Dynamic pricing and the $135 cab fare

I missed this when it came out last week, but Nick Bilton of the New York Times wrote an interesting article on how dynamic pricing—a pricing model where the price rises or falls based on real-time changes in demand—affected users of Uber – the service that allows people to order livery cabs through a smartphone application. Dynamic pricing, long hated (but accepted) by most airline customers for the past two decades is now becoming more common in our everyday lives. And judging by the reaction by Uber’s customers, it still has a long way to go until it is viewed in a positive light.

On New Year’s Eve, Dan Whaley, a tech entrepreneur in San Francisco, got into a black Town Car and was driven one mile to a holiday party. The ride cost him $27. At the end of the night out, Mr. Whaley took a Town Car home from the party. This time, the exact same ride cost $135.

Mr. Whaley was using Uber, a service that allows people to order livery cabs through a smartphone application. On New Year’s Eve, Uber, a start-up in the city, adopted a feature it called “surge pricing,” which increases the price of rides as more people request them.

Although New Year’s Eve was very profitable for Uber, customers were not happy. Many felt the pricing was exorbitant and they took to Twitter and the Web to complain. Some people said that at certain times in the evening, rides had spiked to as high as seven times the usual price, and they called it highway robbery. Uber’s goal is to make the experience as simple as possible, so customers are not shown their fare until the end of the ride, when it is automatically charged to their credit card. While the app does not show the total fare in dollars when customers book a ride, Uber did show a “surge pricing” multiple to customers booking rides for New Year’s Eve.

Economists call this “dynamic pricing.” It is deployed by only a small number of businesses, like hotels, airlines and car rental companies, which raise prices on weekends and holidays when demand surges.

The author then asks, “why do people accept this pricing from the airlines and hotels but become irate with Uber?”

One reason is that the airlines (and hotels to a lesser extent) use dynamic pricing to help separate the business traveler (less price sensitive) from the average traveler (more price sensitive). Those weekend stay and non-refundable ticket requirements effectively place fences up so that business customers can’t take advantage of the same prices offered to the average traveler. Additionally, most travelers book their travel days (even weeks) in advance and thus have time to ‘shop around’ for the best fare.

Unfortunately, if you were a New Years Eve reveler and looking for a ride back to your home or hotel at 2:00 am, you probably didn’t have a lot of choice; both in terms of flexibility of travel time or in the ability to shop around for a better fare. You were stuck and the folks at Uber knew it.

Paying $27 for a one-mile taxi fare and then being charged over four times as much for the same trip hours later is a bit much; so much that it makes even the worst airline pricing models look a bit tame – American Airlines are your listening?

While the numerical algorithms that power dynamic pricing are certainly cutting edge, by far the biggest challenge for its adoption into more mainstream business settings will be in changing the negative consumer attitudes that typically accompany this type of pricing model. And while the model may calculate that the demand-driven price for a one-mile taxi fare is $137, it takes some basic common sense to understand that charging this price would come under the heading of “penny wise and pound foolish.” Let’s hope that common sense prevails going forward.

Here’s the takeaway: Dynamic pricing is here to stay, but the difference between success and failure will be in implementation. Putting a human touch and knowing when, and to what extent you can raise prices (no matter what the “model” says) will separate the winners from the losers.