Fixing Uber’s Surge Pricing
Their surge pricing model is on the right track, and with a little tuning could become a service that’s both truly reliable for the customer and financially optimal for the company.
Let’s imagine you’re living in San Francisco, California and you decide to take a weekend trip to Denver, Colorado to go skiing during the Martin Luther King weekend. You’ve always booked your flights with Southwest Airlines, and you begin at their website by entering in the details for the trip. Instead of providing the flight costs, Southwest informs you that since it’s a holiday weekend, there’s a really high demand. To make sure everyone who can afford to fly to Denver that weekend can go, the company has instituted an 800% increase on the prices of flights. You’re not sure how much the final cost will be, but you book the flight anyway. After spending the weekend in Denver and flying back to San Francisco, you receive a receipt saying you’ve been charged $3120 for the airfare. You had no idea what the final cost would be until after the trip, and you’re likely frustrated and angry.
This is exactly how Uber works, and the company has consistently argued this model is best for both the company and the customer. Let’s begin by examining the economics forces involved with Uber’s surge pricing model:
Uber argues that it’s in the best interest of customers if there are always cars available, regardless of demand. This requires that supply must always be greater than demand, and raising the price is one way to achieve this. First, the price increase encourages more drivers to work during peak hours, thus increasing supply. Second, high prices discourage riders from using Uber thus decreasing demand. Economics purists argue that this is the ideal situation because supply and demand are always at equilibrium until demand subsides. While this may be ideal in the academic world, in the real world it introduces several problems for the company.
1) Sticker shock
Uber’s surge pricing model provides little transparency to its customers. Like the Southwest Airlines example, it’s impossible to know what the final cost will be, and customers have been complaining in droves about expensive rides. While it might be great that surge pricing allows someone to always get a ride if they’d like one, it has resulted in an unacceptable amount of angry customers. The customer should never be responsible for a problem, and Uber needs to take accountability. Customers requesting rides from bars and clubs after several drinks are less aware of surge pricing warnings and wake up with both a hangover in their head as well as their wallet.
2) Reduces reliability
Uber touts reliability by always having a car available for someone who can afford one. While this might mean reliability for a small fraction of their customers who are willing to pay $160 for a 1-mile ride, the vast majority of their customers will not see this as an option. Reliability is better defined as an available ride when a customer needs one at a price the majority of customers would be willing to pay. Uber’s competitors such as Lyft (peer-to-peer), Sidecar (peer-to-peer), and Flywheel (taxi) have the opposite problem. Their rides are always affordable to their customers because they are at a fixed cost, but they don’t always have a ride available. Customers are thus more likely to check these apps first, and only resort to Uber if there is no availability and they’re willing to pay the extra surge pricing.
3) Narrows the target market
Uber began with a very strong brand when they initially launched. They innovated a new, sleek way to hail a cab at a reasonable price. Three years later, many alternatives to Uber have sprouted up and I currently have six similar transportation apps on my iPhone. Since they’ve implemented surge pricing, I’ve read dozens of horror stories about customers paying ridiculous prices for very short trips, and it’s now common to open the app and see surge pricing in effect. They’ve inadvertently repositioned their brand where it’s now viewed by the media and mainstream consumers as a service that’s grossly overpriced. While surge pricing might be financially optimal for the company at that exact moment, it ends up tarnishing the brand in the long run.
Solutions
While much of the media hoopla surrounding Uber’s surge pricing stems from increased prices, the problem lies with the implementation and not the concept itself. Paying a higher price when there is a higher demand is something consumers have come to expect in many industries (flights, hotels, sports tickets, etc). Here are some ways Uber can improve its surge pricing model.
1) Cap surge pricing
The core problem with Uber’s surge pricing is the price gouging. It has no limits and continues to increase until demand subsides. While Southwest Airlines might be able to charge $3120 for a round-trip flight from San Francisco to Denver, they don’t. Uber should limit surge pricing to an acceptable ceiling of 3x to make it more trustworthy and reliable for their customers. This will create periods where there are no rides available, which leads to my next suggestion.
2) Add a ride queue
Trying to order a ride from Uber when there is no availability would be a frustrating experience, and this happens with Lyft and Sidecar. Fortunately, riders already expect to wait while the car comes and typically request rides from a place where they’re comfortable (their house, at work, a bar, etc). Implementing a queue would allow customers to order a ride even when there’s no availability and they would be presented with an estimated time until the car’s arrival. This also allows for ride matching optimization: the service could match a driver dropping a passenger off with the rider in the queue with the closest vicinity.
3) Increase transparency
While Uber informs users of the multiplier (i.e. 8x increase), the customer has no idea what the final price will be until after the ride is completed. It’s been proven that consumers find surge pricing acceptable if they know what they’ll pay prior to making the decision. One way to improve this is to add a fare calculator. Users could enter the destination name or address and Uber will give them an estimated price. (Edit: They’ve added this, although it’s a bit hidden) Another strategy is to allow users to check the price during the ride. Much like a taxi always displays the price, Uber could show the real-time price on the app. This would give users a sense of control over the extra fees and avoid surprises after the ride is completed.
4) Downsell and upsell
Uber is unlike its competitors in that it actually offers a taxi, peer-to-peer, and a black car option. Implementing a fare calculator would allow the company to pitch its other services to customers. If the rider calculated a fare for its peer-to-peer option that was currently in surge pricing, it could show the rates for the other services and suggest them alongside the original fare.
Being one of the more innovative services in the last several years, Uber has disrupted an antiquated industry as well as inspired dozens of startups in other industries. Their surge pricing model is on the right track, and with a little tuning could become a service that’s both truly reliable for the customer and financially optimal for the company.
