Uber Should Ditch Surge Pricing, Yesterday

I really, truly, deeply dislike Uber’s surge pricing.  I know.  It’s been lauded as a masterful execution of economic theory in a product by many in the tech world, but I think it’s bad for consumers.  I’ve probably had twenty conversations with other tech friends on this topic over the last 12 months.  Largely what I’ve found is that these conversations converge to a few simple points.  Here are a few reasons why I think Uber should ditch surge pricing and some random thoughts on how to do it differently:

1. It’s not “fair”

I bet you can’t believe I just said that!  As an MBA graduate, statistically speaking, I shouldn’t have a sense of “fairness” (shame on me for trying!).  Studies have shown that business school folks are much more likely to think, for example, that offering different people on Amazon.com the same DVD at two different prices is perfectly reasonable.  From an economic standpoint, the idea of fairness is irrational and irrelevant because everything is supply/demand driven.  Even as I write this, I’m thinking: “that price discrimination – love that stuff!  Brilliant!”

All of this said, it’s important to recognize how “fairness” affects the consumer psyche and to understand that fairness, while not rational, is a valid and important emotional response.  Consumers care innately and deeply about being treated fairly.  They want to know that they’re not getting cheesed over or that someone’s hanging them out to dry.  They want to know that they’re not getting gouged or taken advantage of.  Parting your initial experience with a businesses’ product or service with the feeling of being (please pardon the pun) “taken for a ride” is up there as one of the most damaging things that can be done to a relationship (and can be a death knell for companies requiring repeat business).

Take the following example: it’s 2005 and Hurricane Rita is on it’s way to the gulf coast.  There are suddenly millions of folks on the road evacuating inland.  Convenience stores are stripped of all goods; gas is running low.  A market solution to this supply issue: charge $20/gallon for gasoline and triple the price of perishable goods.  If that’s the market clearing price, then that should fix the demand issue and everyone will be happy… right?  No.  Just because more people all of the sudden want something, doesn’t mean that they will feel it’s fair for you to charge them 2-6x as much for it.  In fact, they will hate you for doing so and hold a deep grudge about it.

In this vein, the issue with surge pricing is that… well… it surges.  It fluctuates and moves all over the place.  Every time you log onto the Uber app on New Years Eve, you’ll get quoted a different rate.  While I appreciate the supply/demand forces that drive that dynamic pricing, as a consumer, it doesn’t seem fair to me that one minute ago something costs $20 dollars, and just now, it costs $40.  It’s the exact same ride.  It feels like price gouging and it leaves a bitter taste in the mouth.

2. It’s not predictable

Let’s say I want to go out to dinner and drinks with a few friends.  I can reasonably estimate that dinner will cost around $25 bucks and that maybe drinks will be another $20.  That’s $45 bones for the night.  Now, what if transportation could cost anywhere between $20 or $100?  Or, in other words, what if my night is now in the range of $65 to $145 dollars?  That’s a lot of variance.  If it’s the former, maybe I’m heading out.  If it’s the latter, I’m probably watching Netflix on my Roku.  Adding that level of unpredictability can meaningfully influence the choices I make and that’s not good business for consumers who generally crave, and will pay premiums for, predictability.

What’s important to realize here is that consumers respond to unpredictability with loss aversion.  They make less risky choices even if those choices are more costly than the expected value of the outcome.  To provide a classic example – random people are offered to toss a coin with the following scenarios:

• Game 1 – one coin flip => you lose, you pay $1; you win, you earn $2.
• Game 2 – one coin flip => you lose, you pay $1,000; you win, you earn $1001.

The expected value of both of these games is $0.50.  So, rationally speaking, you would expect 100% of people to participate in both games 100% of the time (assuming the cost of participating is $0).  But, given the financial impact of losing game 2 ($1,000!) vs. the expected value of only $.50, most people would shy away from playing it.  The idea of risking the loss of $1,000 far outweighs the marginal expected value of playing the game.

Surge pricing dabbles dangerously in the psyche of loss aversion.  If I go onto Uber and get 1x the fare, I’ve achieved parity and gotten what I expected.  If I get anything greater than 1x the fare, I’ve lost.  As a business, you never want your customers playing games where they feel like they’ve lost.  Ultimately, what customers will do in this environment is seek out substitute goods and services that provide more predictability.  In other words, I’ll decide to drive, carpool, take public transportation, bike, or book a cab to avoid the risk of getting gouged.  And what’s more, I’ll go through great lengths, unnatural acts, and lots of inconvenience in the process.

