I’m writing about Uber after a really long time on this blog. Basically I’d gotten tired of writing about the company and its ideas, and once I wrote a chapter about dynamic pricing in cabs in my book, there was simply nothing more to say.
Now, the Nobel Prize to Richard Thaler and his comments sometime back about Uber’s surge pricing has given me reason to revisit this topic, though I’ll keep it short.
Basically Thaler makes the point that when businesses are greedy and seen to be gouging customers in times of high demand, they might lose future demand from the same customers. In his 2015 book Misbehaving (which I borrowed from the local library a few months ago but never got down to reading), he talks specifically about Uber, and about how price gouging isn’t a great idea.
This has been reported across both mainstream and social media over the last couple of days as if Thaler is completely against the concept of surge pricing itself. For example, in this piece about Thaler, Pramit Bhattacharya of Mint introduces the concept of surge pricing and says:
Thaler was an early critic of this model. In his 2015 book Misbehaving: The Making of Behavioral Economics, Thaler argues that temporary spikes in demand, “from blizzards to rock star deaths, are an especially bad time for any business to appear greedy”. He argues that to build long-term relationships with customers, firms must be seen as “fair” and not just efficient, and that this often involves giving up on short-term profits even if customers may be willing to pay more at that point to avail themselves of its product or service.
At first sight, it is puzzling that an economist would be against the principle of dynamic pricing, since it helps the marketplace allocate resources more effectively and more importantly, use price as an information mechanism to massively improve liquidity in the system. But Thaler’s views on the topic are more nuanced. To continue to quote from Pramit’s piece:
“I love Uber as a service,” writes Thaler. “But if I were their consultant, or a shareholder, I would suggest that they simply cap surges to something like a multiple of three times the usual fare. You might wonder where the number three came from. That is my vague impression of the range of prices that one normally sees for products such as hotel rooms and plane tickets that have prices dependent on supply and demand. Furthermore, these services sell out at the most popular times, meaning that the owners are intentionally setting the prices too low during the peak season.
Thaler is NOT suggesting that Uber not use dynamic pricing – the information and liquidity effects of that are too massive to compensate for occasionally pissing off passengers. What he suggests, however, is that the surge be CAPPED, perhaps at a multiple of three.
There is a point after which dynamic pricing ceases to serve any value in terms of information and liquidity, and its sole purpose is to ensure efficient allocation of resources at that particular instant in time. At such levels, though, the cost of pissing off customers is also rather high. And Thaler suggests that 3 is the multiple at which the benefits of allocation start getting weighed down by the costs of pissing off passengers.
This is exactly what I’ve been proposing in terms of cab regulation for a couple of years now, though I don’t think I’ve put it down in writing anywhere. That rather than banning these services from not using dynamic pricing at all, a second best solution for a regulator who wants to prevent “price gouging” is to have a fare cap, and to set the cap high enough that there is enough room for the marketplaces to manoeuvre and use price as a mechanism to exchange information and boost liquidity.
Also, the price cap should be set in a way that marketplaces have flexibility in how they will arrive at the final price as long as it is within the cap – regulators might say that the total fare may not exceed a certain multiple of the distance and time or whatever, but they should not dictate how the marketplace precisely arrives at the price – since calculation of transaction cost in taxi pricing has historically been a hard problem and one of the main ways in which marketplaces such as Uber bring efficiency is in solving this problem in an innovative manner using technology.
For more on this topic, listen to my podcast with Amit Varma about how taxi marketplaces such as Uber use surge pricing to improve liquidity.
For even more on the topic, read my book Between the buyer and the seller which has a long chapter dedicated to the topic,