Each time Uber angers customers with another surge pricing incident, or angers a city by ignoring its laws, an army of fans jump to its defense and cry “free market.” This is followed by a litany of complaints about stupid consumers or old fart city leaders, along with an easy, breezy explanation of supply and demand. The New York Times recently went so far as to run a headline about the ride-for-hire firm that declared, “Uber improves life, economists agree.”
Uber is making a lot of people into amateur economists, including, it seems, many professional economists. It’s a trap many have fallen into before: thinking a free-for-all market is a free market. I’m going to call that Ubernomics.
Before I go on, let me get this out of the way: I like the concept of Uber and Lyft, the ride-hailing company notable for its large, pink mustaches. I use them. Uber has clearly demonstrated a better way to move people around. Cheers to you, aggressive ride-hailing firms.
But a hard-headed economic analysis of Uber suggests that the ride-for-hire firm is driving itself, its passengers, and perhaps America’s public transit systems, toward a dangerous disaster. It can, and should, be saved, but that won’t happen until folks stop defending the firm’s bad behavior with ill-considered assertions about the “free” market and Silicon Valley “disruption.”I, too, am an amateur economist, so I went to a real one for insights on Uber’s pricing strategy. His name is Dr. Joe Sulmona, a transportation strategist and economist based in Vancouver, British Columbia. He’s helped plan major transportation systems around the globe, He likes Uber, too. But he’s very worried that it has begun a race to the bottom that no one can win, and no one is talking about.
I asked Uber if it wanted to talk about the race but did not get a response. I’ll happily update this story if the firm, or a competitor, would like to respond.
The trouble begins not because Uber prices are too high for New Year’s Eve drinkers (though that’s a problem, too), but because Uber’s prices are too low.
Problem No. 1 — Destructive Competition
Uber is a raging success right now for one simple, oft-ignored reason: People hate taxis and deservedly so. They can be scammy. They are inefficient. They are rude. They often smell. They are expensive. They deserve a kick in the ass. They are ripe for creative destruction, mainly because consumers will do almost anything to find an alternative.
I’d call this the Netflix effect, which I explored in great detail in my book “The Plateau Effect.” It was a really dumb idea to snail-mail millions of movies to people right as high-speed Internet access was slithering its way toward people’s homes. But Americans hated Blockbuster and its insane late fees so much that they put up with the decidedly low-tech solution. Netflix users weren’t signing up for a service as much as they were joining the resistance. This happens to a lot of industries that get fat, old and lazy. Uber, and it users, are gleefully escaping the bonds of a deeply flawed industry.
So far, so good. Thanks, Uber, for scaring taxi drivers. But outside of some very marginal gains in deployment of available car resources, don’t fall for the theory that Uber has created a new product with great value or invented game-changing efficiency improvements. The costs – largely gas – are still the costs. Its “product,” an app, is easily copied.
Why is this important? There are only two ways to make money: 1) Invent something new that creates value out of thin air, or 2) Suck money out of some existing value chain. Uber is much more the latter than the former. That means its fate is sealed. It has begun a cycle of destructive, and fatal, competition. It doesn’t end well.Uber’s ethos is to turn virtually anyone with a car into a potential part-time income earner. No fussy taxi medallions to purchase, no rules to hold back innovation. Sounds great! But that means there is virtually no barrier to entry in the car-for-hire business. It means the price will ultimately sink lower and lower and lower, until it approaches the price of gas itself. And what happens then? The same thing that happens in every industry that has ever suffered the same fate. Car-for-hire companies operating without rules will continually undercut each other until two terrible things happen:
“Destructive competition drives prices so low, at some point it comes apart because people can’t make a living at it,” Sulmona warns. “Cars fall apart. You are into safety issues.” In other words:
1) Some drivers who begin to lose money will quit or disappear, making the service unreliable.
2) Others, in order to survive on thinner and thinner margins, will take excessive risks, like driving too many hours, driving without insurance, or cutting maintenance corners.
