivers. On average, over 80% of gross fares end up in the hands of drivers. What’s more, of the percentage that is retained by Uber, a large portion goes to cover variable expenses within the service. These expenses include payment processing, payment fraud, refunds, customer service, dispute resolution, cellular handsets and service fees for the drivers, and local regulatory efforts. The bottom line is that this is a low margin business — much more akin to Amazon than Google.

3) Uber is a committed to being a low-price leader.  Some have suggested Uber is a “luxury brand.” This confusion is understandable, as Uber’s initial focus was on traditional black-car services. However, since its launch of the low-priced uberX brand over 18 months ago, Uber has been laser-focused on leading at all price points. This goal is to expose Uber’s amazing customer experience to a much broader base. UberX is now the company’s most strategic and fastest growing offering, and has become the company’s largest offering in many cities passing Uber black in number of daily rides. The company has also intentionally worked to lower price on uberX as often as it can (in some markets it has already lowered price four times). Despite this, some competitors still hold on to the convenient delusion that Uber is solely a high-end service, perhaps akin to CDNow assuming Amazon was only a bookstore.

Screen Shot 2014-03-06 at 11.11.46 PM

4) Uber’s dynamic pricing (“surge pricing”) affects a tiny minority of all Uber rides, less than 10% of trips. Dynamic pricing is most common on peak times on Friday and Saturday nights, on certain Holidays, such as Halloween and New Year’s Eve, and during particularly big events and bad weather conditions. All told, it’s a fraction of the time that Uber drivers are operating. The vast majority of the time, Uber’s increasingly low basic rates (uberX is often 40% cheaper than the local taxi alternative) are the primary price points for the service.

5) Uber is remarkably transparent about its dynamic rates. Ever since the company first encountered feedback about its pricing model, the company has gone out of its way to make sure that customers are aware of the policy and how it works. They have inserted special splash screens where the customer has to key in a specific confirmation of the increased rate. Additionally, the company has gone out of its way to publicize how and why the program works. This past New Year’s Eve, the CEO even published a how-to video encouraging riders NOT to ride at certain times.

The Origins of Uber’s Dynamic Pricing

So why does Uber’s dynamic pricing even exist? The answer lies in understanding that Uber is fundamentally a marketplace, where supply is controlled not by the company but by the legion of independent contractors and transportation providers with whom they work.

Back in early 2012, Uber’s Boston team noticed a problem. On Friday and Saturday nights, around 1am, the company was experiencing a spike in “unfulfilled requests.” The root cause was that drivers were clocking off the system to go home, just before the weekend partygoers were ready to venture home themselves. There was a supply-demand imbalance, and the result was a lot of very unhappy customers. So the Boston team had an idea. What if they offered the drivers a higher price to stay on the system longer (until around 3AM)? Would more take home dollars for drivers increase supply? In just two weeks they had a resounding answer. By offering more money to drivers, they were able to increase on-the-road supply of drivers by 70-80%, and more importantly eliminate two-thirds of the unfulfilled requests. The supply curve was highly elastic. Drivers were indeed motivated by price.

Based on the results from the Boston experiment, Uber implemented its dynamic pricing policy to be used solely when demand is materially outstripping supply. Dynamic pricing changes are driven algorithmically when wait times are increasing dramatically, and “unfulfilled requests” start to rise. In essence, there are two functions of the increased price model. One is to increase supply. The second function of the price increase is to temporarily intentionally reduce demand. Through these two mechanisms, the company is able to (a) increase supply, (b) assure reliability, a key tenet of the company, and (c) maximize the number of completed rides.

Economics 101: Supply and Demand Curves

If you were to pick up a copy of any introductory economics textbook, in either the first or second chapter you will find a description of the supply-demand curve. It is the key operating model for economic analysis, and is as fundamental to economics as DNA is to biology. If you have never been exposed to these topics, I highly suggest Khan Academy’s Microeconomics courses. As one might expect, the demand and supply curves are the first two sections.

Screen Shot 2014-03-07 at 6.41.40 AM

There are a few things to note about Uber’s marketplace and the supply-demand curve. First, Uber’s analysis and research has shown that both the supply curve and the demand curve are highly elastic. The Boston experiment, and every effort since then, confirms that higher prices increase supply, all things being equal. This is true in every market the company has entered.

On the demand side, the company has confirmed price-elasticity in two different areas. First, when prices surge, they see an immediate reduction in open-to-order ratios. As expected, higher prices do indeed reduce demand. Moreover, as mentioned in this video interview with Uber’s CEO Travis Kalanick, the converse is also true. Uber’s numerous price decreases have all resulted in materially increased demand. Basically, Uber’s marketplace is highly efficient, and operates in the exact way that your economics professor would expect. When you consider that both sides of the model – Uber’s riders and drivers – are both large groups of fragmented independent agents, this is no surprise. The market should operate efficiently.

