Utpal Dholakia | @ud | January 27, 2016
This item is a guest post by Utpal M. Dholakia, the George R. Brown Professor of Marketing at Rice University. It originally appeared on Psychology Today’s The Science Behind Behavior blog.
An economist will tell you that the fairest price for any product is the “equilibrium price” at which consumer demand matches the product’s available supply. If supply increases, the price should go down; but if buyer demand increases, the price should rise. So it is no surprise that people often pay thousands of dollars for a single Super Bowl ticket. Or that these prices fluctuate wildly the week before the big game depending on which teams are playing and how deep-pocketed their fan bases are.
The controversial practice of surge pricing used by high-profile rideshare company Uber is based on this logic of fairness. The idea behind surge pricing is to adjust prices of rides to match driver supply to rider demand at any given time. During periods of excessive demand when there are many more riders than drivers, or when there aren’t enough drivers on the road and customer wait times are long, Uber increases its normal fares. They do this with a “multiplier” whose value depends on scarcity of available drivers. On a Friday night in midtown Houston for example, the surge fare may be twice the normal fare (in which case the multiplier is two). When surge pricing is in effect, Uber’s riders are informed that their fares will be higher, and they have to agree to pay the amount. Only then is a driver dispatched to pick them up.
Surge pricing achieves two important goals for Uber and its customers. One is that it increases supply of drivers. Lured by the ability to earn more, new drivers may clock in, or drivers from other areas may home in on the neighborhood with the surge price. In one study conducted in collaboration with Uber, researchers found that surge pricing doubled the number of drivers during a busy period after a sold-out concert in New York City. Second, surge pricing is an effective way to control customer demand and allocate available rides to those people who value them more. Some Uber customers may simply find the high surge price to be unacceptable and find other means of transportation. Others, who value the ride more, will be willing to pay the surge price.
Why? Here are four reasons that explain consumers’ hatred.
- Uber’s own low normal price makes its surge price seem exorbitant. When consumers use the Uber service, its normal price sets the reference point for what an Uber ride “should cost.” In most markets, this price is lower than what a taxicab or a limo service costs. For example, one 2014 test found Uber to be cheaper than a taxi in all 21 cities considered. Because of the low reference point, when Uber’s surge price kicks in, it seems wildly expensive by comparison even when a low multiplier is used. After all, when you have just paid $13 on the way to a party, paying $47 three hours later for the same trip in reverse is bound to seem pricey. Bolstering the power of the low reference point is the fact that virtually none of Uber’s competitors (taxicabs, limousine services, buses) use variable pricing. So consumers have fixed reference points for all of them, and they are all mostly lower than Uber’s surge price. Stories of disgruntled customers’ experiences, such as someone having to pay $500 for a ride go viral from time to time and generate a lot of negative publicity and impressions among Uber users.
- Surge prices kick in at the worst possible time for riders. By its very design, Uber’s surge pricing kicks in when demand is high, that is under circumstances when many of its customers really want to use the service. And perversely, the more intense their desire for an Uber ride, the higher the surge price is likely to be. The desire for Uber rides (and corresponding high demand) is fueled by different reasons. Large numbers of people want to go out on Friday and Saturday nights, want rides to and from big concerts at around the same time, and want to be shuttled to restaurants on special days like New Year’s Eve and Valentine’s Day. Many also need rides in the middle of a blizzard or a rainstorm just when few Uber drivers want to be out. So it is natural for consumers to feel that Uber is taking advantage of them by ramping up prices when they are in direst need. Explaining the rationale for surge pricing does not weaken the inherent sense of injustice. It is not surprising that a Google search with the joint phrases “Uber surge pricing” and “price gouging” generates more than 2,000 hits.
- Drastic changes in surge prices creates doubt and uncertainty. Compounding the perception problem is the fact that Uber’s surge prices fluctuate drastically and all too often. One study found that in Washington DC, surge prices were 2.3 times normal price at 1:54 pm on a Tuesday in March 2015, but had returned to normal levels just six minutes later. The study also reported that Uber surge prices changed so rapidly, that many changes occurred every 3 to 5 minutes. Furthermore, surge prices are also location-specific and may be several times higher in one neighborhood than an adjoining one. When prices are so volatile, many consumers simply stop trusting the company, because they don’t know when to pull the trigger or whether they are getting fleeced.
- It is not clear how the surge price multiplier is calculated. Uber uses a rather sophisticated computational algorithm to figure out how high to raise its surge prices. For riders, the bad news is that the algorithm is a closely guarded secret and much too complicated to explain to users anyway. This creates the sense that the surge multiplier calculation is a “black box”. Just as bad, in keeping with economic theory on which surge pricing is based, there is no upper limit on how high prices can go. Figuring out the surge multiplier is like bidding in an auction: as long as there is an imbalance between supply and demand, the multiplier will keep rising, resulting in the possibility of some Uber riders paying obscene prices. Because of the lack of information or what journalism scholar Nick Diakopoulos has called “algorithmic accountability”, consumers feel powerless and disgruntled when confronted with surge pricing.
Although its rationale is sound and it is meant to help customers, surge pricing is hated by Uber riders for fundamentally psychological reasons.
Can Uber do something to fix these negative assessments and use surge pricing successfully?
Yes, it certainly can. Just like the problems with surge pricing I have discussed in this post, many of the fixes would rely on applying principles of consumer psychology. My follow-up piece providing the solutions appears on the Harvard Business Review site: Everyone Hates Uber’s Surge Pricing – Here’s How to Fix It.