As if on cue, the day after I spoke to Sulmona, Uber announced price drops in 48 cities where it has a small presence to drum up business.
“Why not drop the fares by 95 percent, then we could all expect about 50 rides per hour?” wrote one concerned driver, the New York Times noted.
If you want to see what happens when there’s a race to the bottom in something that involves critical safety issues, do a little reading on the Chinatown bus wars between New York, Washington and Boston. Fares between these cities fell as low as $10 a trip.
But you really don’t want someone driving 50 souls valued at only $500 on a five-hour bus ride. Bad things inevitably happen. Like this: In September, a bus traveling between D.C. and New York operated by a firm that had been cited for 18 violations in the past 24 months had a horrific, deadly crash.
This is why cities have rules. Rules don’t just hassle business owners, they create a barrier to entry that improves safety and has the effect of setting a price floor. Of course, rules don’t always work well. But the only thing worse than regulation is no regulation. You don’t want people opening restaurants that don’t have to pass health inspections. You don’t want truck drivers hauling goods for 20 straight hours. And you don’t want Uber breaking down all rules to selling rides.
Problem No. 2 — Uber is like Enron, and “perishable” markets
Dynamic pricing sounds like the Holy Grail for free marketeers. The price of goods rises and falls instantly based on supply and demand. Not enough cars? Raise prices and attract more cars! Then prices go back down again. Everybody wins! At least, that’s true in a perfect world, and it’s kind of true in the commodities markets, where prices, supply and demand can all adjust in milliseconds.
Here in the real world, all sorts of things prevent dynamic pricing from functioning as it seems it might. It’s not easy to get 20 drivers out of bed to flood a car-starved neighborhood in two minutes or less. What does that mean? Everybody still has to guess. Drivers still have to guess where the demand will be; riders have to guess when and where cars will be. Journalists make charts with guesses about when cars will be expensive on New Year’s. That doesn’t sound like free market Shangri-la, does it?
But for fun, let’s assume these logistics weren’t the massive problem they are, that Uber’s surge tactic is a magic potion that erases all market friction. The most serious problem with surge pricing still remains: it’s called market power. When Enron rampaged through America’s energy markets, it turned spectacular profits in part because it realized that the best way to make money was to artificially decrease supply and raise prices. Even slight constrictions on supply can lead to large spikes in prices. And it makes sense: If you’re freezing cold in winter, and there’s just not quite enough gas to go around, you’ll pay just about anything to beat out other bidders for the last bit of it. Sound familiar? Even in situations where there’s “competition,” as in the energy markets, suppliers are very good at signaling to each other and artificially decreasing supply/increasing demand. It’s just too easy to raise prices this way. That’s why energy auctions are so heavily regulated (and probably not regulated enough).
And that’s why, even with some competition in Uber-land, it will be very easy to raise prices during times of even moderate demand. In fact, drivers themselves could collude to create surge pricing in certain areas simply by making side agreements to stay out of one anothers’ way.
But why would Uber do this? Back to point No. 1: Uber is in a destructive race to the bottom, and its drivers are severely underpaid, but for the promise of surge pricing. It’s in everyone’s interest here (except the consumer) to ramp up surge revenues as soon as possible. In fact, it’s essential to Uber’s survival. Just ask the Uber drivers in Seattle who quit after yet another price decrease last year.
Dynamic pricing is far easier to manipulate than amateur economists realize. Far from being market Utopia, it’s almost certainly going to become market hell, unless serious safeguards are enacted. We should have a hint already. Name another good or service with a price that can fluctuate 500 percent, or even 1,000 percent, during a single evening? Price controls are obviously terrible for an economy; but so is the death of the price tag, one of my favorite topics. When people don’t have any idea what things will cost, when prices don’t exhibit some reasonable degree of predictability, there is no free market. Free markets require perfect information on all sides of a transaction. Here, Uber feels a lot more like a Third World economy with inflation so fast that this morning’s taxi fare dollars can’t pay for the evening’s taxi ride home.
