If you hailed a ride home from Uber on New Year's Eve after a night of intense celebrating, good for you. You helped make the roads safer for everyone.
But if you are a bit taken aback by what the fare turned out to be, you shouldn't have been surprised. The ride-sharing platform employs what is known as “surge pricing,” meaning the price will go up when there is a surge in demand, such as a holiday.
While no one wants to pay more than necessary, researchers at Washington University in St. Louis have concluded that surge pricing is actually an efficient system that benefits everyone, both consumers and drivers.
Kaitlin Daniels, assistant professor of operations and manufacturing management at Washington's Olin School of Business says Uber provides an interesting case study in how a business uses prices that go up and down with demand.
“Since drivers decide for themselves when they drive, price in this setting influences not only the firm’s margin but also the number of drivers out on the road serving customers,” she said.
How consumers can benefit
It may seem counter-intuitive, but Daniels and her colleagues say consumers can actually benefit from surge pricing. If demand for rides is not being met by a traditional taxi service, they say surge pricing will encourage more ride-sharing drivers to hit the road, increasing what ordinarily would be a limited supply. You might pay a little more for your ride, but at least you'd have a ride.
“Because taxis charge fares that are independent of demand for rides, they experience one of two possible inefficiencies,” Daniels said. “Either taxis fail to satisfy peak demand, or many taxis idle during times of normal demand. Drivers can only tolerate so much idleness because they are paid per ride, so in many cases taxis opt for the former inefficiency over the latter.”
Airfares also rise and fall with demand
Airlines have long employed surge pricing in setting their fares. Fares for travel during peak demand season, such as the holidays, cost more than during off-peak times.
Booking several weeks in advance usually provides a lower fare than booking a few days before departure, when prices for the few remaining seats surge higher. While that's largely a product of the nature of the business – once a flight takes off no more seats can be sold – Daniels says surge pricing in the ride-sharing industry can actually expand supply.
“In this case, surge pricing allows service to expand during peak demand without creating idleness for drivers during normal demand,” she said.
That means everyone gets a ride, even if they have to pay more for it. Daniels says it also means during non-peak times, riders will pay less. The net effect is regular Uber riders will likely come out ahead, even if you pay more for a lift home on New Year's Eve.