Incredible stupidity in taxi marketplaces

So it’s nearly a week since Uber and Ola drivers in Bangalore went on strike, and there’s no sign of it (the strike) ending. The longer the strike goes on for, the more incredibly stupid all parties involve look.

The blame for the strike should first fall on Uber and Ola, who in some hare-brained madness, forgot that running a platform means that both sides of the market are customers and need to be taken care of. They took good care of passengers, providing discounts and growing their market, but rather quickly pulled the plug on drivers, and there is no surprise that drivers are a rather pissed off lot.

The root cause of driver dissatisfaction has been falling bonus payments, and consequently, incomes. This is a result of Uber and Ola providing too great a subsidy during the time they built up the market.

I don’t fault them for providing those bonuses – when you are building a two-sided market, you need to subsidise one side to solve the chicken-and-egg problem. Where I have the problem is with the extent of bonuses, which gave drivers an income far in excess of what they could make in steady state. This meant that as the market approached steady state and incentives were withdrawn, once side of the market started getting pissed off, undermining the market (Disclosure: I’d once proposed to Ola that they hire me to help them with pricing and incentive structuring. the conversation didn’t go too far).

With Uber and Ola having done their stupid things, the next round has gone to the drivers. In a misguided attempt that a long strike will help them get better deals from the platforms, they are prolonging the strike. They’ve even ransacked Uber’s offices, and gone to the government for help.

What they don’t realise is that having invested what they have in their cars to drive on these marketplaces, their success is inextricably tied to the success of the marketplaces. And the more the jeopardise the marketplaces, the less their incomes in future.

A long strike reduces market size on two counts – it gives people time to adjust to the absence of service and get adjusted to alternate arrangements, and it decreases the reliability of the marketplaces in the eyes of the passengers. Thus, the longer and more frequent the strikers by the drivers, the less that passengers will look to use these services in the future.

A strike can work when the striking employees are protected by some form of labour laws, and there is no way ahead for their employers apart from a negotiated settlement. In case of a marketplace, the platform has absolutely no obligation to the drivers, and Uber and Ola can simply do what Uber and Lyft did in Austin, TX – pack up and move on. And if they do that in Bangalore, the drivers with their shiny new cars will be significantly worse off than they were before the strike.

The other act of stupidity on the drivers’ part has been to involve the government, which, as expected, has responded in a nandelliDLi (“where do I keep mine?”) fashion. The recent ban on shared rides (UberPool/OlaShare) came after a regulator read the rulebook after the last strike by the drivers. Given the complex economics of platform markets, any further regulation can only hurt the drivers.

All in all, the drivers’ stupidity can be traced back to not understanding platform markets, and protesting the way protests used to be done in highly unionised industries. Drivers, whose main skill is in driving cars, cannot be faulted so much for not understanding platform markets. Uber and Ola, on the other hand, have no such excuse!

Who do you subsidise?

One basic rule of pricing is that it is impossible for all buyers to have the same consumer surplus (the difference between what a buyer values the item at and what he paid). This is because each buyer values the item differently, and is thus willing to pay a different price for it. People who value the item more end up having a higher consumer surplus than those who value it less (and are still able to afford it).

Dynamic pricing systems (such as what we commonly see for air travel and hotels) try to price such that such a surplus is the same for all consumers, and equal to zero, but they never reach this ideal. While the variation in consumer surplus under such systems is lower, it is impossible for it to come to zero for all, or even a reasonable share of, customers.

So what effectively happens is that customers with a lower consumer surplus end up subsidising those with a higher consumer surplus. If the former customers didn’t exist, for example, the clearing price would’ve been higher, resulting in a lower consumer surplus for those who currently have a higher consumer surplus.

Sometimes the high surplus customer and the low surplus customer need not be different people – it could be the same person at different times. When I’m pressed for time, for example, my willingness to pay for a taxi is really high, and I’m highly likely to gain a significant consumer surplus by taking a standard taxi or ride-hailing marketplace ride then. At a more leisurely time, travelling on a route with plenty of bus service, I’d be willing to pay less, resulting in a lower consumer surplus. It is important to note, however, that my low surplus journey resulted in a further subsidy to my higher surplus journey.