Using the supply and demand curve as a model, Uber’s dynamic pricing model is rather straightforward. When demand outstrips supply, dynamic pricing algorithms increase prices to help the market reach equilibrium. Of course, these situations are always temporary, eventually supply outstrips demand, and the price falls back to normal. If demand were to spike with no resulting price increase, you would have what is known as an economic shortage. Without a price increase, Uber’s unfulfilled rate would skyrocket, and most customers would be left without a ride. With dynamic pricing however, the variable Q on the graph is further to the right than it would be without.  More absolute rides are fulfilled precisely because supply increases.

Comparing Uber to Hotels, Airlines, & Rental Car Companies

Many of the articles about Uber’s pricing model have noted that airlines, hotels, and rental car companies frequently use dynamic pricing, and typically at ratios (10X differentials in these industries are common) that are very similar to Uber’s highest peaks on New Year’s Eve. For a hotelier, the demand for a room on New Year’s Eve is dramatically higher than a random weekday two weeks later. With no ability to increase supply, they are left with the alternative of selling to the highest payer. This is a relatively well-understood and accepted practice. No one appears even the least bit emotional about it, as it is well understood and expected.

There is, however, one key difference that materially increases the need for dynamic pricing in Uber’s case. With hotels, airplanes, and rental cars, supply is relatively fixed. One cannot build more rooms for New Years Eve, and then take them down. Uber has a problem these companies do not. At the exact time that riders want more availability – Friday and Saturday night, in a bad storm, on New Years Eve – drivers would rather not be driving. You see, while hotel rooms are fixed, Uber’s supply actually shrinks at these times, because the drivers would prefer not to be working at those times either. The exact events that increase demand for needing a driver also cause supply to shrink. In these cases the supply curve is moving left at the exact same time that the demand curve is moving right. As a result the need for a price catalyst to increase supply in the Uber case is vital.

Another factor that impacts driver supply is substitute opportunities. Drivers have lucrative alternative opportunities on event nights like New Years Eve. Some party-goers are willing to book a single captive driver for a flat rate which could be well over $1000 for the night.  And in this case, the driver enjoys quite a bit of downtime.

The Only Real Alternative – “No Cars Available”

Some have argued that they understand the economic underpinnings of Uber’s dynamic pricing, but they suggest that the “PR hit” is so great that the company should reconsider its policy. This single-step analysis fails to consider the real alternative to dynamic pricing – tons and tons of unsatisfied customers complaining about a lack of availability/reliability (two of the key tenets of the Uber customer proposition).

photoThe bottom line is that the only real alternative to dynamic pricing is a ton of customers staring at screens that read “No Cars Available.” This is the fact that is least appreciated by Uber’s critics. Remember the PR hit that UPS took this Christmas when they could not deliver packages as customers expected? The idea that Uber could make its network available in a normal state and at a normal price while demand is increasing and supply is shrinking is quite simply unfeasible. And the argument that Uber should keep prices flat in moments of peak demand is a de facto argument that Uber should be comfortable stranding the majority of its customers with the disappointing message: “No Cars Available.”

If this sounds to you like an apology for the price increases, try the following experiment: the next time you see a message indicating that Uber’s surge pricing is in effect: immediately try an alternative other than Uber. In other words, try to hail a cab, call a traditional black car service, find a rental car, or jump on a bus or subway. You will find that availability and reliability for all forms of transportation are under stress at that same precise moment in time. At these times, a fixed price taxi will be highly unavailable, and a fixed price subway will be remarkably over-crowded. Relative to those choices, Uber prefers to be reliable and available for the maximum number of customers it can serve, and believes that the customer dissatisfaction from being unavailable would be way worse than the limited customer dissatisfaction with their dynamic pricing model.

Drivers Are People Too

Another point to keep in perspective is that the operator of each and every car on the Uber service is a human just like all of the passengers. Why should we expect that individual to be excited about working precisely when we want to be out of the town? Do you enjoy working on Friday and Saturday night? What about Holidays? What about New Year’s Eve? Nurses and doctors routinely receive 2-3X overtime pay for work at those times; is there a reason that a driver should not? What about during really bad storms? Should the independent driver be more concerned about your needs, or those of their own family and friends? This is not a plea for you to be overly empathetic for the independent drivers on Uber’s system, but rather simply asking you to consider the basic human reasons why they may chose not to drive at the exact same time that you are most interested in not driving. Is it unreasonable to expect higher fares if they are sacrificing their own time at the least convenient moment?

