Thaler and Uber and surge pricing

I’m writing about Uber after a really long time on this blog. Basically I’d gotten tired of writing about the company and its ideas, and once I wrote a chapter about dynamic pricing in cabs in my book, there was simply nothing more to say.

Now, the Nobel Prize to Richard Thaler and his comments sometime back about Uber’s surge pricing has given me reason to revisit this topic, though I’ll keep it short.

Basically Thaler makes the point that when businesses are greedy and seen to be gouging customers in times of high demand, they might lose future demand from the same customers. In his 2015 book Misbehaving (which I borrowed from the local library a few months ago but never got down to reading), he talks specifically about Uber, and about how price gouging isn’t a great idea.

This has been reported across both mainstream and social media over the last couple of days as if Thaler is completely against the concept of surge pricing itself. For example, in this piece about Thaler, Pramit Bhattacharya of Mint introduces the concept of surge pricing and says:

Thaler was an early critic of this model. In his 2015 book Misbehaving: The Making of Behavioral Economics, Thaler argues that temporary spikes in demand, “from blizzards to rock star deaths, are an especially bad time for any business to appear greedy”. He argues that to build long-term relationships with customers, firms must be seen as “fair” and not just efficient, and that this often involves giving up on short-term profits even if customers may be willing to pay more at that point to avail themselves of its product or service.

At first sight, it is puzzling that an economist would be against the principle of dynamic pricing, since it helps the marketplace allocate resources more effectively and more importantly, use price as an information mechanism to massively improve liquidity in the system. But Thaler’s views on the topic are more nuanced. To continue to quote from Pramit’s piece:

“I love Uber as a service,” writes Thaler. “But if I were their consultant, or a shareholder, I would suggest that they simply cap surges to something like a multiple of three times the usual fare. You might wonder where the number three came from. That is my vague impression of the range of prices that one normally sees for products such as hotel rooms and plane tickets that have prices dependent on supply and demand. Furthermore, these services sell out at the most popular times, meaning that the owners are intentionally setting the prices too low during the peak season.

Thaler is NOT suggesting that Uber not use dynamic pricing – the information and liquidity effects of that are too massive to compensate for occasionally pissing off passengers. What he suggests, however, is that the surge be CAPPED, perhaps at a multiple of three.

There is a point after which dynamic pricing ceases to serve any value in terms of information and liquidity, and its sole purpose is to ensure efficient allocation of resources at that particular instant in time. At such levels, though, the cost of pissing off customers is also rather high. And Thaler suggests that 3 is the multiple at which the benefits of allocation start getting weighed down by the costs of pissing off passengers.

This is exactly what I’ve been proposing in terms of cab regulation for a couple of years now, though I don’t think I’ve put it down in writing anywhere. That rather than banning these services from not using dynamic pricing at all, a second best solution for a regulator who wants to prevent “price gouging” is to have a fare cap, and to set the cap high enough that there is enough room for the marketplaces to manoeuvre and use price as a mechanism to exchange information and boost liquidity.

Also, the price cap should be set in a way that marketplaces have flexibility in how they will arrive at the final price as long as it is within the cap – regulators might say that the total fare may not exceed a certain multiple of the distance and time or whatever, but they should not dictate how the marketplace precisely arrives at the price – since calculation of transaction cost in taxi pricing has historically been a hard problem and one of the main ways in which marketplaces such as Uber bring efficiency is in solving this problem in an innovative manner using technology.

For more on this topic, listen to my podcast with Amit Varma about how taxi marketplaces such as Uber use surge pricing to improve liquidity.

For even more on the topic, read my book Between the buyer and the seller which has a long chapter dedicated to the topic,

The real benefit of direct benefit transfer

A week ago, I gave up. My LPG subsidy that is.

Having been out of the country for a few months, with our normal LPG usage being much lower than the average family’s, and having forgotten to book my spare cylinder, my LPG account had been “suspended”, for not booking a refill for over six months.

Back in the day when all domestic LPG connections were subsidised, you were required to book a cylinder every six months, else your account would get suspended. This was a measure to get rid of fake accounts and duplicate connections owned by a family (a family could have only one connection, legally).

So when I went to my dealer last week asking for my account to be unsuspended, I was told to submit my Aadhaar number to get it released. When I said I don’t have an Aadhaar number (I have one, but don’t want to use it unless mandatory), the clerk asked if I could give up my subsidy. With the LPG subsidy being a minuscule part of my overall annual expense, I quickly agreed, and after filling up a form and submitting a copy of my driving license, I had “given up”.

Later that day, my account was unsuspended, and I could presently book a refill, which arrived today. And having “given up”, there is no compulsion now to book a cylinder every six months!

The real benefit of the direct benefit transfer scheme adopted by the union government for LPG subsidy transfer is that it is now possible to have two classes of LPG connections, with several benefits.

Firstly, rules such as minimum and maximum frequency of booking don’t apply any more. Secondly, and more importantly, it is far easier nowadays to get an LPG connection – someone I know went to a nearby dealer to get a connection, and after submitting basic identification documents and paying a deposit, it took only a couple of days for the cylinders to arrive.

