Part of the beauty of Uber is that the payment process is all automated. Once your ride is complete, the firm bills the credit card they have on file, minimizing the time it takes to wrap up your trip; there is no fussing over payments and tips with the driver. But how should the driver be paying Uber? The driver after all is dependent on Uber to match them with riders. Currently, the drivers pay (effectively) by sharing their fares with the company. However, the Economist argues that such an arrangement is inefficient (Pricing the surge, Mar 29).
There is some evidence Uber’s surge pricing is improving taxi markets. The firm says drivers are sensitive to price, so that the temptation to earn more is getting more Uber drivers onto the roads at antisocial hours. In San Francisco the number of private cars for hire has shot up, Uber says. This suggests surge pricing has encouraged the number of taxis to vary with demand, with the market getting bigger during peak hours.
However, the inflexibility of Uber’s matchmaking fee, a fixed 20% of the fare, means that it may fail to optimise the matching of demand and supply. In quiet times, when fares are low, it may work well. Suppose it links lots of potential passengers willing to pay $20 for a journey with drivers happy to travel for $15. A 20% ($4) fee leaves both sides content. But now imagine a Friday night, with punters willing to pay $100 for a ride, and drivers happy to take $90: there should be scope for a deal, but Uber’s $20 fee means such journeys won’t happen.
Despite the revenues a matchmaking fee generates, it may not be Uber’s best strategy. A fixed membership charge is often firms’ best option in two-sided markets. By charging drivers a flat monthly fee Uber would generate revenue without creating a price wedge that gets in the way of matches. Since stumping up cash might put infrequent divers off, they could be offered a cheaper category of membership. Uber should keep its surge pricing in place. But to make the market as big as possible, and really revolutionise taxi travel, it might need to retune its fees.
At some level, it is hard to fault this argument. As the example demonstrates, there is the possibility that Uber’s vigorish could keep efficient deals from happening. However, there are other considerations that may keep a fixed fee from working well. For example, appropriately screening drivers who work different amounts of hours may require more than two categories of memberships. But even with two categories it is not clear how this gets operationalized. Do drivers in the cheaper tier get bounced from the system once they hit some preset number of hours? That seems necessary if there is going to be a real reason to buy a full membership (alternatively, one could keep lower tier drivers from taking full advantage of surge pricing but that is going to exacerbate the problem this structure is supposed to solve). But it is not clear to me that a hard cap is going to be easy to enforce. When push comes to shove, Uber wants users served quickly. If the only way to get the necessary capacity is to call on a driver who has exhausted their monthly hours, it’s going to be hard to say “no” to that. Of course, once you say “yes”, the whole thing starts to unravel and no one wants to pony up for an upper tier membership.
Another consideration is risk sharing. In the current arrangement, both drivers and Uber are subject to variations in market demand. If drivers pay upfront and then keep all of their fares, Uber’s revenue is fixed but drivers face more risk. Thus what Uber could extract from them would be less than the average amount the drivers are currently turning over to Uber (assuming the drivers are risk averse).
A final consideration. Under the current arrangement, Uber makes more money as the system grows. This is true even if the growth in the number of drivers does not keep up with the growth in the number of riders. Further, since there are economies of scale in service systems like this, the number of drivers can grow more slowly than the number of riders while still maintaining a good service level. If the number of Uber users increases by 10%, the number of drivers needed to keep up the service level should go up by less than 10%. Uber can take advantage of that under the current system. If Uber charged a fixed fee to access its market, it would have to keep upping its fee as the number of riders increased or keep adding drivers to get its share of the pie.