tl;dr While surge pricing is economically efficient, its true benefit needs to be a less risky consumer product.
A lot has been written about Uber’s surge pricing but I wanted to take a stab at explaining my thoughts from a product and marketplace perspective. At it’s core Uber’s demand based pricing allows for a more capital efficient allocation of a semi-fixed supply (drivers) and secondarily provides incentive for drivers to increase that supply. It allows consumers that want the flexibility of Uber’s service to rely on access (with an increase in price) and offsets demand from price sensitive consumers that don’t value the delta between Uber’s experience and other competitive options (public transit, cabs, and self propulsion).
The crux of consumer outrage centers on a lack of transparency and predictability when surge pricing strikes. It seems to me that this criticism misses the point. On the other hand, Uber CEO Travis Kalanick is fond of saying, surge pricing can increase supply, while this is true this seems like a second order and largely theoretical benefit.
As an Uber customer, I can feel confident that if I ever need an Uber I can get one. I may have to pay an expensive price, but in a jam if I need to get from point A to point B, Uber will always work. This is true because variable pricing ensures that the relatively fixed resource is allocated according to consumer willingness to pay (an expression of value). In a snow storm, when most drivers don’t want to work, there is a contraction of the supply in Uber’s marketplace. As a consumer, if I value the service sufficiently, I can always choose to use it. Consumer services that are subject to risk have a hard time becoming habitual with out disproportionate reward.
Now a second point that hasn’t been addressed. There are two types of risk in these marketplaces, access and pricing. To better mitigate risk of their platform, Uber needs to ensure that they set consumers expectation for a high value service. This requires setting and maintaining prices consistently as low as possible. Minimizing prices requires elaborate demand and supply prediction. As Uber continues to drive toward liquidity in all of their 50+ markets, like most marketplaces they are subsidizing one side. In Uber’s case this needs to be supply. Their recent price cut’s recognize this and continue to serve to mitigate consumer perception of risk.
Hotel Tonight is a similar on demand marketplace to Uber. Their model is to give consumers access to remnant hotel rooms that would otherwise go unsold. Because the variable cost to a hotel for selling a room is very low, to maximize profits they can sell rooms at anything above essentially the cost of cleaning, as long as they don’t cannibalize existing sales. This results in great savings for a consumer. In aggregate, 60% of hotel rooms get sold in a year, 40% lie fallow. In general, there is a lot of inventory for the Hotel Tonight platform. In practice, like the snow storms for driver, on some days hotels fully sell out (think Manhattan on New Years Eve). The Hotel Tonight product needs to have coverage for all days in order to satisfy consumer. The fastest way to lose a customer would be to have no inventory after they fly to New York expecting a hotel tonight. While Hotel Tonight does not explicit set prices for their hotel rooms, they consistently work to ensure that they have inventory at all times and that their prices are as good as or better than any other channel.
Ultimately, surge pricing is a good thing. It gives consumers a choice. However, if Uber doesn’t manage the supply and demand of their marketplace, surge pricing could introduce more price risk than it is mitigating. I look forward to watching Uber continue to build an excellent product and marketplace.