It’s Not Just Uber That Profits From Surge Pricing
(This post originally appeared on Entrepreneur)
Did you hear about the woman this week who “almost passed out” after being charged $640 (instead of the normal $50-$70) by Uber for a 30 minute cab ride to the airport? Welcome to surge pricing! Are you familiar with this practice? It’s become part of our vernacular, thanks to Uber.
People think it’s a new thing, but it’s really not.
Surge pricing, in case you haven’t heard of it, is Uber’s practice of adjusting its prices based on demand and other factors. Like our airport customer above, and like a friend of mine from the Bay area who had a similar experience last New Year’s Eve when he booked a ride home from a restaurant only to find out he was to be charged more than three times Uber’s normal fare.
“What a racket!” he later complained to me. “I can’t believe they get away with this!”
Of course they do. They should. This is America and as Don Barzini so aptly put it in The Godfather, “after all – we are not communists.”
In Uber’s defense, the company sent emails to its existing customers in the Bay area warning them that due to high demand and a lower supply of drivers, prices would be higher on New Year’s Eve. Uber has competition from other taxi and ride-sharing services. I received a similar email from Uber before a big snowstorm was predicted to hit my city, also warning me that fares during that event would be higher (Uber is by law limited to charging a maximum of 1.9 times its normal fare during emergencies). My friend had a choice. He chose to grudgingly pay the higher fare. No surprise, he has continued to use Uber. No one likes Uber’s surge pricing,but we get it.
Surge pricing is nothing new. It’s just getting very popular. For that we can blame two things: technology and math. As more and more “big data” is gathered by corporations the ability analyze trends, preferences and spending power is becoming easier. The growing number of math majors graduating from Stanford and MIT are writing better and more complex algorithms to take advantage of this new computing power. Such is why discount bus services like Bolt Bus can charge between $1 and $40 for a fare from Boston to New York, depending on unfilled seats, gas prices and time of day. Or how American Airlines can charge my seatmate $100 less for the same ticket I bought because he bought his ticket during a low demand period.
Dell has been found to charge different prices for the same computer depending on the industry of the buyer. Disney has been accused of charging different prices to its theme parks depending on where its customers live. Amazon.com updates its prices 2.5 million times a daybased solely on demand.
What Uber is doing is no different than these companies. They have the money and resources to employ the best technology and smartest mathematicians around to figure out the best prices to maximize their profitability. The challenge for you, me and other small business owners is: can we do the same? Guess what? We can! We can do it even with our limited resources. Just ask Gary.
Gary is a client of mine. His company is located in the Philadelphia suburbs and does printing jobs — brochures, signs, books, manuals, mailings — for his corporate customers. His business has been around for more than 30 years. He’s survived the ups and downs of the economy, and the new do-it-yourself printing technology that’s put many of his competitors out of business. He’s a smart guy who runs a profitable company. For 30 years he has employed his own form of surge pricing, just like Uber. Except unlike Uber he calls it something else. He calls it…if you’ll allow me…”A-Hole Pricing.”
OK, I never said Gary was the most politically correct guy around. You can probably figure out what he means by “A-Hole.” So let me let you on his secret calculation, not that it’s not so hard. For every job that comes in, his estimators create a cost sheet. They price out the materials needed, the presses to be used, the labor that will be required and then apply an overhead factor to take into account his fixed costs. They also work in a standard 20 percent profit margin. Each cost sheet then goes to Gary for approval. This is a small business, so we’re talking maybe 20-30 sheets a day. It’s not an insurmountable amount.
Gary’s role in this process is critical. He’s the one who determines the final A-Hole Pricing. He looks at the costs and the expected profit, then he looks at the customer.
“Oh yeah,” he mutters to himself. “That’s the guy who stiffed me on that one order last month.” Or “That’s the guy who always takes four months to pay.” Or “That’s the guy who calls us every 10 minutes with another demand.”
Like the Soup Nazi on Seinfeld and using his 30 years of experience, Gary then applies a discretionary price increase to what’s been estimated based on his gut. This is the number that makes or breaks his profit. Gary, like me (and probably you), will pretty much do business with anyone — as long as they pay enough to make it worth it. His time-tested A-Hole Pricing is the difference between profit and loss, survival and failure.
Surge Pricing. A-Hole Pricing. Call it whatever you want. Adjusting your prices based on supply, demand and customer behavior is nothing new. Just ask any successful businessman, like Gary.