Understanding Will Improve With Time

Uber is indeed sensitive to the perspective that some customers have about dynamic pricing, and this is precisely why they work so hard to message awareness to their consumers. Just last week, the company announced a new feature called Surge Drop that will notify the customer when surge prices have fallen, enabling someone to wait until the supply and demand are more in balance, and avoid the higher fees.

As many have noted, dynamic pricing policies are well understood in hotels, airlines, and rental cars. This awareness makes the changes expected and less surprising. Increased awareness will help to reduce the element of surprise that some customers may encounter. It will also cause certain customers to steer clear of time windows when prices are higher, and when they would then prefer not to transact. Basically, as more people understand the model, they will become more comfortable with what to expect, and can make informed choices.

Screen Shot 2014-03-06 at 11.47.32 PM

Fundamentally, most critics of Uber’s pricing model fail to recognize that Uber is a true marketplace. The majority of leading Internet marketplace companies use dynamic pricing as a solution when confronted with a scarcity of supply. This was the fundamental premise behind Ebay’s original auction model. It is also exactly how things work on StubHub (ebay’s ticketing engine), as well as Airbnb and Homeaway. Additionally, it is the key pricing algorithm behind Google’s core Adwords offering — a service that has over one million customers, and takes in close to $50 billion in revenue. Its usage is tried and true which is partially why Uber’s CEO has confidence that it’s the right model here as well. Uber has no intention of abandoning dynamic pricing precisely because it is in the consumer’s best interest, especially when one understands the true alternatives.

51 Comments

  1. Jared McKiernan March 11, 2014

    Wouldn’t a true marketplace allow each driver to set their own rates?

    Reply
    • bgurley March 11, 2014

      That is a more complex implementation, but yes it would be even more dynamic. Would have to be balanced against customer confusion and quality.

    • Niv Dror March 11, 2014

      Drivers setting their own rates would be an inefficient market and there would a be (rightful) lack of trust. How do you know the driver is not over charging you? Even a well intentioned driver won’t be able to answer that. Economics is not a very useful college course because there are so any externalities in the real world that limit its actual applicability (regulation, human emotion/bias, time lags, etc.)The most amazing thing about Uber is that its an economics textbook (or Kahn Academy course) applied in real life – it’s fascinating to see. #LongSurge

  2. Brad Heitmann March 11, 2014

    I’m curious — on the driver side of things, can drivers set trigger prices on an hour-by-hour basis to receive notifications when fares are spiking? For example, “I won’t get out of bed at 1:00 AM unless fares are above $X per Y.” If not, a deeper view of contingent supply could come in handy in determining true supply elasticity; it would be a cool feature for the drivers as well. {This is the part where someone inevitably will suggest something completely loco — like allowing drivers to sell call options on their availability. Uber would be the only game in town — trading vol on supply and demand of personal logistics. But that’s crazy talk.}

    Reply
  3. Colin March 11, 2014

    The problem with surge isn’t the surging – rational folks agree that this is the only way to a balance a marketplace. The issue is back to expectations.

    If consumers can’t understand (and predict) when and why it occurs, that is where ‘unfairness’ strikes. Hoards of psych studies have shown that fairness revolves around expectations. If consumers open the app at 8pm and see a $10 ride and open the app 20 minutes later to a $30 ride, uber has a problem. The surge drop solves the less important side of the equation (fairs dropping), but what customers want to understand reliably is when fares are about to rise (or will simple be) higher than expected.

    That is uber’s surge problem.

    Reply
    • Sam March 11, 2014

      Colin – I think you are absolutely right.

  4. Bobak March 11, 2014

    This was quite the read, and for me it re-affirms what an amazing and unique service Uber is turning out to be.

    I’d be curious to see if there is anything uniquely different that its’ competitors (Lyft, Sidecar, Taxis, etc.) are doing to account for the same basic supply and demand problems that Uber encountered in Boston. I occasionally pick up Sidecar when there are no Uber cars around, but nearly 95% of the time, I use Uber.

    Reply
  5. Werner March 11, 2014

    Excellent piece, Bill.

    I think their biggest challenge, as a pioneer in this field (not adjusted pricing, but real-time adjusted pricing for a car service) would just be to slowly keep reminding riders (their core customers) that it is in the best interest of them and the drivers.

    The reliability (and availability) of a lot of services is far more important than having a constant price tag that is deemed fair.

    I wrote a little about it here: http://www.wernervanrooyen.com/uber-surge-pricing/

    Reply
  6. Zachary Taylor March 11, 2014

    The resistance to surge pricing is a weird psychological problem. I wonder if opt-in for surge pricing would help address it. Surge pricing is great and necessary, and opt-in is lame, but it may be the best time to explain to users what it is, why it’s good, and why they are not getting ripped off, before showing them a fare that is several times what they were expecting.