When it comes to markets with network effects (whether direct, such as telecommunications, or indirect, like any two-sided marketplace), this surplus transfer effect is further exacerbated – not only do low-surplus customers subsidise high-surplus customers by keeping clearing price low, but network effects mean that by becoming customers they also add direct value to the high surplus customers.

So when you are pleasantly surprised to find that Uber is priced low, the low price is partly because of other customers who are paying close to their willingness to pay for the service. When you pay an amount close to the value you place on the service, you are in turn subsidising another customer whose willingness to pay is much higher.

This transfer of consumer surplus can be seen as an instance of bundling, but from the seller’s side. Since a seller cannot discriminate effectively among customers (even with dynamic pricing algorithms such as Uber’s surge pricing), the high-surplus customers come bundled with the low-surplus customers. And from the seller’s perspective, this bundling is optimal (see this post by Chris Dixon on why bundling works, and invert it).

So the reason I thought up this post is that there has been some uncertainty about ride-hailing marketplaces in Bangalore recently. First, drivers went on strike alleging that they weren’t being paid fairly by the marketplaces. Then, a regulator decided to take the rulebook too literally and banned pooled rides. As i write this, a bunch of young women I know are having a party, and it’s likely that they’ll need these ride-hailing services for getting home.

Given late night transport options in Bangalore, and the fact that the city sleeps early, their willingness to pay for a safe ride home will be high. If markets work normally, they’re guaranteed a high consumer surplus. And this will be made possible by someone, somewhere else, who stretched their budget to be able to afford an Uber ride.

Think about it!

Cross-posted at RQ

More on focal points at reunions

On Friday, just before the IIMB reunion started, I had written about reunions being focal points that help a large number of alumni to coordinate and meet each other at a particular date and venue. What I’d not written about there was the problems that could potentially be caused with the said venue being large.

In this case, the venue was the IIMB campus itself. While all official events, meals and accommodation for outstation attendees had been arranged in a single building (called MDC), the fact that people would explore the campus through the event made the task of coordination rather difficult.

The whole point of a reunion is to meet other people who are attending the event, and so it is important that people are able to find one another easily. And when the venue is a large area without clear lines of sight, finding one another becomes a coordination game.

This is where, once again, Thomas Schelling’s concept of Focal Points comes in. The game is one of coordination – to land up at locations in the venue which maximise the chances of meeting other people. While our class WhatsApp group enabled communication, the fact that people wouldn’t be checking their phones that often during the reunion meant we could assume there was no communication. So when you arrived at the venue, you had to guess where to go to be able to meet people.

Schelling’s theory suggested that we look for the “natural, special or relevant” places, which would be guessed by a large number of people as the place where everyone else would coordinate. In other words, we had to guess what others were thinking, and what others thought other others were thinking. Even within the reunion, focal points had become important! The solution was to search at those specific points that had been special to us back in the day when we were students.

On Saturday morning, I took about ten minutes after entering campus to find batchmates – I had made poor guesses on where people were likely to be. And once I found those two batchmates at that first point, we took a further twenty minutes before we met others – after making a better guess of the focal point. Given that the reunion lasted a bit more than a day, this was a significant amount of time spent in just finding people!

 

 

A simpler solution would have been to start with a scheduled event that everyone would attend – the venue and starting time of the event would have defined a very obvious focal point for people to find each other.

And the original schedule had accommodated for this – with a talk by the Director of IIMB scheduled for Saturday morning 10 am. It seemed like a rather natural time for everyone to arrive, find each other and go about the reunion business.

As it happened, revelry on the previous night had continued well into the morning, because of which the talk got postponed. The new starting point was to “meet for lunch around noon”. With people who were staying off-campus, and those arriving only on Saturday arriving as per the original schedule, search costs went up significantly!

PS: This takes nothing away from what was finally an absolutely fantastic reunion. Had a pretty awesome time through the duration of it, and I’m grateful to classmates who came from far away despite their large transaction costs.

The purpose of reunions

So later today and tomorrow, the class of 2006 at IIMB is going to have a reunion. Reactions to this have been mostly mixed. Some people have been excited about it for months together. Some have been dismissive, loathing the idea of meeting some people they used to know. Most have gone along with the flow, quietly registering and promising to turn up.

