Uber's Pricing Puts Economists Before Customers

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Last year, I wrote about Uber, the upstart car-dispatch service that is upending taxi markets around the world. At the time, I argued that Uber's biggest threat comes from regulators -- and its biggest strategic resources were its customers, whom the company had mobilized into a powerful weapon against special interests and the politicians who catered to them.

Now Uber is facing a new strategic threat from its customers.

At the core, Uber is not a taxi company; it's a technology company. The company has a lot of data on where its customers are, and where they like to go. That enables some cool stuff: Travis Kalanick , the company's chief executive officer, told me that Uber can slightly outperform gambling spreads on whether a team will win a home game, just by looking at stadium trips. More practically, data enables them to move cars to where they might be wanted, which means it's easier to get a car if you are outside the dense urban core. And when demand is very heavy, data enables Uber to dynamically price rides to ensure that cars are always available -- if you're willing to pay.

I love Uber's surge pricing; it means that we can get a car home on New Year's Eve. Yes, it costs a lot, but the alternative is hoofing it for a few icy miles through some not-quite-safe streets.

But I'm an economic policy journalist, not a normal person. Normal people hate this sort of dynamic pricing, which they call "price gouging."

This came to a head last week, when a brutal snowstorm on the East Coast kept taxis off the streets. Desperate folks in the New York metro area turned to Uber -- and then screamed at the bills they got for hundreds of dollars, even though Uber's smartphone app seems to have clearly warned them that this was going to happen. Economically illiterate recrimination ensued. Kalanick took to his Facebook page to make fun of an outraged customer.

On the economics, Kalanick is clearly right. When demand is very high, and supply is very limited, the right thing to do is let prices rise. This performs two functions: It ensures that available supply is distributed to people who want it pretty badly, and it can attract more supply into the market.

But on the business side, I'm not so sure. These kinds of pricing extremes make people extremely angry, for reasons that I think Mike Munger has explained best: We do not like market transactions made under duress, even if the seller is not responsible for the duress. Merchants in disaster areas often charge less than they could because they know that the goodwill costs will exceed the profits from maximizing their markup.

Another way to put it is that when demand is scarce, price-sensitive people would prefer a lottery ticket that gives them a 1-in-20 chance of getting a car at the normal price, than a certain chance of getting a car at a price they are not willing to pay. And almost by definition, there are more of the former than there are people who will happily pay $300 for a car ride because they really need it.

Allowing prices to surge into the hundreds of dollars is undoubtedly efficient, in the economic sense, but it is not necessarily smart, in the business sense. Uber may have to rethink its dynamic pricing policy, for example by putting a limit on how high prices can go. Economists will sadly shake their heads. But the customers will be smiling -- and they're the ones who ultimately matter most.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net