    If a user isn’t interested in paying surge rates, they can decline, and see ‘No cars available’ instead of feeling outraged that people are paying $75 to get home from the bar.

    Would it be worth the user experience trade-offs?

    Reply
    • J2k March 21, 2014

      Theyve actually sort of addressed this. You can wait until the surge ends and get a notification. See more at http://blog.uber.com/surgedrop

  7. UberJesus March 11, 2014

    I am a driver in Minneapolis and can tell you first hand that this will be the new standard in the next 5-10 years. Passengers are willing to pay the surge because 1) at x1.5-x1.75 its still pretty close to the average taxi cab fare 2) its super convenient, 3) its reliable. While UberX isn’t necessarily a premium service like UberBlack, you will never have to go onto Google and call 4 different cab companies, talk to a disgruntled operator who promises that youre taxi will arrive within 20 minutes, cross your fingers that one shows up on time, or hop into an absolutely filthy car leased by a cab company that doesn’t care about customer service or accountability as long as they get their car rent and have to rush through airport security because your cab is late. You’ll rarely have to wait more than 20 minutes for a ride, always get someone who can communicate with you and hopefully friendly, never get hassled about credit cards, never have to pay a tip, always get to your destination in the most efficient route possible (Uber can track if drivers are cheating for longer routes), get to rate your driver at the end of the trip and get free rides for special events and referals. By the time you factor in that you have to tip a taxi driver, they won’t give you change, they take the longest route possible, refused to use the meter so they can round up the fare, free water and goodies, plus $20 referal bonuses for new riders you’re still way ahead. IMO.
    Hope you’re shaking in your boots taxis! You can throw all the regulatory hurdles and lawsuits you want. The days of regulation protecting you outdated business model and shielding innovation are over. Your time is limited. We are the new business model.

    Reply
  8. ESRogs March 11, 2014

    *incentives

    Reply
  9. Rashaun P. Sourles March 11, 2014

    I’m an Uber Black car driver in SF/Silicon Valley. I’m also an entrepreneur myself (last startup failed). I’ve been driving Uber Black because their business model fascinates me. It’s taken me four months to come to terms with surge pricing. “What,” you might be thinking, “Drivers should love surge pricing because they benefit financially.” It’s not that simple—please let me explain.

    I talk to Uber drivers all the time. And since I spend my days/nights in my black car, I talk to lots of Uber customers, too. Where 9 of 10 customers hate surge pricing, maybe 5 of 10 drivers hate it too. Here’s the thing about surge pricing—drivers appreciate the extra $$, don’t get me wrong—but because surge pricing is so misunderstood by passengers, the entire ride is dominated by the negative spectre of the surge. Passengers are really frustrated, cancellations on the driver are higher, and drivers often receive low ratings because the passenger wants to vent their frustration about the surge. At first, I sided with the passengers because I’m a customer evangelist at heart. But then I saw the light.

    Here’s what I’ve come to realize: Surge pricing makes Uber a better product. So whenever you see a surge, don’t blame Uber, but instead look at the other transport options you have in your city. Don’t blame Uber for giving you an amazing, *reliable* option that, by the way, you have no obligation to use. Instead blame your city leaders for the lack of options and weak condition of your city’s transportation infrastructure.

    Uber is by definition an on-demand e-hail service. So think about this—if demand is high and customers can’t get cars, customers suffer. Customers only hail a vehicle when they need one. And with Uber, what you need is what you get, that’s the Uber brand—reliability and dependability in transport. Surge pricing (or better put, dynamic pricing) ensures that there are enough cars for the passengers who truly are willing to pay for a private vehicle. Uber has multiple price points—SUV, Black and UberX—so don’t accuse Uber of being elitist with this talk of “private” vehicles. The bottom line is that we live in an age where transport options are pathetic in most cities. Uber makes getting through your city easier and more reliable.

    Uber is pushing the envelope way far ahead, and the entire market is simply missing the point. Uber is not an innovative startup because they’ve capitalized on GPS and smart-phones and idle black car drivers to enable “e-hailing” of private vehicles. Uber is innovative because they aim to solve transportation problems in every city they enter and use features like surge pricing to first highlight the transport infrastructure breakdown, then do their part to execute the change to make it better: enter free-market principles like dynamic pricing. Dynamic pricing is fundamental to making the transport system work better, and while Uber is taking lots of hits to the chin these days about it, in the end, other parts of our transport system (read: Congestion Pricing on roads in Europe – http://en.wikipedia.org/wiki/Congestion_pricing) will adopt dynamic pricing because it will make any transport system work more efficiently.