But wait, how can I complain about too-low pricing and too-high pricing at the same time? Well, because that’s what economic theory predicts.
“The theory in perishable markets (where there are time-limited goods, like car ride seats) says early predatory pricing will eventually lead to market concentration,” Sulmona said. And of course, those with the deepest pockets can ride out the predatory pricing phase.That’s not to say there isn’t logic to raising prices during times of great demand, sure there is. That’s the future of our roadways, implemented with tools such as HOT lanes and a reasonable energy plan. The problem is the black box. With pricing a practical mystery, abuses are certain to occur. You could say you trust Uber not to do these kinds of things, but given the firm’s explicit rejection of local and state laws — and some would say, decency — that trust would seem ill-placed. But even if you trust Uber, do you trust its competitors?
Predictable “surge” pricing, on the other hand, creates some interesting opportunities. Say Uber announces that all rides from 11 p.m. to 2 a.m. on New Year’s cost triple. That would be an interesting start. So would prepurchase of a round-trip fare. These things would also solve the next problem I want to describe.
Problem No. 3 – Unreliability and drunken driving
You might not care if drunks are price gouged on weekends when trying to get home after a night of partying, but Sulmona says you should. Because you will end up paying for the messes they make.
You go out on a Friday night and spent $20 with Uber to get to a bar. You plan to come home with Uber at 1 a.m., and the cost will be $20 or $50 or $110. You don’t know. That’s nuts. Imagine if you set out on a family road trip this summer, and when you start gas costs $2.50 a gallon, but when you are 1,000 miles from home, gas costs $12 a gallon. The drive out costs you $100, and the drive back will cost, heck, who knows? That’s Uber. That’s unreliable.
What if you need to get to the airport, and suddenly the trip costs $150 instead of $35? That’s unreliable. Transportation is critical to a society, but a transportation agent only helps move a society when it’s reliable. If traveling creates unpredictable risks that could triple or quadruple the price, then many rational actors will choose not to travel.
Rational Uber drivers, meanwhile, won’t be able to help themselves from playing a “wait for the surge” game. Wouldn’t you sit on the sidelines waiting for your pay to double or triple? Of course you would. Especially if you save money by not driving at the normal, depressed rates, which barely cover your gas. There are anecdotal reports of Uber drivers canceling rides when they realize surge pricing has just begun, so they can get the higher rate. Of course they are.
Unreliability has other consequences, too. Sulmona once helped British Columbia design its anti-drunken-driving program, and he approached it with a simple notion: Don’t expect people to make good choices at 1 a.m. The choice to drive drunk or to stay safe is made back at 9 p.m., when the partier sets out for the evening. If transportation is reliable, people will make better choices. If folks go out and don’t know how they can get home, or what it might cost, they are more likely to choose to drive.
Problem No. 4 – Stranger pricing
Transportation is not precisely a utility, like energy or water, but it has some elements of a utility. We all have an interest in making sure folks have reliable, predictable transportation to and from their evening fun. But it’s not just partiers, of course. What about the elderly, or the handicapped? Folks who suffer car accidents or layoffs and are without cars for a while? Do we really want them to effectively negotiate a new price each time? Do you want to do that?Remember, anything goes with dynamic pricing. As we’ve seen in the airline industry, and in some cases, e-shopping, dynamic pricing can be used to punish loyal customers. People can and are charged more for products when companies discover they are buying on auto-pilot. When will Uber start charging you more than the person on the street next to you because it knows you? Or, they charge you more because you are elderly and unlikely to notice? Or, using traditional economics terms, they ask more because you are a tourist and not a local? Forget surge pricing; Sulmona worries about “stranger pricing.”
“Now tourists don’t have to be driven through Staten Island to get ripped off,” Sulmona says. “You don’t have to do surge pricing, just stranger pricing.”