As I’ve dealt with people showing all these reactions, I was thinking of why reunions make sense. I had even tweeted this last year:

As the reunion has come closer, though, my views have become more nuanced. Yes, I’ve kept in touch with all those batchmates I’ve wanted to keep in touch with. However, transaction costs (have I told you I’m writing a book on that topic? Just wrapped up third draft) mean that it’s not been possible to meet many of them.

It is not feasible, for example, to schedule a trip all the way to London because a handful of people you want to meet live there. Nor is it possible that even if you visit Mumbai, regularly, you are able to put “gencu” with everyone you have intended to put gencu with.

And so it remains, that you keep putting off meeting those people you want to meet until a time when transaction costs are low enough for you to be able to meet.

There are transaction costs that operate in other ways as well – a scheduled bilateral meeting is a commitment to exclusively talk to each other for at least close to an hour. And sometimes when you want to meet someone for the purpose of catching up, you aren’t sure if you can spend an hour with them without either of you getting bored. And so you put off that gencu.

The beauty of a scheduled reunion is that it takes into account both these costs. Firstly, by ensuring a large number of people congregate at one place at one time, it amortises (among all the counterparties you meet) the cost of having travelled to the meeting. Secondly, given that there are so many people around there, you don’t have an obligation to talk to anyone beyond the time when it’s pleasant for both of you (sadly, IIMB has outlawed alcohol on campus during the last decade so “i’ll go get a refill” trick of walking away won’t work).

The other great thing about a scheduled reunion (organised by the Alma Mater’s alumni office) is that it acts as what Thomas Schelling termed as “focal points“. Focal points are basically solutions to coordination games where each player plays in a natural or obvious way, expecting others to play the same way as well, so that they coordinate.

Now let’s say that the IIMB Class of 2006 decided to all meet sometime during the course of the year. Coordinating on a date would have been impossible, with any arbitrarily chosen date attracting too few people for network effects to take effect.

With the alumni office proposing a date and venue, it now becomes an “obvious solution” to everyone coming together and going through a process on that date (anchoring is also involved). People are willing to make the investment to meet on that date because they expect others to be there as well. So I’ve registered for this weekend’s event with the expectation that a large number of my batchmates would have done so as well, and each of them would have in turn registered for a similar reason.

Over the next couple of days I expect to spend a lot of time with people I’ve anyway been in touch with over the last 10 years. I might also spend a small amount of time with people I don’t really want to meet. But there is a large number of people I want to keep in touch with, but can’t due to transaction costs, and that is where I expect the reunion to add most value!

Damming the Nile and diapers

One of the greatest engineering problems in the last century was to determine the patterns in the flow of the Nile. It had been clear for at least a couple of millennia that the flow of the river was not regular, and the annual flow did not follow something like a normal distribution.

The matter gained importance in the late 1800s when the British colonial government decided to dam the Nile. Understanding accurately the pattern of flows of the river was important to determine the capacity of the reservoir being built, so that both floods and droughts could be contained.

The problem was solved by Harold Edwin Hurst, a British hydrologist who was posted in Egypt for over 60 years in the 20th Century. Hurst defined his model as one of “long-range dependence”, and managed to accurately predict the variation in the flow of the river. In recognition of his services, Egyptians gave him the moniker “Abu Nil” (father of the Nile). Later on, Benoit Mandelbrot named a quantity that determines the long-range dependence of a time series after Hurst.

I’ve written about Hurst once before, in the context of financial markets, but I invoke him here with respect to a problem closer to me – the pattern of my daughter’s poop.

It is rather well known that poop, even among babies, is not a continuous process. If someone were to poop 100ml of poop a day (easier to use volume rather than weight in the context of babies), it doesn’t mean they poop 4ml every hour. Poop happens in discrete bursts, and the number of such bursts per day depends upon age, decreasing over time into adulthood.

One might think that a reasonable way to model poop is to assume that the amount of poop in each burst follows a normal distribution, and each burst is independent of the ones around it. However, based on a little over two months’ experience of changing my daughter’s diapers, I declare this kind of a model to be wholly inaccurate.

For, what I’ve determined is that far from being normal, pooping patterns follow long-range dependence. There are long time periods (spanning a few diaper changes) when there is no, or very little, poop. Then there are times when it flows at such a high rate that we need to change diapers at a far higher frequency than normal. And such periods are usually followed by other high-poop periods. And so on.

