Megan McArdle: The price is right, or Uber will raise it

Even in the absence of price-gouging laws, some businesses try to avoid raising prices under extreme conditions. Uber, however, just called it 'surge pricing' and let prices rise with demand

One can’t help but admire Uber’s willingness to follow the basic logic of economics any place it happens to lead. Even to price gouging. Soaring prices after a natural disaster or during extreme weather are simply, economists would say, the market’s response to changing supply and demand, as disruptions make it harder to get some things just as demand spikes (for instance, for generators, gasoline, bottled water, first aid supplies). The price increase helps cut down on marginal uses (taking a bath with your bottled water), while drawing new supply in from unaffected regions, because people there now have a strong incentive to load up supplies and go sell them in the affected area — quickly. The market is working. But the optics are terrible. Humans intuitively see price gougers as bad agents, exploiting the suffering of others. So even in the absence of price-gouging laws, businesses try to avoid raising prices under extreme conditions. Whatever they could gain in immediate revenue, they would lose more in future sales as disgusted customers walk away.

That’s most businesses. Uber, however, just called it “surge pricing” and let prices rise with demand. There has been some transitory squawking, but by and large customers have accepted it. Increasingly, the company is following similar logic on the compensation side — that is, rather than setting a commission and leaving it there, Uber seems to be spending a lot of time playing around with the compensation structure, most recently by testing a programme which gives the company a higher cut of the fares, especially from folks who don’t drive that much. Obviously, there are some advantages: The latest structure encourages people to drive full-time rather than part-time, and Uber will make more money off of its part-time drivers than it used to. But there’s a reason most companies don’t do much of this, with either wages or prices.

I know, I know: It can seem like companies spend all their time trying to chisel every last dime out of their suppliers and staff. But the surprise in the economic literature is how little they do this, even when they could get away with much more. One reason for that is that the chiselling tends to create some unhappy side effects.

After all, Uber is not exactly the first company to discover that they might be able to make more money by a) shifting the terms of their contracts more often to b) test more lucrative and complicated compensation schemes that c) try to channel behaviour in ways more in line with the company’s goals. Ask any sales rep who’s been in the business for a while, and they can regale you with all the crazy new compensation schemes they’ve lived through, often expensively constructed with the help of outside consultants. And yet, frequently, these efforts end up abandoned. Why?

Because it’s often counterproductive; what you gain in revenue, you lose in morale. A front-line employee or contractor is the public face of your firm. If they think that no matter what they do, you’ll keep altering the payment system in order to shake every last penny out of their pockets, they’ll get surly or quit. Managers will waste a lot of energy having fights about the compensation system. So many companies fall back to something that’s reasonably straightforward and predictable.

Of course, this doesn’t apply as strongly to part-time and contract workers, like Uber drivers; companies are much more willing there to cut pay, or encourage turnover so that they can pay workers less. However, it’s a dangerous strategy for any company whose workers are close to the customers. One disgruntled contractor can do a lot of damage before you figure out what’s happening. And since Uber needs its contractors to invest in and maintain a late-model car, the company probably needs to provide some up-front assurance that the investment in the car will not become an albatross.

The risks of frequent revisions will become a bigger problem as Uber matures. Right now, Uber gets a fair amount of leeway from both customers and drivers because, after all, you don’t have to deal with the company if you don’t want to. They’re not foreclosing the other options you already had, just opening up new ones. Dealing with Uber is, in other words, a form of what Mike Munger has dubbed euvoluntary exchange, which is a fancy Greek way of saying truly voluntary trade.

If I were a contract driver and I didn’t want to drive for Uber, I could drive for Lyft, or apply for a taxi licence, or decide to do something else entirely. As a rider, if I don’t want to pay Uber’s surge pricing, I can resort to whatever I would have done a few years ago, when there was no Uber. So even if I don’t particularly like the deal they offer, it doesn’t feel coercive.

On the other hand, if the company succeeds in pushing taxis and other potential employers out of business, then the deals Uber offers will feel less and less voluntary — which means that the company will get more and more pushback.

But that’s the future risk. There may be a problem already. To gain the sort of competitive advantage it’s seeking, Uber needs to build and maintain a high-quality network of drivers. Frequent shifts in the approach to compensation are going to make that harder. On the other hand, Uber has pretty consistently overcome the obstacles I’ve seen, from regulatory interference to the stigma of price gouging. Maybe the company really does have what it takes to overcome our euvoluntary instincts. Maybe we’ll all start to think like economists.

The writer is a Bloomberg View columnist