Uber’s surge pric­ing ap­plied to smooth­ies

The Pak Banker - - OPINION - Mo­hamed A. El-Erian

HOW could this be: A "healthy ca­sual" restau­rant that de­mands a 35 per­cent sur­charge if cus­tomers want just one kind of fruit in their smoothie, rather than a com­bi­na­tion? At first, I thought I had read the menu item wrong. Surely, the ex­tra $2 was ap­plied if a cus­tomer asked for an ad­di­tional va­ri­ety of fruit. But no. When I checked the menu again, the restau­rant re­ally was ask­ing cus­tomers who opted for no fruit di­ver­sity to pay more. I asked some friends to help me fig­ure this out. They couldn't. So when I went back to the restau­rant, I asked sev­eral em­ploy­ees. Two ex­pressed sur­prise; two oth­ers sug­gested that I had mis­read the menu; and one pro­vided me with the ex­pla­na­tion. It makes sense (though it may not be the best out­come for all). It turns out that this seem­ingly coun­ter­in­tu­itive pric­ing ap­proach is an at­tempt by the restau­rant to man­age the de­mand for its fruits. Specif­i­cally, man­age­ment is wor­ried that cer­tain cus­tomers may "over-or­der" a par­tic­u­lar va­ri­ety (mango was cited as an ex­am­ple), thus de­plet­ing the sup­ply and lim­it­ing the abil­ity of other cus­tomers to get their de­sired mix. But the restau­rant doesn't want to out­law the one-fruit smoothie al­to­gether -- thus the hefty 35 per­cent sur­charge.

I sus­pect this ap­proach will dumb­found many cus­tomers, but it has some an­a­lyt­i­cal merit. In fact, free mar­ket econ­o­mists would ap­plaud the restau­rant's at­tempt to use the pric­ing mech­a­nism as a way to meet busi­ness ob­jec­tives: Rather than im­pose a quan­ti­ta­tive limit or risk pre­ma­turely run­ning out of prod­uct and dis­ap­point­ing cus­tomers, the restau­rant is seek­ing -- pre-emp­tively -- to bal­ance sup­ply and de­mand through dif­fer­en­ti­ated pric­ing.

Yet, this par­tic­u­lar use of dif­fer­en­tial pric­ing may not be the best op­tion avail­able here. First, I sus­pect that a $2 sur­charge is rather ar­bi­trary, backed by lit­tle im­pact anal­y­sis. This spec­i­fi­ca­tion could un­nec­es­sar­ily dis­tort choices that could be more con­sis­tent in bal­anc­ing cus­tomers' pref­er­ences with the restau­rant's in­ven­tory man­age­ment. Se­cond, it is not clear that the costs of dis­cour­ag­ing a few cus­tomers from order­ing sin­gle-fruit smooth­ies are worth­while, par­tic­u­larly since the ma­jor­ity won't ex­pe­ri­ence a short­age of any par­tic­u­lar fruit. Third, the pol­icy is re­ally hard to ex­plain -- so much so that many of the restau­rant's em­ploy­ees ap­peared per­plexed. Ideally, the restau­rant would be able to ap­ply a more dy­namic ver­sion of dif­fer­en­tial pric­ing -- chang­ing the sur­charge in line with ac­tual de­mand, rather than set­ting an ar­bi­trary one based on crude es­ti­mates of changes in fruit in­ven­tory, if any.

This, of course, is what Uber does with its vari­able-pric­ing ap­proach, in­clud­ing "surge pric­ing." By rais­ing prices as de­mand in­creases, Uber is able not only to in­flu­ence de­mand in line with sup­ply, in­clud­ing by en­cour­ag­ing rid­ers to share cars; it also can en­cour­age more driv­ers to take to the road, thus in­creas­ing sup­ply. Cer­tainly, this prac­tice is not with­out crit­ics. It re­quires lots of changes in the pric­ing menu that can ir­ri­tate and con­fuse cer­tain clients. And it can lead to ex­cesses un­der cer­tain cir­cum­stances, as il­lus­trated by the out­rage over Tur­ing Phar­ma­ceu­ti­cals' de­ci­sion to in­crease the price of its drug Dara­prim by 5,000 per­cent to ex­ploit very in­elas­tic de­mand. Yet when dif­fer­en­tial pric­ing is used smartly and de­cently, and when the prac­tice is ex­plained proac­tively and trans­par­ently, it is in fact the ap­proach that best meets many (oth­er­wise-com­pet­ing) ob­jec­tives. And, I sus­pect, it is an ap­proach that may work par­tic­u­larly well in many leisure ac­tiv­i­ties and that prob­a­bly will spread

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