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Uber's Sydney fiasco: the problem with surge pricing is everyone hates it

Kevork Djansezian/Getty Images

Taxi cabs often become scarce during bad weather or other scenarios that lead to a surge in demand. Uber has developed an economist-friendly solution to the problem — raise prices when demand spikes. But it's a solution that keeps getting the company into trouble, most recently when Uber Sydney tweeted that surge pricing would be in effect in the wake of the hostage crisis that unfolded over the past twelve hours.

The backlash was fast and furious and the company immediately backed down.

People hate variable pricing

The basic economic logic of raising prices when demand surges is hard to argue with. If you got a job offer at 2:00 PM, and then immediately got a second job offer at 2:05 PM you would negotiate with both potential employers (and your current boss) for the best overall job — not feel compelled to take the offer that happens to have come in first.

Cold hearted rationalists like me have often wondered why this logic is not more broadly applied in business life.

Why do concerts and sports events regularly sell out leaving thousands of fans out in the cold, rather than featuring prices high enough to roughly balance supply and demand? Why don't popular restaurants charge more for a 7:30 PM reservation on a Saturday night than for a 9:00 PM reservation on a Wednesday? Why does the hardware store run out of salt during snowstorms rather than hiking prices?

The endless cycle of backlashes provoked by Uber's efforts to apply variable pricing to a consumer good help us understand these puzzling economic questions — people really hate it and it hurts your brand. People would rather see inefficient allocations of scarce goods, lower overall supply, less total employment and job creation, and perennial shortages than let prices float up and down according to demand.

Can Uber make this work?

Uber's stubborn refusal to conform in this regard is, in a way, admirable since it gives us all something to talk and think about. Can they make it work?

One possible solution would be to copy the major consumer-facing industries that do impose variable pricing — hotels and airlines. The way these companies generally manage to get away with it is through a massive lack of transparency. You can't look up "the price" of a United flight from Newark to Chicago, and then see whether the price at any particular time reflects a surge multiple of the base or not. You need to go online, try to book a flight, and then just see what they want to charge. Hotels operate the same way.

In both cases, the actual price-determining formulae are much more complicated than Uber's surge multiples. Consumers don't exactly love these industries, but by making it unclear when prices have spiked, airlines manage to get away without storms of social media outrage over spiking prices.

Many retailers accomplish something similar by making the "official" price ridiculously high, and then offering various discounts. At JC Penny, the question is whether your shirt will be 25 percent off or just 15 percent off, a non-transparent framing of surge pricing that people seem to like better.

A windfall for drivers?

Another idea would be to give all the surge revenue to drivers.

Right now, an Uber fare is an 80:20 split between the driver and the company. So when fares rocket up to 3X, Uber gets much more revenue per rider. Uber could structure it's surge pricing so that the company's revenue per rider does not rise when surge pricing is in effect, instead directing all the surplus to the driver of the car. Since more drivers will drive when their wages are higher, this would still lead Uber with more revenue at high-demand periods than at low-demand periods. But riders might be more sympathetic to the idea of a windfall landing in the pocket of a driver than of a well-financed tech company.

I am a little skeptical this will work. The fact that restaurants and bands don't attempt surge pricing suggests that public resentment of variable prices is fundamentally about public resentment of variable prices and not about resentment of rich technology companies.

A huge public policy challenge

Popular hatred of demand-responsive pricing is in many ways a huge challenge for transportation policy. That's because most wonky analysts think the government should be acting more like Uber, while most people seem to want the government to force Uber to stop acting like Uber.

Rather than under-pricing street parking and leading to constant shortages and fights, cities should be charging market rates for scarce space. This would both make it easier to find parking, and generate a big new stream of revenue that could be used to boost incomes (through lower sales taxes) or increase public service levels. Similarly, traffic jams could be made a thing of the past through congestion pricing on roads. Here, again, demand-responsive pricing would not only help address a specific problem, but unleash a gusher of useful revenue.

These are good ideas and well-known in the policy community, but they're rarely implemented. That's presumably for the same reason it's hard, but not necessarily expensive, to get a table at a popular restaurant on the weekend — politicians fear the public backlash.

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