It’s commonly believed that raising prices when acute shortages occur is wrong. Indeed, a google search about “price gouging” returns stories about how a New Jersey Hotel raised room rates by 150% to $199.99 per night during Hurricane Sandy, a case of water selling for $40 in the midst of Hawaii’s severe water shortage, and a hotel room 23 miles from downtown Indianapolis, which normally rents for $74 a night, going for $399 a night the week of the 2012 Indianapolis Super Bowl.
More recently, Uber’s critics proclaim that the ride sharing company’s dynamic pricing strategy wrongly gouges riders by charging higher prices when demand surges in bad weather or on weekend nights.
What critics fail to understand is that raising prices during shortages is the quickest way to correct the shortage because it encourages suppliers of the scarce good or service to produce more. Uber investor and board member Bill Gurley explains how dynamic pricing actually encourages more Uber drivers to get on the road:
Back in early 2012, Uber’s Boston team noticed a problem. On Friday and Saturday nights, around 1am, the company was experiencing a spike in “unfulfilled requests.” The root cause was that drivers were clocking off the system to go home, just before the weekend partygoers were ready to venture home themselves. There was a supply-demand imbalance, and the result was a lot of very unhappy customers. So the Boston team had an idea. What if they offered the drivers a higher price to stay on the system longer (until around 3AM)? Would more take home dollars for drivers increase supply? In just two weeks they had a resounding answer. By offering more money to drivers, they were able to increase on-the-road supply of drivers by 70-80%, and more importantly eliminate two-thirds of the unfulfilled requests. The supply curve was highly elastic. Drivers were indeed motivated by price.
Gurley explains one key difference between Uber and hotel chains and airlines which also use dynamic pricing - the latter have a fixed number of seats or hotel rooms, while UBER has an adaptable supply of drivers in its markets. The key problem with regulated, less dynamic taxi fares isn’t a lack of drivers, it’s not enough drivers on the road when demand suddenly surges.
Uber’s CEO Travis Kalanick sums up the key advantage of Uber’s dynamic pricing model, “Higher prices are required in order to get cars on the road and keep them on the road during the busiest times. This maximizes the number of trips and minimizes the number of people stranded. The drivers have other options as well. In short, without Surge Pricing, there would be no car available at all.”