    Reply
    • Jimbo June 25, 2014

      Rashaun, I’m a prospective rider in L.A. (will be taking UberX from southeast Los Angeles County to the San Fernando Valley next week) thanking you for taking the time to even further clarify Bill Gurley’s post. Makes sense to me. My brother, an O.C. resident, uses UberX all the time and loves it. Keep pushing the envelope!

  10. Jon M March 11, 2014

    Great Article- uber pricing is actually a very rational approach.

    Reply
  11. Boycott March 11, 2014

    Would it not be wonderful if Uber’s ability to connect passengers with rides proved only its second greatest achievement? Its real, substantive achievement might be to educate the world about markets – to demonstrate the awesome power of the pricing mechanism and how it can be employed to harness the most efficient outcome from finite resources, for the greater good.

    Uber might achieve acceptance of that which Hayek spent a lifetime proselytising.

    Reply
    • Rashaun P. Sourles March 11, 2014

      Absolutely true. This is how truly disruptive technology should work–we get some cool App and then learn that what lies beneath is a concept, principle, or behavior much more profound and revealing. The neat thing about the brouhaha re: Uber surge pricing is that surges by definition represent a threat to any system. When people get up-in-arms about surge pricing they are in fact reflecting something negative about transportation in their city. As in, something is clearly broken if demand far outstrips supply.

      It would be nice to think that civic leaders actually care about how well transport systems work–they’ve tried to convince us that transport is best run as public utility. But it’s taken Uber introducing concepts like e-hailing and dynamic pricing–taking on the taxi commissions and city hall in the process–to really highlight how little our civic leaders actually care about efficient transport, and how much more they seem to care about protecting their little fiefdoms of power, isolated from the real, living and evolving marketplace.

  12. Dora Fang March 11, 2014

    yes. yes. yes. and thank you.
    i know that it’s my choice to accept surge pricing, or not be able to get where i want to go. parking would be exorbitant, taxis will be unavailable, and public transport will be crowded or broken down. when surge pricing kicks in, it’s due to other options becoming non-options for your transport needs.

    Reply
  13. Jason Kincaid March 11, 2014

    All of the above makes sense (and is fairly intuitive, I think). But the comparison to car rentals/flights/hotels seems to ignore a key distinction. Everyone knows that it costs a lot to book a flight or hotel at the last minute. With Uber, there’s no way to predict when a surge is coming (sure, I can assume Friday night will be busy, but sometimes it’s 1.25x, and sometimes it’s 3.5x). This problem is especially bad when I’m already ‘out’ and have few other options to get home.

    Which isn’t to say the arguments for surge pricing don’t make sense, but just that the comparison to flights/hotels/cars only goes so far.

    I’ve wondered whether Uber could offer a Prime-esque subscription — call it Surge Protection — where I pay $X/year to guarantee that I won’t have to deal with surge pricing at all. Or maybe it gives me Y number of times where I can ‘Skip the Surge’. Maybe you throw in occasional free upgrades to black car service. Basically I’m looking for a get-out-of-jail free card for those nights when it’s late, I’m drunk, and just want to go home.

    Reply
  14. Mo March 11, 2014

    “Many of the articles about Uber’s pricing model have noted that airlines, hotels, and rental car companies frequently use dynamic pricing, and typically at ratios (10X differentials in these industries are common) that are very similar to Uber’s highest peaks on New Year’s Eve.”

    This is an exaggeration of the dynamic pricing in those other industries and would like evidence of this. I have never seen a flight, rental car or hotel anywhere near 10x. This includes experience with flights around Christmas, a hotel for a college football national championship game or major conference or a rental car at same. There was a piece on Planet Money that spoke about the issue and economist Richard Thaler estimated the consumer tolerance for surge to be ~3x.

    http://www.npr.org/templates/transcript/transcript.php?storyId=265396928

    Reply
  15. Smerian March 11, 2014

    Uber should cap surge price to max 4x. Anyway regular fare is said to already gives some profit, so 4 times the fare will give enough profit to those willing.

    Reply
  16. Roy March 11, 2014

    Overall a good explanation, but I think that what is meant by “reliability” should be defined. The only way raising prices reduces demand is if people who _intended_ to use Uber decided not to when they saw the increased fare. Uber was not a reliable source of transportation for them. It was available, but not at an acceptable price. Surge pricing only makes Uber “reliable” for those willing/able to pay the surge pricing, by making it unreliable for those unwilling/unable to pay. This serves to continue the perception that Uber is a high-end service, as it will only be reliable for people who are not cost sensitive.

    Reply
    • bgurley March 12, 2014

      I understand your point, but if you keep prices flat, it won’t be reliable to anyone, regardless of price. Your argument is equally true of every airline, every hotel, every rental company, and stub-hub and Homeaway.

