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Surge pricing: Is there fairness in profit-seeking?

10:04 14 July in Best practices in price monitoring
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Economists would say that demand dictates the price – it’s as simple as that. 

Apart from economists, the transportation industry has agreed with this statement for years. That’s how a surge pricing strategy kept fueling one debate since the 1950s. 

Is it foolish to expect fairness in the profit-seeking, or do some rules still need to be followed?

What is surge pricing?

The literal translation would be a price increase. Enough to make buyers shake their heads and sellers rub their hands.

The concept of surge pricing is nothing more than a dynamic pricing method used in periods of higher demand and limited supply. Therefore, surge pricing is used to bring the market back to equilibrium by setting higher prices which decrease the demand. 

It’s well-known that time is a very influential factor when it comes to defining prices. That’s why surge pricing is often referred to as time-based pricing. The price dynamic will depend on the time of the day and expected demand. For example, research shows that people tend to order more during working hours. Retailers are well aware of this, hence, the prices will be higher usually between 9 AM and 5 PM. In the evenings, however, the prices go back to their lower level. 

Another used tactic is related to weather conditions. If the weather is bad, transportation companies will usually go ahead with this strategy. In that case, you will pay more for the ride than you usually do because the demand is much higher.

Over the years, surge pricing has become one of the most prevalent pricing strategies in the transportation industry. But we said that the beginnings of this strategy date back to the 1950s. Believe it or not, the problem with demand in the transportation industry still existed back then.

Crowded public transportation even in the 1950s

And you thought you were born at the wrong time and that is going to work used to be much simpler! Well, some problems seem to be universal.

In the 1950s, the New York subway faced a problem familiar to everyone around the world. During the peak hours, it became overcrowded, while at all other times the transportation was almost completely empty. Trying to understand the problem, the mayor came to one conclusion – the flat fare of 10 cents needs to be revised. 

One of the economists who were in favor of this idea was William Vickrey. He suggested that it would be wise to adopt a structure where the ticket price would depend on the length, location, and time of the ride. In other words, peak hours would be more expensive. Thus, those were the very beginnings of surge pricing. 

Apparently a simple and smart idea, yet difficult to implement. 

Hiring more ticket clerks was out of the question – that would only increase the overall costs. An ideal solution would be to create an automated solution that could calculate different rates depending on the factors mentioned above. Of course, that was a very challenging demand at that time, so it wasn’t delivered. 

However, the idea was so important that William Vickrey won a Nobel Memorial Prize in 1996

The time will show that the automated solution was really a good idea which delivered its product years later. 

But we’ll soon come to that.

What companies get out of surge pricing?

The transportation industry might be the most obvious example, but in reality, many other companies are using this pricing method. 

Surge Pricing - Pros and Cons

Why is that the case?

Besides the most obvious reason – getting higher profits – surge pricing comes convenient when there is a need to control demand

High demand means that it’s difficult to ensure stable supply, so setting a higher price can help solve this issue. The customers will inevitably be divided into 2 groups: the ones that will proceed with their purchase, and the ones that will postpone it until the price drops. As you can see, this decision will be based on customers’ willingness to pay. 

It’s not expected that retailers change the prices so frequently as for example, Uber does, but surge pricing benefits them as well. They use this method when the supplies are low, or if there are problems with the distribution. 

If we need to point out one rule, then it would probably be that surge pricing works well when the supply is limited and when the products are not so elastic. If that’s not the case, using this pricing strategy wouldn’t be so recommendable. 

Pros and cons of surge pricing

The main benefit of surge pricing is that it helps your business to adjust prices according to the market trends. This enables you to gather more profit. It also helps with avoiding running out of stock. Over time, you get a better understanding of the market, and you’re able to anticipate periods of higher demand.  

What however arises as a logical dilemma is fairness to the customers. 

This challenge comes as the main disadvantage of surge pricing. It can usually harm your consumer’s price perception. If the prices are changed (increased) all the time, customers perceive it as a fraud. They feel cheated, which results in a loss of trust in the brand and lower customer loyalty. Thus, it’s obligatory that surge pricing is implemented only after extensive market research! You need to know both your customers and competitors very well in order to use this pricing strategy in a successful way. 

Should you implement surge pricing?

As we mentioned, those automated solutions that William Vickery was talking about were a great idea. However, the way they work today is a bit more sophisticated. 

Surge Pricing

They are called automated pricing solutions, or price monitoring tools, and can help you implement different pricing conditions. Those conditions can be, for example, based on time, supply, location, or your competitors. 

Therefore, whenever this tool spots that some of your conditions have been activated, you’ll get an automated email of that change. For instance, your main competitor changed its prices, ran out of stock, or started a promotional activity. All of these actions require a price reaction on your part as well. If, however, you’re not informed about it on time, you’ll miss out on the opportunity to stay competitive. 

So, should you implement a surge pricing strategy? 

If it’s suitable for your business, and if you’re using the right price monitoring tool, then yes, you can give it a try. Remember, the key is to know your customer base and react promptly to all market changes. Be careful not to make any abrupt changes, or changes that are not in alignment with the suggestions from the price monitoring tool. 

Conclusion

We started this article with a moral dilemma. Is it fair to benefit from a higher demand? 

Well, if we ask the companies, the ones that are good at this, will certainly say it is fair. On the other hand, it is safe to say that customers don’t agree as much. 

Whether we like it or not, the economic rules are clear. The price is fair if it is linked/caused by a specific condition, and it’s not fair if it’s linked to a specific person.

In conclusion, we can say that surge pricing comes beneficial when you want to take advantage of demand peaks. However, if you don’t pay close attention to your customers and competitors, it can easily become a double-edged sword.

What are your thoughts about this pricing method? Feel free to share your impressions in the comments. 

 

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