On Uber and other electronic market places

A lot of the Uber criticism seems, to me, a red herring. Cities extract enormous rents from the taxi business by selling medallions and collecting licensing fees. These fees substantially increase the price that riders must pay. Additionally, local regulators fix prices that all taxis must charge at all times. Whether it is Friday night at 2am or Sunday afternoon, you pay the same high price. But the pool of potential drivers is vast — really anyone with driving skills. This means that cabbies are willing to work for less than what they do work for, creating additional rent-extraction opportunities.

Drivers bribe dispatchers for lucrative airport rides and referrals, cab companies charge $150 per shift for a rundown smelly car (that comes with a medallion).  Some drivers with capital are able to buy their own medallions and then rent them to cab companies or other drivers without capital. Even the financial sector is getting in on the action as they lend money to purchase medallions, securitized by the medallions themselves. In short, there is a huge pyramid of rent-seeking, from the city to the cab companies, to the banks, to the dispatchers, to the medallion holders to the cabbies — all piled onto the shoulders of fare-paying customers who are just trying to get home from the bar.

At the same time, there are complaints of riders refused service by cabbies based on their race or destination and of poorly maintained vehicles; there is the notorious body odor problem.

Along comes Uber, which found some loopholes (e.g. don’t flag the car on the street, but order it on a cell-phone) to provide taxi-equivalent services without a taxi license. Of course, it was always possible to hire a car service and many firms had contracts with car services in the past, but you typically needed an account with them which might require high volumes, you needed to call in advance on a landline, and these services were generally aimed at the higher end market.  Uber and the other firms disrupting this space realized that with smartphones, account setup is easy, you can order your ride while waiting on the street, and even see which cabs are available in your area. Customers can be notified of the cab that will pick you up.  This eliminates the need for large volume orders or human dispatchers and a ratings system brings greater transparency (also tackling the body odor issue).

On net, these are huge gains. I am glad that I don’t need to pay off someone’s million dollar medallion investment with my cab fare. I have no pity for taxi owners who decided to fund their retirement on the re-sale of their medallion and now find that their licenses are decreasing in value as the taxi cartel gets disrupted. I have no pity on city agencies that are able to extract fewer rents, on dispatchers who collect fewer bribes, or taxi companies that may need to invest in their fleet, lower the lease rates, and compete (potentially) with everyone that has a modern car to provide transportation services to the public. Let them compete!

And it seems to me that all these complaints — about lack of insurance, background checks, and surge pricing are basically a smokescreen. In my experience Uber drivers are just as competent as cabbies, and for the most part are current or former cabbies. Uber vehicles are modern, clean, and well-maintained. Uber fares are generally 40% cheaper than taxi fares. Uber added insurance and background checks and the taxi cartels responded with other things to complain about. The fundamental disagreement — really the only disagreement — was whether the economic rent extraction by existing gate-keepers would continue.

Of the various complaints, surge pricing seemed to have legs as an Uber criticism. It is hated by many. But try to hail a cab on a Friday night, and see how long you have to wait! With Uber, if you prefer to wait, you can decline the surge pricing and be sent an SMS notification when the surge ends. This is the best of both worlds, because the surge pricing will clear the backlog sooner even if you never pay the surge price. The taxi cartels, on the other hand, only give you the option of waiting. And of course since the number of medallions is fixed, there is an upper bound on the number of taxis that can be supplied in busy periods. With Uber, if you can convert your regular car into a taxi, then the number of possible taxis increases.

Here, it seemed to me, was a cynical ploy to use the public’s emotional reaction against variable pricing to try to keep the rotten taxi pyramid going a bit longer.

But as I was enjoying my Uber Eden, I began to have some doubts. Why do people hate surge pricing? Yes, there are some welfare concerns for poorer users who would rather wait, but Uber allows you to wait. Fundamentally the issue is one of equity, not distribution. And why is equity so important? Why do people really hate being contingently charged a higher price, even if they are offered a price that they are willing to pay? What if Uber, which can easily collect lots of data about its users, decides that person A can afford to pay a higher price, and sends the surge pricing notification only to them? This is the consumer horror story and retailer’s dream, promised by Big Data and realtime dynamic pricing. How do you know, when looking at airline fares, that some algorithm isn’t using data collected about your income and purchasing habits to charge you the maximum possible price, when displaying the fare available? How do you know that Amazon isn’t setting prices especially for you based on your past purchasing history, the zip code where you live, and information about your income/retirement status? I guarantee you that at least some of the above is happening as producers try to capture more of the consumer surplus for themselves by charging different prices to different online customers for the same good.  They would be foolish not to. It wouldn’t break any laws and would increase profitability.

To be clear, I don’t think Uber does this. They publish up-to-date fares and have a fare lookup calculator online. It works in private browsing mode, and you are not required to log in to use it. But it only estimates fares. I kinda sorta maybe trust Uber a little. Right now.

What is to stop them from doing this once they collect enough data and are confident in their algorithms? What is to stop them when there is a profit squeeze or the next round of earnings targets needs to be met? If they determine that a user has accepted surge pricing in the past, why not send another notification that a surge is present? If they notice that users going from point A to point B are generally higher income and less price-elastic, why wouldn’t they charge a higher fare for that route and a lower fare for other routes?  They have your name and address (at least as it appears on the credit card) and can obtain reams of personal data about you from various information warehouses, as well as their own data stockpile of past rides, times, locations, ratings, etc. The opportunities for price discrimination are endless.

This is true of any electronic marketplace. From Amazon to Ali-Baba to Uber, electronic marketplaces will be lowering consumer welfare with real-time, sophisticated price discrimination.

Surge pricing is just beginning.

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On Uber and other electronic market places

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