  17. WSE51 March 11, 2014

    I enjoyed the article and the comments; and I agree that dynamic pricing is required when there is a true supply/demand imbalance. I recently heard two Uber drivers talk about artificially creating a surge by waiting just outside a geo-fence limit and then swooping in once the surge pricing starts. I hope Uber’s systems are set up to detect this and reverse the pricing premium.

    Reply
  18. Doug Williams March 12, 2014

    I ask drivers about their experience on the other side of the app during Surge nearly every ride. They all report that they can see an area on the map outlined in red if it is surging if they are logged in. Drivers do not report Uber sending a notification if they aren’t logged in at the time. If the goal of Surge is to balance supply and demand, proactively notifying the supply side in an earnest attempt to get more drivers on the road is low hanging fruit.

    Reply
  19. Ramesh Johari March 12, 2014

    Enjoyed this article; cogent explanation of a charged topic.

    One point I’ve made in a couple discussions about Uber (and Lyft) is that they and their passengers would benefit from greater price discrimination on risk.

    I think one aspect of surge pricing that passengers complain about is not so much supply-and-demand but rather the uncertainty involved in not knowing what the surge price might look like in the future. (E.g., I take a car *to* wherever I’m going out on Friday in the afternoon or early evening and it’s cheap, but then I take a car back *from* that same place, and the price has surged up.)

    Classically, a simple approach to address this heterogeneity in preferences for risk is to price discriminate. For example, Uber could offer two plans: one is the “locked in weekend surge plan”, where you are subject to a fixed surge price (say 1.25) on all your Friday 6 PM – Sunday 6 AM rides. Another is a “take a chance” plan, where you pay whatever the spot surge price is in the Uber marketplace (sometimes no surge at all, but possibly a high surge well above 1.25).

    Set correctly, this is preferable for passengers and Uber. Uber can charge a premium on the actual willingness-to-pay of the risk averse passengers because they are risk averse, and so (in expectation) make more money on those rides than they would if these same passengers used the spot market. And of course, passengers now have a clear choice that caters to their respective risk preferences. There are other benefits, such as improved capacity planning.

    Price discrimination is usually viewed in a negative light by the public at large, as a way for monopolists to squeeze their customers. But it is also often a tool that can effect improvements that help the business and its customers at the same time.

    Reply
    • bgurley March 12, 2014

      interesting. similar to Amazon prime. worth some thought.

    • Krishna March 17, 2014

      This solution and the Amazon Prime-like solution proposed by Jason Kincaid above only take into account the customer’s role in the market, i.e. the customer wanting to protect against surge pricing by paying for an insurance policy against it. It fails to account for the driver’s side of the equation – why does a driver have any incentive to pick up a passenger who has such insurance? Or how does Uber compensate the driver for picking up such a passenger vs another who hasn’t purchased such insurance?

  20. MCF March 12, 2014

    Great in-depth look at the fundamentals of marketplace pricing and challenges at scale. Question – you discuss the price elasticity of both supply and demand but is demand also elastic with respect to time? Consumers value urgency to varying degrees (e.g. I need to be somewhere now versus I can wait till prices drop) so how much demand is time-shifted into the future by surge prices.

    Comparing the unique fulfilled-to-opener rate over a sufficiently long time window to the total rate during peak versus non-peak is where I’d start. This would also seem like a natural success metric for the new surge price “snooze” function.

    Reply
  21. Mo March 12, 2014

    Bill, I would be curious what your evidence is that 10x is common in different industries. Chicago economist Richard Thaler was on a Planet Money piece on Uber and said that those industries rarely go over 3x because customer tolerance is exceeded and there is a backlash against the business. Which is why companies with a long term horizon will tolerate rare shortages in order to avoid alienating customers.

    Reply
  22. fred wilson March 12, 2014

    great post Bill. this is not very well understood and this post should help increase understanding and awareness

    Reply
  23. J. Lewis March 12, 2014

    So should there not be a corresponding anti-surge (ie discount) pricing when car supply exceeds demand? Would that not bolster trade for otherwise idle drivers by drawing in customers from subways, walking etc.
    Currently it seems there is protectionism at one end of the supply demand curve and free marketism at the other.

    Reply
    • Tyler Willis March 13, 2014

      Earlier in the post, he mentioned that this was a low margin business. For options like UberX, esp. in competitive markets where they have dropped the price several times, they may not have much room left to lower prices.

  24. Kevin Goldberg March 12, 2014

    Excellent post Bill,

    A few questions, however:

    1. Since Uber very publicly announced the drop in UberX prices, it seems surge pricing is even more present. Is this strictly because the supply/demand open market? If they hadn’t lowered the prices would we see less surge?
    2. The lack of predictability is truly worrisome. Shouldn’t Uber become more transparent in displaying total demand? It’s understandable New Years, Halloween, rainy days, etc. have surge. However, this past Saturday afternoon it was 2.5x surge in SF. No Giants game, Bay to Breakers, Pride, festivals, Fleet Week, holidays, etc. It was just a normal Saturday afternoon.

