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No. 3120:
Supply, Demand, and Surge Pricing

by Andy Boyd

Today, surging into the future. The University of Houston presents this series about the machines that make our civilization run, and the people whose ingenuity created them.

Imagine hopping off a plane in, say, Washington D.C. You check your mobile device and find you can hail an Uber driver to take you to your destination for twenty dollars. The driver can be there in five minutes. So far, so good.

But while waiting for your luggage, a thunderstorm moves through. When you pick up your bag and hail a driver, you find the fare has jumped to sixty dollars. How outrageous, you think, that Uber could take advantage of rain to drive up the price by a factor of three.

Surge Pricing
Photo Credit: flickr

And you wouldn't be alone. "Last night I paid $83 for a five-minute Uber ride," wrote one New Year's Eve passenger. "Uber charged me $97 to go 2 miles last night. This type of price gouging has to be illegal," wrote another.

I hadn't given Uber's surge pricing much thought until I attended an academic presentation by the company's former Head of Dynamic Pricing Research. He's still at Uber, though his new alt is Head of Marketplace Optimization. He's also a highly-respected professor at Columbia University's School of Business.

So what's going on inside Uber? For one thing, a lot of math. Of course, the audience wasn't privy to the equations, but the company's philosophy came through pretty clearly. It boiled down to two words: supply and demand.

Photo Credit: Wikimedia

Taken together, these two words have become a cliché. But as with many clichés there's good reason. Uber keeps vast historical records, which, among other things, make for good PowerPoint slides. We observed minute by minute charts detailing how passenger demand went down as prices went up. But we also witnessed something most businesses don't see. When prices went up, the supply of drivers also went up. Cab companies work with a fixed number of cars so can't do that. With demand falling and supply rising, Uber kept the waiting time for a ride to a few minutes. Without surge pricing, Uber passengers would've experienced much longer wait times.

Photo Credit: flickr

And good service in the form of controlled wait times is high on Uber's list of goals. My strong impression was that the surge pricing algorithms were designed to achieve specified wait times, not more profit. Does that mean Uber's goals are altruistic? I wouldn't go that far. But there is method to the madness.

Like so many technology companies today, Uber has its sights set high. Providing an alternative to taxicabs is only the beginning. If Uber can ensure a ride is always only minutes away, would ever more people in dense urban centers abandon their cars altogether? Therein lies Uber's motivation. In the vernacular of the times, the company is seeking to disrupt the market for personal transportation. 

It's an interesting experiment, and only time will tell if the many elements of Uber's vision will allow it to thrive or, for that matter, survive.

I'm Andy Boyd at the University of Houston, where we're interested in the way inventive minds work. 

(Theme music)

Z. Epstein. New Year's Eve Surge Pricing Enrages Uber Users; One Man Hit With $1,100 Fare. From the  BGR website:. Accessed April 18, 2017.

This episode was first aired on April 20, 2017