Uber's Surge Pricing Applied to Smoothies
How could this be: A “healthy casual” restaurant that demands a 35 percent surcharge if customers want just one kind of fruit in their smoothie, rather than a combination?
At first, I thought I had read the menu item wrong. Surely, the extra $2 was applied if a customer asked for an additional variety of fruit. But no. When I checked the menu again, the restaurant really was asking customers who opted for no fruit diversity to pay more.
I asked some friends to help me figure this out. They couldn’t. So when I went back to the restaurant, I asked several employees. Two expressed surprise; two others suggested that I had misread the menu; and one provided me with the explanation. It makes sense (though it may not be the best outcome for all).
It turns out that this seemingly counterintuitive pricing approach is an attempt by the restaurant to manage the demand for its fruits. Specifically, management is worried that certain customers may “over-order” a particular variety (mango was cited as an example), thus depleting the supply and limiting the ability of other customers to get their desired mix. But the restaurant doesn’t want to outlaw the one-fruit smoothie altogether -- thus the hefty 35 percent surcharge.
I suspect this approach will dumbfound many customers, but it has some analytical merit. In fact, free market economists would applaud the restaurant’s attempt to use the pricing mechanism as a way to meet business objectives: Rather than impose a quantitative limit or risk prematurely running out of product and disappointing customers, the restaurant is seeking -- pre-emptively -- to balance supply and demand through differentiated pricing.
Yet, this particular use of differential pricing may not be the best option available here.
First, I suspect that a $2 surcharge is rather arbitrary, backed by little impact analysis. This specification could unnecessarily distort choices that could be more consistent in balancing customers’ preferences with the restaurant’s inventory management.
Second, it is not clear that the costs of discouraging a few customers from ordering single-fruit smoothies are worthwhile, particularly since the majority won't experience a shortage of any particular fruit.
Third, the policy is really hard to explain -- so much so that many of the restaurant’s employees appeared perplexed.
Ideally, the restaurant would be able to apply a more dynamic version of differential pricing -- changing the surcharge in line with actual demand, rather than setting an arbitrary one based on crude estimates of changes in fruit inventory, if any.
This, of course, is what Uber does with its variable-pricing approach, including “surge pricing.” By raising prices as demand increases, Uber is able not only to influence demand in line with supply, including by encouraging riders to share cars; it also can encourage more drivers to take to the road, thus increasing supply.
Certainly, this practice is not without critics. It requires lots of changes in the pricing menu that can irritate and confuse certain clients. And it can lead to excesses under certain circumstances, as illustrated by the outrage over Turing Pharmaceuticals' decision to increase the price of its drug Daraprim by 5,000 percent to exploit very inelastic demand.
Yet when differential pricing is used smartly and decently, and when the practice is explained proactively and transparently, it is in fact the approach that best meets many (otherwise-competing) objectives. And, I suspect, it is an approach that may work particularly well in many leisure activities and that probably will spread.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Mohamed A. El-Erian at firstname.lastname@example.org
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