    All in all, I understand why Uber has surge and I think most consumers have been too spoiled by the convenience for too long. I think the Uber Comms team needs to do better at articulating the rationale and the company as a whole needs to increase their transparency.

    Reply
    • bgurley March 12, 2014

      Communication is clearly part of the solution. We are actively working on that. Also remember that demand is undergoing hyper-growth, which makes planning harder.

  25. Stuart March 12, 2014

    Thanks, Bill.

    I’m a price sensitive fellow, so when surge pricing kicks in, unless it’s urgent, I’ll sit it out and wait for it to drop back to normal pricing. Usually this is no biggie, I’ll be with friends, or in a bar, so we’ll just grab another drink.

    What I would LOVE you guys to have, is the option to “hail a cab when surge pricing falls to [insert level]“. This way I can order a cab even if surge pricing is on, but I can go back to enjoying myself and then get a message when a cab is on the way that meets my pricing desire. At the moment, I end up checking my phone every few minutes to check if surge pricing has returned to normal. This would be a major improvement on the current customer experience for cheap sons of bitches such as myself.

    Cheers.

    Reply
    • Stuart March 12, 2014

      I just noticed your ‘surge drop’ article – I think this should help.

  26. Deepti Chheda March 12, 2014

    Great post Bill!

    I completely understand why Surge pricing makes sense – for all parties involved. However, lately I’ve been seeing more “predictable” surge prices.

    1) I’ve been seeing Surge pricing on UberX from ~8.30am – 9.30am in SF . This is just during regular weekday mornings when people are trying to get to work/subway/train. However, I see plenty of cabs available via Uber Taxi. That certainly makes customers doubt the entire Surge pricing model – if users feel that this is not a “real” stressful time. Overall it’s harmful to the UberX brand if people feel cheated. It also promotes Uber Taxi over UberX. Personally, this has been the biggest cause of frustration for me.

    2) Another consequence of this “predictable” Surge pricing is UberX drivers are now more incentivized to start driving later, after Surge pricing kicks in. That’s something to watch out for.

    To improve the pricing model, it would help to take other factors into account – like past trends, rate of bookings/min, total supply across all drivers, better ways to gauge real demand by tracking history per user (not just rely on # of people who have the app open)

    Reply
  27. Thomas March 12, 2014

    One possible way to combat things like surge pricing is to allow users to reserve “future” rides at a known rate, perhaps for a small premium. That way, if I know I need a pickup at 8AM tomorrow, I’m sure to get one, and I know what it will cost.

    Heck, if I can program my dishwasher to do a load 8 hours from now, I don’t see why I cant reserve an Uber for tomorrow.

    Reply
  28. Manny March 12, 2014

    GREAT ARTICLE!!! WELL SAID!!! I am an UberX driver in Los Angeles area and I have heard numerous times from customers that the same trip they are taking at the moment they are in my car cost them 3X more when they took a taxi, even during Uber surge pricing.

    Reply
  29. Manny March 12, 2014

    The same surge pricing applies to so called “FasTrak” or ExpressLanes on Los Angeles highways. For example, during off peak hours it costs $1.25 to use these lanes, during morning/evening rush hours the same lane cost $8.75 to use, that 7X surge. The surges for this is not predictable either.

    Reply
  30. Harry DeMott March 13, 2014

    Nice post Bill.

    I still never understand the complains about the surge pricing. What you say makes complete sense. It is a marketplace where supply meets demand through price – a very efficient mechanism.

    What has boggled my mind is the fact that no one HAS to take an Uber. However, I feel that many people have gotten used to the service, and feel it is a right – like hailing a yellow cab in NYC – and are therefore surprised when that right somehow changes in price.

    What pepole fail to notice is that even regular yellow cab rides differ wildly in price depending on the time of day (there is surge pricing in NYC yellow cabs) as well as on traffic. In my normal route from Grand Central Station to the Meatpacking district – I can see all in fares between $12 and $20 – which is a pretty wide dispersion depending on time and traffic (which is why I will primarily take the subway – cheaper and faster)

    The only complain I can see with Uber pricing is that surge pricing exists in an asymmetric way. Too much demand or too little supply, and you end up in surge pricing. However, there are times when there is too much supply and not enough demand – and at these times prices never drop below a floor. Put that into the app – and I think you could never garder a well reasoned complaint.

