Surge Pricing

Surge Pricing = Peak Period Pricing
Hendrik Holler / LOOK / Getty Images

The Concept: Surge pricing, a phrase that has been popularized by the fast-growing ride-hailing service Uber, is essentially new terminology for an old concept, peak period pricing. That is, increasing prices during periods of peak demand to bring demand down into line with supply, as well as in an attempt to maximize revenues and profits.

At its most basic level, when Uber detects a surge in customer demand for rides (hence the derivation of the phrase) at a given time and in a given geographic area, it will raise prices in an attempt to bring supply and demand into equilibrium.

In major cities, surge pricing inevitably will produce fare increases during commuter rush hours, for instance. Given the contention among customers for rides during peak periods, surge pricing results in the available rides being allocated to those customers who are willing to pay the most for transportation service.

In New York City, where generations of commuters have been inconvenienced by taxi shift changes that inexplicably are scheduled to take place during the evening rush hour, the dearth of available cabs during this peak demand period has been a huge boost to Uber's business, even despite the price premium exacted by the surge pricing scheme.

Like price optimization, surge pricing as practiced by Uber is a data-driven strategy designed to maximize revenues and profits. It also essentially is a variation on yet more classic themes in economics, selective pricing and price discrimination.

Uber uses complex mathematical models, based on analyses of big data performed by its in-house data scientists. Also, see our discussion of predictive models. Uber's surge pricing models represent a form thereof.

In fact, surge pricing is an especially up-to-the-minute variant of dynamic pricing. Uber's computer algorithms apparently give it the ability to adjust prices almost continuously in response to fluctuations in the supply of and demand for its affiliated drivers.

Criticism: Uber's surge pricing scheme has been attacked as a form of unfair price gouging by some politicians, as well as by traditional taxi operators who are rapidly losing business to Uber, in markets where Uber operates. Ironically, many of those who take this line, especially those in the political arena, support similar rush hour or peak period pricing on government owned and operated toll highways, bridges, and tunnels, or on public transit systems.

Surge pricing also is essentially the same concept as peak period pricing of electricity, which also tends to be favored by regulators as a means of conserving and rationing a scarce resource. Likewise, the imposition of surcharges on water usage during periods of drought is another similar approach to resource management.

The one key respect in which Uber-style surge pricing differs from these more established forms of peak pricing is, as discussed above, its truly dynamic nature. With tolls and transit fares, for example, peak (and off-peak) pricing periods are set in advance and remain static for long periods of time (oftentimes for years without change). Moreover, the price differentials themselves are also set in advance and likewise remain static.

In Uber-style surge pricing, prices instead are adjusted in response to current market conditions. If a surge in demand occurs before or after normal peak periods, that is when a surge in price will occur. If demand is weak during the usual peak period on a given day, then surge pricing will not go into effect at that time. Furthermore, the change in price dictated by Uber's programs is itself subject to continuous adjustment. A large part of the critics' complaints no doubt derives from this element of uncertainty that the consumer faces.

Example: An Uber driver of this writer's acquaintance reports that surge pricing is a great moneymaker for him. The lack of other drivers late one night produced a surge price of $125 for a 12-minute ride (of which $100 was the driver's share) between towns on the New Jersey shore.

The customer was willing to pay because taxis were not available, and because, after spending hours drinking in a bar, he was in no condition to drive himself safely.

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