01 Jun 2016 15:13 IST

The economics behind surge pricing

Hiring an Ola or a Uber at peak time isn’t very different from paying more for onions when there is a shortage

Should you feel cheated that you ended up paying ₹450 for a 10-kilometre cab ride at 9 pm when the same trip would cost a third just 10 hours earlier? If your answer is yes, then you are not alone. Delhi Chief Minister Arvind Kejriwal is quite exercised about Uber and Ola, the two technology companies that help consumers and service providers arrive at an agreement on differentiated prices for different times of the day.

Kejriwal has taken to social media platform Twitter to vent his annoyance at the phenomenon. Not to be left behind, the Karnataka Government too has thrown the Motor Vehicles Act rulebook at the hapless cab drivers/ owners, whose only crime is to have been registered with the app-based ride share companies. But the State’s displeasure notwithstanding, it is difficult to see what they can do about it. The public had better get used to the Brave New World of ‘surge pricing’!

All about pricing

Of course, it has to be said that the proposition can easily be turned around by saying that you ought to feel blessed that you escaped paying ₹150 for a 10 kilometre ride because earlier there were occasions when it did cost you ₹450 to traverse this distance. It is always that the lower price is the ‘fair’ and the higher one is an ‘outrage’. It would never occur to us that the ₹450 would be full cost recovery price and the late morning price (₹150) approximates to a variable cost-based pricing.

Human beings are conditioned to take their good fortune for granted while quick to adopt an air of ‘why-have-I-been-singled-out-for-such-harsh-treatment’ at the slightest hint of a misfortune befalling them.

Cars and kandas

Price volatility is not unique to taxi rides alone. Just this time last year, the price of onions shot up to nearly ₹80 per kilo, while it is currently ruling at a fifth of that price, if not lower. There was a news item just the other day which spoke of a farmer netting a mere rupee for a tonne of onions after meeting transportation, loading/unloading and mandi commissions.

It is not just onions. There is a whole range of goods ranging from cereals and milk to fruits and meat on which we spend money on a regular basis, that see price spikes and dramatic declines from time to time.

No doubt, there is a lot of noise that is generated about spiralling prices when food prices go up, but in the end, the public just grins and bears it. Or, eats it.

The Government too, makes politically correct noises. The minister in-charge would say his Government is going after hoarders and black marketers. They would then contract some token shipments of imports of whichever commodity is in short supply and whose price has shot up. They know all too well that it is not going to make much of a difference to the price situation.

The world simply doesn’t have a surplus of onions to feed a large, ravenously hungry population such as that in India. But no harm done, for, in due course, the supply situation improves with corresponding price correction and everybody goes about their normal business. That is, till the next commodity crisis breaks out. It is ‘rinse and repeat’ time once again.

Market mismatch

The market for personal mobility solutions too experience temporary mismatches in supply and demand, just as they do in the case of onions.

And just as they do in onions, using appropriate price signals is the only way to smoothen the demand-supply imbalance. The only difference between food items (onions) and cab rides is that the imbalances in the latter tend to be for extremely shorter durations of time — between late afternoons and late evenings or between central business districts and residential areas.

But in the case of general commodities, the imbalances are measured in terms of a few months or that they have a tendency to quickly spread themselves out across a much larger geographical area. But none of that makes a case for resorting to something other than price signals to remedy the situation.

Taking the moral road

Let us look at the moral case for regulating ‘surge pricing’. The exercise smacks of price gouging by taking advantage of a customer’s desperate situation.

Imagine it is 10 pm. You’ve just come out of the theatre after watching a movie, but there is not a taxi to be had. You spot something on the horizon. The driver demands ₹450 for the ride while at other times of the day, the fare would have been just ₹200. Is the driver exploiting your vulnerability? Possibly. But what if there are two other customers waiting to hire a taxi and there is only one available at a given point? Who should get the nod? You might say that the one who stood waiting for a longer time must get it.

The principle of ‘first-come-first-served’ seems an ethical way to resolve the problem, but while we are on the point of an ethical solution, let’s make this that bit more complex.

What if the other person too came out of the same theatre just a second later and happened to be a bit older than you. In fact, he was frail of health, with a polio stricken leg to boot. Should his claim to engaging the taxi not rank superior to your own? Having resorted to finding answers in the theory of ethics, you can’t now turn around and tell the old man, ‘Tough luck, that’s the way the cookie crumbles’.

While we are at it, we may see if ethics has answers for even more complex situations: such as where the person has been waiting even longer but happens at the other end of the street. How does one adjudicate between conflicting claims of two prospective customers where one spots the taxi first but the other is a mere 50 metres away but had been waiting for a far longer time than the first one? How does one distinguish between someone merely wanting to return home and the other needing the taxi to get to a hospital or railway station? The moral dimensions can be multiplied to any degree of complexity and there is no one elegant solution in ethical theory that would be universally acceptable.

Which is why…

No, for all its apparent defects, a market solution using price signals is the only way to smoothen out mismatches between demand and supply. Why, then, does the State feel that it has to intervene to a point that there is not even a legal basis under the current law for its actions? The Delhi Chief Minister has coarsely confined himself to using Twitter posts to express his displeasure against ‘surge pricing’.

But the Karnataka Government has gone one step further by actually rounding up a few cab drivers and imposing fines on them for violation of Section 93 of the Motor Vehicles Act. Now, what does this section say? Merely that no person shall engage himself as an agent or canvasser in the sale of tickets for travel by public service vehicles except when he is licensed by the State.

Now if a car owner has registered himself with Ola or Uber and is responding to a request for a ride-share by a person who logs in his intention and location on a mobile app, how does that make the driver an agent ‘canvassing sale of tickets in a public service vehicle’?

Managing monopoly

Indeed, it is equally open to challenge if the car in question is actually a public service vehicle within the meaning of that term under the Motor Vehicles Act. The absence of tickets, a pre-determined point of origin and destination with stops along the way and a fixed fare make the vehicle anything but a ‘public service vehicle’.

The reason why States are attempting to tie themselves up in legal and regulatory knots is that for long, they held the monopoly on licensing vehicles for transporting people from one location to another.

But information technology has rendered that role inconsequential. A customer and a vehicle owner/driver no longer need the intermediation of the State. The mobile app is now the State. That is the reason why the Empire has chosen to strike back!

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