Surge Pricing: Concept, History and Future

Surge pricing has been in the media for some time now. Companies urge it is a way of managing supply when there is high demand and regulators see it as a means of increasing profit and exploiting customers. The advent of technology has enabled companies to process large amounts of data and information at an aggregate level quickly and react to it on the ground, making surge not only a possibility but also much more responsive to actual situations rather than fixed alterations to pricing customers are used to.

We have also seen an uptake of the concept by new sectors and industries. The food industry being the latest adopter of the concept and making customers pay more in times of increased demand. Before we make up our mind on the merits / demerits of surge pricing it is worthwhile to understand how it works and what are the different arguments behind it.

How it works in different industries and different models it can take

Mobile and online cab services such as Uber and Ola have been at the forefront of adopting and promoting surge pricing. Uber’s algorithm uses the number of people opening the app as a proxy to the demand of cab services in an area and starts applying surge when there is unusually high demand. Cab drivers can also see where surge pricing is active and can then choose to service that location in hopes to earn higher income. A study by Chicago Booth evaluated request fulfillment and driver supply when there was increased demand and compared these parameters when surge pricing was active and when it wasn’t. They concluded that the algorithm, by giving incentives to drivers and thereby increasing supply enabled a higher completion rate in comparison to a time when surge was not active. While there can be many view points to this argument and its implementation the fact is that surge allows for an increased supply and therefore, given sufficient willingness of customers to pay should increase fulfillment rates of services in high demand times. One such argument can be found here.

Implementation of Surge by Swiggy has been a little different. Swiggy does not alter the prices of the products / food that is ordered, only the delivery charges are increased to give incentives to delivery boys to take to the roads. Also, unlike Uber’s implementation where pricing has been seen to go up by more than 3X at certain times Swiggy (at-least for now) charges a modest Rs 20 more for delivery, a fixed rate that goes directly to the delivery team. Whatever the model may be, surge pricing is not as new as some of us may expect it to be.

History of Surge pricing

Surge pricing seems to be a new concept, however customers have seen it in different forms before. Restaurants give higher discounts on Wednesdays or during weekday lunch hours. Sometimes even the menu and rates are changed over the weekend to benefit from increased demand. Auto rickshaws and cabs too charge significantly higher when servicing during peak times and late nights. Airline tickets and hotel bookings in tourism are another example where surges in demand corresponded to increased fares. Few people know of the experiment done by Coke. Vending machines would automatically charge higher in locations such as sports events where there was higher demand for Coke, the move backfired and Coke received tremendous negative publicity for it and was quickly aborted.

The concept, in a raw form has been prevalent much before Uber came about and algorithm-sized it. However, limitations of the responsiveness of technology ensured there was a cap to the surge as well as a human touch behind the implementation that Ubers interface lacks. Situations such as unreasonable surges during times of catastrophe were definitely out of question. As technology advances and pricing algorithms will get better at predicting and applying surge. Many people will argue for it and many against it, nevertheless unless regulators are able to keep a step ahead of such changes by bringing laws in quickly and actually implementing them, surge pricing seems to be here to stay and we are just starting to discover how it can be impact our lives.

Future of Surge pricing

Apart from the cab industry and the food delivery industry there are other industries which are naturally suited to applying surge pricing in order to alter consumer and service provider behavior. Marketplace business models seem well suited for such an implementation as these companies cover larger service areas and therefore have much more data to analyse and use to alter pricing. Industries such as local services and home improvement where demand is higher at certain times (in this case the weekend) can easily adopt surge pricing. Other industries such as on demand auto repair, online books and the entertainment industry as well as B2B logistics and courier companies are environments where surge pricing can be / already is being adopted.

All said, the jury is still out on the impact of surge pricing on consumers and suppliers of services and products. In its current form it is a relatively new concept and if applied correctly and within boundaries has the potential to better impact outcomes for both companies as well as customers. There are still many parameters that need to be better understood to comprehend the impact it has on society as a whole, but it is here to stay, at least for the moment.

Further reads:

http://faculty.chicagobooth.edu/chris.nosko/research/effects_of_uber%27s_surge_pricing.pdf

https://www.washingtonpost.com/news/wonk/wp/2015/04/17/how-uber-surge-pricing-really-works/

http://www.cs.cmu.edu/~mklee/materials/Publication/2015-CHI_algorithmic_management.pdf

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