A Deeper Look at Uber's Dynamic Pricing Model - Abovethecrowd
A Deeper Look at Uber's Dynamic Pricing Model - Abovethecrowd
A Deeper Look at Uber's Dynamic Pricing Model - Abovethecrowd
com
publicize how and why the program works. This past New Years Eve, the
CEO even published a how-to video encouraging riders NOT to ride at
certain times.
There are a few things to note about Ubers marketplace and the supplydemand curve. First, Ubers analysis and research has shown that both
the supply curve and the demand curve are highly elastic. The Boston
experiment, and every effort since then, confirms that higher prices
increase supply, all things being equal. This is true in every market the
company has entered.
On the demand side, the company has confirmed price-elasticity in two
different areas. First, when prices surge, they see an immediate
reduction in open-to-order ratios. As expected, higher prices do indeed
reduce demand. Moreover, as mentioned in this video interview with
Ubers CEO Travis Kalanick, the converse is also true. Ubers numerous
price decreases have all resulted in materially increased demand.
Basically, Ubers marketplace is highly efficient, and operates in the
exact way that your economics professor would expect. When you
consider that both sides of the model Ubers riders and drivers are
both large groups of fragmented independent agents, this is no surprise.
The market should operate efficiently.
Using the supply and demand curve as a model, Ubers dynamic pricing
model is rather straightforward. When demand outstrips supply,
dynamic pricing algorithms increase prices to help the market reach
equilibrium. Of course, these situations are always temporary,
eventually supply outstrips demand, and the price falls back to normal.
If demand were to spike with no resulting price increase, you would
have what is known as an economic shortage. Without a price increase,
Ubers unfulfilled rate would skyrocket, and most customers would be
left without a ride. With dynamic pricing however, the variable Q on the
graph is further to the right than it would be without. More absolute
rides are fulfilled precisely because supply increases.
that are very similar to Ubers highest peaks on New Years Eve. For a
hotelier, the demand for a room on New Years Eve is dramatically
higher than a random weekday two weeks later. With no ability to
increase supply, they are left with the alternative of selling to the
highest payer. This is a relatively well-understood and accepted
practice. No one appears even the least bit emotional about it, as it is
well understood and expected.
There is, however, one key difference that materially increases the need
for dynamic pricing in Ubers case. With hotels, airplanes, and rental
cars, supply is relatively fixed. One cannot build more rooms for New
Years Eve, and then take them down. Uber has a problem these
companies do not. At the exact time that riders want more availability
Friday and Saturday night, in a bad storm, on New Years Eve drivers
would rather not be driving. You see, while hotel rooms are fixed, Ubers
supply actually shrinks at these times, because the drivers would prefer
not to be working at those times either. The exact events that increase
demand for needing a driver also cause supply to shrink. In these cases
the supply curve is moving left at the exact same time that the demand
curve is moving right. As a result the need for a price catalyst to increase
supply in the Uber case is vital.
Another factor that impacts driver supply is substitute opportunities.
Drivers have lucrative alternative opportunities on event nights like
New Years Eve. Some party-goers are willing to book a single captive
driver for a flat rate which could be well over $1000 for the night. And in
this case, the driver enjoys quite a bit of downtime.
fails to consider the real alternative to dynamic pricing tons and tons
of unsatisfied customers complaining about a lack of
availability/reliability (two of the key tenets of the Uber customer
proposition).
The bottom line is that the only real alternative to
dynamic pricing is a ton of customers staring at
screens that read No Cars Available. This is the
fact that is least appreciated by Ubers critics.
Remember the PR hit that UPS took this Christmas
when they could not deliver packages as customers
expected? The idea that Uber could make its network available in a
normal state and at a normal price while demand is increasing and
supply is shrinking is quite simply unfeasible. And the argument that
Uber should keep prices flat in moments of peak demand is a de facto
argument that Uber should be comfortable stranding the majority of its
customers with the disappointing message: No Cars Available.
If this sounds to you like an apology for the price increases, try the
following experiment: the next time you see a message indicating that
Ubers surge pricing is in effect: immediately try an alternative other
than Uber. In other words, try to hail a cab, call a traditional black car
service, find a rental car, or jump on a bus or subway. You will find that
availability and reliability for all forms of transportation are under
stress at that same precise moment in time. At these times, a fixed price
taxi will be highly unavailable, and a fixed price subway will be
remarkably over-crowded. Relative to those choices, Uber prefers to be
reliable and available for the maximum number of customers it can
serve, and believes that the customer dissatisfaction from being
unavailable would be way worse than the limited customer
dissatisfaction with their dynamic pricing model.
higher, and when they would then prefer not to transact. Basically, as
more people understand the model, they will become more comfortable
with what to expect, and can make informed choices.
Original URL:
http://abovethecrowd.com/2014/03/11/a-deeper-look-at-ubers-dynamic-pricing-model/