In other words, the amount of poop has positive serial correlation. And to use the index that Mandelbrot lovingly constructed and named in honour of Hurst, the Hurst exponent of my daughter’s (and other babies’) poop is much higher than 0.5.

This makes me wonder if diaper manufacturers have taken this long-range dependence into account while determining diaper capacity. Or I wonder if, instead, they simply assume that parents will take care of this by adjusting the inter-diaper-change time period.

As Mandelbrot describes towards the end of his excellent Misbehaviour of markets , you can  use so-called “multifractal models” which combine normal price increments with irregular time increments to get an accurate (fractal) representation of the movement of stock prices.

PS: Apologies to those who got disgusted by the post. Until a massive burst a few minutes ago I’d never imagined I’d be comparing the flows of poop and the Nile!

When is a war a war?

War is an inherently political instrument used to achieve a political objective, so a credible political adversary is necessary for war to be war.

As the US Presidential election race hots up (or gets more one-sided, depending upon your interpretation), people continue to refer to former President George W Bush leading the US into two “wars” in Iraq and Afghanistan. Thinking about it, I’m not sure the two can actually be classified as wars.

To use a chess analogy, real wars seldom end in checkmate – they most often end in resignation, or an agreed draw. War is an instrument that is used to achieve a political objective, to get the other party to do what you want them to do.

And so war ends when one side has established such an utter dominance over the other that the counterparty decides that to resign, or “surrender” is superior to continuing fighting the war.

For this to happen, however, the counterparty needs to have a political leadership that is able and willing to take a decision, following which the war actually stops. In the absence of such a political leadership, the war will continue indefinitely until “checkmate”, and assuming that the losing side’s force “decays exponentially”, it can take a really long time for it to actually get over.

So based on this definition that war is a political instrument used to achieve a political objective, I’m not sure what happened in Iraq and Afghanistan can actually be classified as “war”.

The “government” of the day in Afghanistan (Taliban), for example, would have never come to the negotiating table with the US, so short of complete annihilation, there was no other “objective” that the US could achieve there.

Iraq, on the other hand, possessed credible political leadership (Saddam Hussein) when the US invaded, but by actually killing him, the US denied themselves the chance of a “real victory” in terms of a negotiated settlement. A game of chess might end when the king is mated (remember that the king never “dies”, only trapped), but in a situation such as Iraq, the battle will rage until each member of the opposing force is taken out.

And so fighting continues to this day, over a decade since it started, with no hope of it ending in the near future. Real wars never go on indefinitely.

Half life of pain

Last evening, the obstetrician came over to check on the wife, following the afternoon’s Caesarean section operation. Upon being asked how she was, the wife replied that she’s feeling good, except that she was still in a lot of pain. “In how many days can I expect this pain to subside?”, she asked.

The doctor replied that it was a really hard question to answer, since there was no definite time frame. “All I can tell you is that the pain will go down gradually, so it’s hard to say whether it lasts 5 days or 10 days. Think of this – if you hurt your foot and there’s a blood clot, isn’t the recovery gradual? It’s the same in this case”.

While she was saying this, I was reminded of exponential decay, and started wondering whether post-operative pain (irrespective of the kind of surgery) follows exponential decay, decreasing by a certain percentage each day; and when someone says pain “disappears” after a certain number of days, it means that pain goes below a particular  threshold in that time period – and this particular threshold can vary from person to person.

So in that sense, rather than simply telling my wife that the pain will “decrease gradually”, the obstetrician could have been more helpful by saying “the pain will decrease gradually, and will reduce to half in about N days”, and then based on the value of N, my wife could determine, based on her threshold, when her pain would “go”.

Nevertheless, the doctor’s logic (that pain never “disappears discretely”) had me impressed, and I’ve mentioned before on this blog about how I get really impressed with doctors who are logically aware.

Oh, and I must mention that the same obstetrician who operated on my wife yesterday impressed me with her logical reasoning a week ago. My then unborn daughter wasn’t moving too well that day, because of which we were in hospital. My wife was given steroidal injections, and the baby started moving an hour later.

So when we mentioned to the obstetrician that “after you gave the steroids the baby started moving”, she curtly replied “the baby moving has nothing to do with the steroidal injections. The baby moves because the baby moves. It is just a coincidence that it happened after I gave the steroids”.