Uber, Ola can now charge twice the base fare: What surge, dynamic pricing means

What exactly is dynamic pricing, when do companies deploy the mechanism, and does it always prioritise drivers over customers? Is it the same as surge pricing? We explain.

Dynamic pricing is a response to customer demand.

Dynamic pricing entails increasing prices when the demand for a product or service is high, and lowering them during periods of low demand.

Companies resort to dynamic pricing models to benefit from the variations in the supply and demand of a product or service. This is, quite simply, market economics at work.

Dynamic pricing follows the economic theory of demand, which states that the price of a product will increase when its demand increases in relation to its supply. This can happen due to a variety of factors. For example, in the case of cabs, rain can reduce the availability or the supply of cabs.

The mechanism is widely used across several industries, including entertainment, utilities and hospitality. Amazon, for instance, has the dedicated ‘Automate Pricing’ tool, which allows sellers to set rules and parameters describing when and how prices may fluctuate for a range of products.

However, the practice has also come under criticism. Last September, fans of the rock band Oasis held the ticketing platform Ticketmaster responsible for inflating concert ticket prices on checkout through dynamic pricing when the band announced its reunion tour in the UK. British Prime Minister Keir Starmer had termed the price hike “depressing”.

The Indian Railways first experimented with dynamic pricing in 2006. The then-Railways Minister Lalu Prasad proposed a dynamic pricing scheme for both freight and passenger trains, impacting peak and non-peak seasons, as well as premium and non-premium services.

In 2016, it was formally adopted with the Railways adopting the ‘flexi-fare’ scheme. Under the scheme, the base fares of Rajdhani, Duronto and Shatabdi trains would increase by 10% with every 10% of berths sold, capping at 1.5 times the original fare.

Surge pricing is only one part of the dynamic pricing mechanism.

While the terms “dynamic pricing” and “surge pricing” are used interchangeably, surge pricing is simply one dynamic pricing strategy. It refers to the additional fee demanded from the consumer during periods of high demand, such as rush hours, when traffic congestion is at its peak. Such fees are also applied to utilities, like electricity, and are used to help manage the supply and demand, preventing potential blackouts.

In the case of ride-sharing aggregators, the premise is simple: Rush hours correspond with periods of increased demand for rides from the likes of Uber, Ola and Rapido. With a larger proportion of users in an area demanding the cab service compared to the number of drivers available there, ride prices in the area surge.

This presents the consumer with two choices — booking the ride at the higher price, or waiting for prices to reduce. The surge pricing also helps attract more drivers to an area to benefit from the increased prices, which ultimately helps reduce and normalise fares.

According to the Uber website, its drivers are made aware of the surge price through a multiplier to the standard rate, an additional surge amount, or an upfront fare including the surge amount, which incentivises them to accept rides. The surge pricing can vary within the areas of a city. The Uber Driver app indicates the area-wise demand spikes through a colour-coded scheme. “Light orange areas represent smaller earning opportunities from surge, while dark red areas indicate larger ones,” according to the website.

In 2016, Wharton Business School researchers Gerard P Cachon, Kaitlin M Daniels and Ruben Lobel argued that the surge pricing model, while critiqued, did benefit Uber consumers by helping subsidise prices during off-peak times.

Their research compared the surge pricing model to a benchmark fixed price and found that it also allowed Uber to serve markets that would otherwise remain underserved under a fixed pricing model, such as consumers hailing a cab on a rainy night. They also noted that Uber allows drivers to “self-schedule”, or decide their operating schedule, allowing them to gravitate towards areas facing a driver shortage when surge prices are effective. (Cachon, Daniels, Lobel, ‘The Role of Surge Pricing on a Service Platform with Self-Scheduling Capacity’, SSRN, 2016)