Dynamic pricing is getting increasingly accepted in everyday life, but certain aspects of it still alienate or repulse customers and evoke heated debates and complaints. In this first part of a larger series, we tackle the topic of price gauging (when a seller spikes the prices to a level much higher than is considered reasonable, and is viewed exploitative, potentially to an unethical extent). How do customers react to what they perceive as price gauging? What do economists have to say about the practice? Is it really unfair, is it legal? Let’s check it through Uber’s example.
On-demand transportation services company Uber had built its very business model around dynamic pricing: when rides are in high demand in a certain area and there are not enough drivers nearby, fares increase to incentivize more drivers to hit the road and to lower demand. Accordingly, fares surge right after a widely popular sports event or during rush hour on New Year’s Eve to balance out supply and demand.
However, if the same happens during cases of emergency, public perception of the pricing strategy changes drastically. When prices doubled during Hurricane Sandy, or quadrupled during the 2014 Sydney hostage crisis, Uber was accused of price gauging, heavily criticized for applying excessive surcharges, and wildly deemed as being ‘únfair’, ‘unethical’, ‘distasteful’, and ‘immoral’. (Remarkably though, even some not algorithm-driven businesses that otherwise have flat pricing also engage in surge pricing during civil emergencies, even when it comes to essentials such as food or water.) But is purely data-driven dynamic pricing during emergencies really unfair? Is it efficient, is it legal?
First and foremost, economists agree that surge pricing is a good thing, with 80 percent saying it raises consumer welfare. Irrespectively of the event that causes a spike in demand, they call surge pricing “compensating differentials.” When conditions are bad, people need to be paid more as compensation for the undesirable aspects of the job. This is how markets work. Even more remarkably, experts do not see anything wrong with price gauging: only 8 percent of the surveyed leading economists agreed with a proposal to prohibit “unconsciously excessive” price gouging during natural disasters. (51 percent disagreed with the proposal, 15 percent were uncertain and 8 percent had no opinion.) Experts opposing the proposal argued that such legislation would lead to a misallocation of resources and lead to lower supply and greater scarcity of the resources, which would harm those who truly in need of the resources.
Nevertheless, people do react if when they think price gauging is practiced, and they react intensely: during extreme and general distress, customers expect empathy and not data-based arguments or even facts about efficacy. So much so that consumers’ perceived price fairness can be considered the most important condition that must be upheld for dynamic pricing to work. Importantly, perception of price unfairness leads to consumer dissatisfaction, leaving the exchange relationship, spreading negative information, or engaging in other actions that deteriorate the reputation or trust of sellers. Richard T. Thaler, who was honored a Nobel prize for work that includes study of what constitutes fairness in markets, also points out that “A good rule of thumb is we shouldn’t impose a set of rules that will create moral outrage, even if that moral outrage seems stupid to economists.” The things that might maximize revenue for any given day might not be the elements that matter in the longer term.
In 35 states, policymakers decided to step in in order to enforce that businesses do not engage in price gauging during civil emergencies or natural disasters. To comply with such local laws, and also to increase customer trust and satisfaction, Uber has implemented some changes in its pricing policy, e.g. they introduced upfront pricing (so customers can learn the costs before they order the service); refunded surcharges in many cases; and agreed to either not apply surcharges, or in some cases, offer free rides, during certain emergencies
In overall, surge pricing (or dynamic pricing in general) is not inherently and universally fair or unfair, not even with price gauging – especially because what seems to be fair to Uber’s customers can be considered as unfair to its drivers. Finally, as several examples demonstrate, the conception of what is fair is changing over time.
Are you interested about dynamic pricing, and wondering about the implications of its introduction? Contact DynamO’s team of experts at email@example.com.