If surge pricing is so bad, why is Uber so successful

I thought this was important to call out.  I’m not saying that surge pricing will ruin Uber.  They’re great.  They’re disrupting an incredibly broken industry and the opportunity is huge.  They’ll continue to be successful and to dominate.  However, I do think that, especially against an onslaught of competitive products and services (Lyft, Hailo, etc), things like surge pricing will hinder growth.  Fixing surge pricing is at the crux of appealing to mainstream consumers (i.e. non-MBA dbag types).

What to do about it?

It wouldn’t really be fair if I just sat here and bitched and didn’t offer up at least one iota of thinking on a different way to do this.  The question at hand is about supply and demand and how to fulfill people’s needs for rides in a reasonable time frame while also extracting as much rent as possible from the service.  Structurally, that means any proposed solution needs to have two constructs: 1) provide a low wait time for those that require it (i.e. meet demand where it softens against longer wait times) and 2) capture more rents from those time sensitive users.

Idea 1 – Limited Uber Annual Memberships

Offer Uber as a membership only service for something like $200 per year.  The number of memberships is proportional to the number of cars that are generally available in the area.  In this way, Uber becomes much more like NetJets or similar services that provide premium level transportation services.  This model solves both issues – it captures a one time membership fee (and thereby extracts higher rents) while constraining the demand curve.  I’m sure there are arguments against this, most likely in the name of market penetration.  One consideration though: given the same pot of money, I might prefer to have 1,000 adoring customers and 99,000 anxiously waiting soon-to-be customers, over 3,000 adoring customers and 97,000 cheesed off ex-customers who feel like they’ve been gouged.

Idea 2 – Flat Published Prices for Seasonality and Special Events

So New Years Eve is the busiest time of the year?  Why not predict the average demand and publish prices ahead of time for those special days.  Similar to seasonal pricing, the idea is that people will still know what the cost of something will be before they embark on their long night of drunken escapades.  This type of pricing is much easier to message as it doesn’t involve “surging” or rapidly fluctuating prices, but rather, focuses messaging on seasonality, a subject that consumers are already familiar with and for which they are accustomed to paying a premium.

Idea 3 – Two Tier Membership

Similar to Idea 1 with a slight modification.  Offer two tiers of membership.  Free basic membership and Pro membership (at some yearly fee).  Free members get cars as they become available.  Pro members get priority access to cars so that their wait times are short.  Offering the pro membership allows you to capture rents up front from consumers who care about wait time and are willing to pay to not wait.

Idea 4 – Offer Reduced Pickup Time at Higher Cost

Inherently, surge pricing is forcing consumers to make a trade-off.  The trade-off is that they value the time they have to wait on a car at a certain price.  For example, let’s say that without surge pricing, you’re going to wait an hour for a cab and it’s going to cost $20.  With surge pricing, the wait time is now 5 minutes but the ride is $100.  The choice that Uber is making for you is that you value being picked up 55 minutes earlier for $80.  Or, that you’re willing to trade about $1.50 / minute for an accelerated pickup.  The problem of course is that not everybody values their time at $1.50 per minute.  Instead of forcing this trade-off on consumers, offer them the ability to accelerate their pickup time for a flat fee (or increased fare).  This eliminates the feeling of “loss” (i.e. being gouged at a higher rate) by allowing users to consciously swap into the higher premium by making the trade off directly.

Idea 5 – Everything is a Discount from the Maximum Rate

Instead of couching surge pricing as 1x – 6x the cost of the ride, couch dynamic pricing as a discount on the maximum fare.  In other words, set a cap for the highest rate that will ever be used: let’s say $10.00/mile and a $10.00/flag fee.  Then, base pricing as a discount on that rate.  Now when you log in to Uber you receive anywhere from 90% to 0% off of the maximum “rack rate” for the ride.*

*Note: I should add a disclaimer that this is probably my least favorite of the 5 as I feel like it’s slightly sneaky being almost entirely messaging oriented and therefore doesn’t really address the core issues**

**Note: Though it sort of does, because at least it forces you to set and message a maximum ceiling price (“rack rate”) for the service.

What not to do about it

Product work.  I was surprised to see all of the time and energy that Uber is focusing on trying to solve the negative messaging and product experience associated with surge pricing with pre-emptive New Years messaging and drunk dialing protection.  When you have to spend that level of effort messaging and fixing product experiences to address an issue, it usually means it’s time to rethink strategy.

Credits: Props to @fancymilk for editing and great suggestions.