What’s Old Is New Again: Surge Pricing

It’s every Uber rider’s worst nightmare: A ride that costs hundreds of more dollars than expected.

In October, an Illinois woman hopped out of an Uber after a 100-mile ride to discover she had been charged nearly a thousand dollars. The ride — from a Chicago suburb to O’Hare International Airport and back — would normally cost $120. But, due to the ridesharing giant’s “surge pricing” strategy, the ride cost nearly eight times higher.

Uber since gave the rider her money back, telling Chicago’s ABC 7 the fare was a “perfect storm” of confusion. Still, tales of overcharging — or even high-tech price gouging — are not uncommon for Uber, which said in 2016 that surge pricing was applied to a whopping 40 percent of its trips.

The ridesharing firm isn’t alone in the price complaints department. Lyft’s surge prices were above 500 percent after the Super Bowl, according to The Drive.

Yet the idea of raising — or lowering — prices based on demand is far from new. Companies have experimented with the concept for years, long before Uber and Lyft were ever on the scene.

Beverages and Airlines

Surge pricing goes back ages, before it was even known by that name. Restaurants offer “early bird” discounts for diners willing to eat their meals before 6 P.M., for example. Tuesday night dinner discounts and lunch buffets are also a part of restaurant pricing history.

One of surge pricing’s innovators is M. Douglas Ivester, the former chief executive of Coca-Cola.

Back in 1999, Ivester came up with the idea of raising the price of the company’s sodas on hot summer days. The company’s vending machines would be equipped with thermometers, and, when the temperature rose, the vending machine would raise soda prices for thirsty customers looking to cool off.

It was an innovation that never saw the light of day. Once customers got wind of the idea, the word “price gouging” was tossed around in a rather unflattering way. To make matters worse, Pepsi took the opportunity to publicly accuse the company of taking advantage of its customers.

The soda wars weren’t the best chapter in American history. Coca-Cola failed because one can’t simply raise prices based on demand, as that is the sort of thing that rapidly angers consumers.

“Those are the situations where consumers really get up in arms. If you’re going to take advantage of the demand, you have to be able to say with a straight face that there’s a benefit that goes with it,” Mike Marn, director of pricing services at McKinsey & Company, told The New York Times in 2005.

Even though Coca-Cola couldn’t make it work, others did by matching supply and demand more subtly.

In the 1980s, Robert Crandall, then-CEO of American Airlines, decided to introduce low fares for tickets bought far in advance and kept last-minute fares close to sky high.

That concept has since become a hallmark of the travel industry: Airlines, hotels and rental car companies have all adopted similar models.

In the modern era, Uber and Lyft seem to have happily taken a page from the same playbook.

Rideshare

The “extra value” Uber offers its customers is a ride that would otherwise be unavailable, because the events that tip off surge pricing are also the types of events that keep drivers off the road. Unlike Coca-Cola, which gave the impression they were raising prices merely because they could, Uber can honestly state the extra funds they accrue are how they can keep extra cars on the road when demand is high.

Uber can even point to the service’s necessity: When a glitch to the system that implements surge pricing occurred on New Year’s Eve in 2014, Uber said it had an opportunity to witness what would happen when thousands of passengers needed a ride but no surge was in effect.

“Without surge, ride requests skyrocketed and only 25 percent of these requests were completed,” Uber researchers wrote. “ETAs also increased sharply. Without surge pricing, rider and driver behavior did not adapt to the increased interest in getting a ride.”

Uber contrasted the New Year’s Eve glitch with a night when Madison Square Garden hosted a sold-out concert and surge pricing went off without a hitch. All passengers who hailed a driver were able to get to their destinations, the company claimed.

New Applications

While dynamic pricing has a particularly strong track record in travel, the applications can range more widely — yoga studios, supermarkets or even something as mundane as take-out can also benefit from the pricing strategy.

Two entrepreneurs in New York — who also happen to be brothers — are capitalizing on the reverse of Uber-style pricing for their Seamless-like mobile app.

Gebni, which launched in February 2017, comes to the world care of Mohamed and Sidi Ahmed Merzouk.

The app helps restaurants acquire take-out orders during their slow periods. It sets dynamic pricing based on an algorithm that reduces the price of menu items according to demand. Discounts change in real time, ranging from a moderate 2 percent to a whopping 35 percent — even on a $10 item. (Tips are not included in the price, but, if a restaurant has a delivery fee, it is clearly stated.)

The methodology behind the model?

“We want people to pay a fair price that reflects current demand for that meal, instead of an arbitrary price set by someone [who] doesn’t really understand market economics, supply and demand,” Mohamed Merzouk told Forbes.

For the record, the Gebni app is not the only service that benefits the consumer with dynamic pricing. Even Uber — for all its surge-pricing horror stories — has tried to implement more ways for users to save money with new features through its app.

However, dynamic pricing is likely to stay — and evolve — to meet the challenge of matching supply with demand.