Think about all Uber knows about you. Reportedly, the firm can even decipher who’s making late-night booty runs. Why wouldn’t it create dynamic pricing that maximizes revenue at every turn? Again, perhaps you trust Uber not to do this. I don’t know why you would. I know, Uber riders have a chance to see the price before they book the car, through Uber’s (very helpful) fare estimate tool. Don’t forget, it’s still an estimate. But don’t believe riders at airports or in cities late at night are in fair bargaining positions to provide the necessary counter-leverage to prevent dynamic pricing abuses. Dynamic pricing is information warfare, and consumers are fighting supercomputers with an abacus.
Problem No. 5 — Common carrier
Charging an elderly person more because they are elderly is illegal. As would be charging an African American more. Not that these things don’t happen now in the taxi world. (Remember, no one is defending taxis here). It’s just that systematic redlining in an Uber-like world becomes very easy.
How easy? An Uber driver I spoke to recently said he has to drive twice as many hours in Washington, D.C., to make the money he made driving a yellow cab, but he does so gladly because of the quality of the clients.
“It’s much less dangerous,” he told me.
While D.C. cab drivers are not known for their honesty or their accurate math skills, I take him at his word that he makes less, but feels safer, driving for Uber. I sympathize. But picking up only clients with smartphones is already a form of class warfare, and it might run afoul of common carrier laws. I know, Uber denies it’s a common carrier, but that’s kind of like denying English. It carries people around. And it cannot make discriminatory decisions, such as refusing to pick up certain kinds of people or charging people more based on this or that personal characteristic. It already does that, implicitly. As Uber becomes more ubiquitous, it will be even more essential that it accepts the role of common carrier. Those problems are easy to predict.
Problem 6 – The end of mass transit as we know it
Could Uber drag down mass transit with it? On this last point Sulmona offers another Ubernomics disaster that I hadn’t considered. It’s one thing to refuse to serve certain people in certain places. It’s another to cherry-pick only the best fares for transporting large groups.
Imagine if an Uber-like ride-hailing firm started hiring drivers with vans who could sprint up and down only the busiest streets in America’s cities, charging half-priced fares and offering nicer seats. It would be illegal in most places, but that hasn’t stopped Uber before.
But why would Uber do that? How could that be profitable?
Transit systems operate on an equation that is terrible for businesses, but (theoretically) good for society. The busy bus lines are profitable and subsidize the nearly-empty bus lines and late-night routes that exist because the transit system sees value in reliability and in extending transportation to less-populated parts of the city. If Uber or an Uber-like bus appeared, it could operate at a much lower cost, cherry-pick only profitable routes and destroy revenue for public transit.
Would Uber really do this? If attracting bus riders was the only way to expand the service, of course it would.
If Uber were a niche, but it’s not
You might be reading these concerns thinking they are flawed, or at least premature, because Uber is still a niche product offering little more than an additional option to passengers with extra money and someplace to go. Were that true, most of these predictions about the flaws in Ubernomics would fall apart. The high incidence of taxi strikes around the country, and around the world, should divest you of that notion. So should the $40 billion valuation of the company. To justify that, Uber has to be a world beater. And the only thing worse than Uber succeeding at that goal is Uber failing, and burning down the taxi business, and other modes of transportation, along the way
But it doesn’t have to be this way. I’ve described a bunch of market failures that are either predictable or already here. The best thing to do with a market failure is to intervene and clean it up before it causes a disaster. You inspect the planes before, not after, the plane crash.
“You need to get back to the reason that regulations were created in the first place,” Sulmona says.
Yes, it’s undeniable that cities can sound silly as they try to make sense out of Uber. Seattle proposed coping with the threat by passing seemingly arbitrary rules such as limiting the service to only 100 cars at a time. It’s hard to set good rules on new markets. That sure doesn’t mean throwing all rules out, however.
“The old transportation for hire rules have to change. To me that is pretty clear. … Credit Uber for showing the better way,” Sulmona says. “But we’ve really got to be careful. If we don’t have smarter regulation, we’re going to discover the need for smarter regulation, because the market will fail … just to throw away the economic regulations with the dear hope that the invisible hand of the market will just sort all this out is nonsense.”
More from Bob Sullivan:
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