    Reply
  31. Michael Mullins March 13, 2014

    Bill,

    The major difference with the transportation and hospitality examples you cite in paragraphs 16/17 is that with those options, customers usually have the option to lock in lower prices by committing earlier. E.g. even day-before-thanksgiving flights are much cheaper when purchased in advance. So when hit with yield management price increases, customers can know it’s the result of their own prior decision not to purchase.

    With uber, it is not (yet) possible to lock in rates, so riders like one of the commenters above who user uber 95% of the time are subject to a surge they regardless feel is out of their control.

    (for the record, I am have been an avid @uber_BOS user since launch there)

    Reply
  32. kbr March 17, 2014

    Bill’s analysis was spot on. Uber is a business . And, like businesses with limited supply, pricing is the only lever available to influence supply and demand. It’s also a business learning to how to apply pricing in a market that is unaccustomed to variable or dynamic pricing. But, what really strikes me as odd is the fact that the customer can always reject the higher pricing and take the alternative. If enough customers don’t like Uber’s pricing, Uber will have to change it’s business model. No doubt, it has factored cancellations into the demand/supply algorithm . As long as cancellations don’t increase significantly and Uber continues to exceed the expectations of the majority of its customers, then it will have a successful business.

    Reply
  33. Kris Tuttle March 17, 2014

    I think this nails down most of the rational facts. Of course consumers (myself included) have emotional reactions to things. The taxi model has provided a basis of fixed pricing with wide variations in wait times and spotty availability. (Try to get a NYC taxi to take you to JFK close to a shift change!) For better or worse it’s a game consumers have learned to play.

    Personally I’ve used Uber several times with radically different experiences in Boston. A few really good and cheap UberX rides, some good but expensive Uber SUV rides and at least one night of absurd surge pricing which forced a longish walk on a cold winter night before eventually being picked up by a sympathetic taxi.

    (Interesting side note from that ride was that this driver said he refused to pick up many passengers during “party times” as they are often drunk and irresponsible. Since we were in black tie he figured we were “alright.”

    This will all blow over as consumers incorporate the new model into their thinking. Uber should be sure to introduce tools that make it easier for consumers to trade off time and convenience for price. Surge Drop is a good example, also some kind of paid loyalty program that can lower the volatility of prices for regular customers might work.

    Reply
  34. Paul Reddick March 17, 2014

    Great post Bill and exhibit A for entry level microeconomics.

    I could see a future evolution of this where Uber can predict supply/demand balance and share that, with no guarantees, to potential riders. For consumers, simply knowing that they have a choice to either pay surge pricing now or wait and pay regular pricing later could make them feel more in “control” and better comprehend what is going on.

    Reply
  35. Joe V. March 18, 2014

    Two critiques of Uber’s claim that surge pricing is all about finding a price point where the market clears (which I generally support):

    First, Uber’s claim is undercut by the fact that the company takes a share of of the additional surge fare. This distorts the market-clearing price, and seems opportunistic on Uber’s part and thus worthy of criticism. I recognize that Uber needs to be compensated for its role as market-maker, and that there are marginal costs involved in providing the tech, responding to complaints, and so forth. But introducing surge pricing on top of regular fares create no further marginal costs for Uber. What is the company’s justification for taking a fraction of the additional surge pricing? This is particularly critique-worthy given that taking a share of the surge pricing makes the surge mechanism less effective at increasing supply, which is the purported rationale for the policy.

    Second, why isn’t this a two-way street? You talk about intentionally reducing demand by increasing prices during periods of inadequate supply. (Effectively firing your cheapest customers.) Why doesn’t Uber also do the opposite, and lower prices below the current “floor” when supply exceeds demand? (Effectively firing your most expensive suppliers.) In other words, what is the policy rationale for making customers bear the costs of a dynamic pricing model, but not introducing any of the potential benefits? In a “highly efficient market” this would happen, yet I don’t seem to get any discount for the fact that, as I write this, there are 18 black cars, uberXs, and taxis within four minutes of my location, and have been as I’ve intermittently checked during the 15 minutes it has taken me to write this.

    Reply
    • bgurley May 28, 2014

      1 – hotels take an even higher percentage profit during times of high demand as their costs are fixed.
      2 – good idea.

  36. Sinjin Lee May 12, 2014

    Great post Bill. Agree that dynamic pricing is a much better alternative than “no cars available”. I take an Uber now each time I travel from the South Bay to the Caltrain on 4th and King. I have accepted surge prices before knowing full well that my alternatives – a cranky taxi driver with an ugly car – is a much less attractive option than riding in a BMW 3 with a pleasant UberX driver. There is no comparison even with the increase in surge prices. The masses want to have their cake and eat it too regardless of violating economic principles. Kudos on the empathetic note on the Drivers – what professional doesn’t get a bonus for working during high stress times?

    Reply

Leave a Comment

Your email address will not be published. Required fields are marked *