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Does your company have a behavioral economist? Uber does, and what I learned about dynamic pricing is fascinating.
Keith Chen is Uber’s Head of Economic Research. He digs deep into the heads of Uber customers using the data behind the wildly successful business. Chen was recently a guest on NPR’s Hidden Brain with Shankar Vedantam.
Chen is one of the people who help determine Uber’s strategic prices known as dynamic pricing. Prices are increased when there is more demand for drivers. This is known as “surge pricing” and customers hate it. What a single fare might cost you now could cost much more in five minutes. Chen explains how it works - and it makes sense.
“The only way to get everyone in a dense part of a city a car within five minutes is to use dynamic pricing to give drivers a strong incentive,” he explains. When the fare prices increase, drivers earn more money on each fare.
Have you ever been stuck trying to find a taxi on a rainy night? There never seems to be any around. The reason for this is cab drivers have a financial goal to reach each shift. When it is raining, demand increases and they reach their goal faster. In most cases they end their shifts early after they reach their goal, this is known as mental accounting. When cabbies call it a night, there are less cabs are on the road.
Uber drivers don’t necessarily go home. They get incentives by surge pricing. If prices are surging, they will earn more money. Drivers plan longer shifts when prices are surging to reap the financial rewards. Not all customers will use Uber when prices have increased, so this helps to reduce demand.
The Round Number Effect
Increasing a price from 1X to 1.2X will see a 27% drop in requests. There is also a strong round number effect. When Uber increases their prices from 1.9X to 2.0X the regular fee, there is a 6X larger drop in demand than an increase from 1.8X to 1.9X. Customers feel 2X is too much. Surprisingly, more people will take a ride at 2.1X than 2.0X the regular price.
Uber can detect interesting patterns from their customers. One of the strongest predictors of whether a customer will accept surged pricing is the level of their battery life. If your phone is nearly dead, you are more likely to use the surged price, rather than wait for the price to lower later after your phone has died. Chen assured listeners that Uber do not use this data. He only shared this fact as an example of the type of information Uber has learned about their customers.
So while surge pricing may tick off passengers, they should consider they would not need to wait in the rain for long.
This article originally appeared in The Tennessean Newspaper.