You might recall a campaign in the late 2000s by the then Karnataka Energy Minister Shobha Karandlaje to weed out duplicate LPG accounts in order to prevent wasteful subsidy. That brought in a regime of submitting a copy of an electricity bill to get LPG connections, in order to prevent one household from having more than one connection. Consequently, getting a new LPG connection became an absolute nightmare.

With the benefits now being targeted, and Aadhaar based, getting a new LPG connection is mostly straightforward, as long as you don’t claim a subsidy. And a lot of the times, the value of the subsidy is far lower than the additional cost of getting the cylinder itself!

In the earlier “indirect transfer regime”, this class of unsubsidided LPG connection did not exist (unless you went with one of the private sector players, most of whom have remained undependable), causing much harassment to consumers, and the need for various workarounds.

The direct benefit regime has thus not only saved the government the cost of wasteful subsidies, but also made life easier for consumers by making the market more rational!

How to improve regulation of utilities – comparing Delhi and DC

The Business Standard reports that the Delhi government has rejected the license applications of Uber, Ola and TaxiForSure. The snippet doesn’t say much more.

Contrast this with Washington D.C. which has passed a law that Uber has hailed as “model”. So what gives between the two capitals?

The answer is simple – it is the privileges accorded to the politicians. As a result of colonial hangover, Indian politicians have been mollycoddled with all kinds of perks such as houses in prime localities, chauffeured cars and the like. Thanks to such perks, bureaucrats are cut off from the market in general, and thus fail to understand any market failures.

The solution is simple in theory but hard to implement – basically cut the perks for government officers and instead compensate them further in cash, with the market value of the facilities that are now being provided for them. Clever structuring can make this cash-neutral. On the one hand, the bureaucrat now has a choice with respect to the kind of facilities he requires, leading to a more efficient allocation of resources.

More importantly, the bureaucrat is now part of the broader market, and thus exposed to the same market failures that plague the common man. If the transport commissioner of Delhi had to catch an auto rickshaw to get to work every day, we might have seen a completely different response in the Uber case.

Brainstorming

I was never a big fan of “brainstorming”. I’m referring to those meetings where everyone gets together and thinks aloud, in order to converge to a solution. In the past, when I’ve been involved in such exercises, they’ve mostly come to nothing, and mostly ended with a list of to-dos which got never done (this was mostly in a corporate context). As a consequence, I started hating large meetings also (either most people wouldn’t add value or it would end up like a group discussion with everyone shouting), and have been trying to avoid them.

This time, though, it was different. The context was not corporate. The agenda did not involve an item of day to day work. None of us had a firm stand on the topic at the beginning of the meeting, with each of us having our own apprehensions of either stand (when people come with preconceived ideas and biases, there usually is nothing to storm our brains about).

And so we got together. And we talked. There were times when no one spoke. There were times when it actually turned out to be like a group discussion (I actually said, “ok I have ten points which I haven’t been able to make in the last one hour. I’ve written them down and let me shoot now”). But the situation never got out of hand. Mutual respect meant that cross-talk quickly died out, and we listened to each other. And it was extremely civil.

And then things started crystallising. Soon, some of us had an opinion. Later, others did. Some were ultimately not convinced, but had an opinion anyway. In a period of about twenty minutes somewhere in the third hour of the session, we all seemed to have an “aha moment” (apologies for that consultantspeak). But such moments occurred at different times for each of us.

And then we did the usual thing of “going round the table” for each of us to express our opinions. And then we did. And as each of us expressed our opinions, we discussed it further. Things crystallised better. And we ended the meeting asking everyone who was there to blog about it.

This is what I wrote:

given that these two internets are independent, the total value is a^2 + b^2. Now, if we were to tear down the walls, and combine the two internets into one, what will be the total value? Now that we have one network of (a+b) users, the value of the network is (a+b)^2 or a^2 + 2 ab + b^2 . So what is the additional benefit that we can get by imposing net neutrality, which means that we will have one internet? 2 ab, of course!

This is what Nitin wrote:

If the government opens up the telecom service market to greater competition, perhaps by issuing unlimited licenses, then there is a case to allow them the freedom to discriminate among customers. As the state-owned carrier, BSNL can provide a neutral internet. However, if the government does not open the sector to further competition, therefore shielding the telecom service providers from more competition, then mandating net neutrality provides a reasonable approach to promoting the public interest.

Varun wrote this:

the regulator’s two major tasks are to enhance social welfare by protecting the consumer interest and to create an environment that is conducive for business — that will further enhance social welfare. A neutral internet will definitely benefit the consumers interest; but since the regulatory framework is not conducive for business, it appears that net-neutrality is in conflict with business interests. The situation can change if the regulatory framework is eased and the markets are opened up.

And Pranay wrote this:

net neutrality as a principle must be upheld. This is because communication network providers should not have the unfair advantage of being able to price internet content differently. Once the communication networks are setup, costs do not change with consumers accessing different content. In any case, the communication service providers are free to have fair internet usage policies to prevent induced demand effects

Gautam went down approximately the same path as me, and wrote this:

This is exactly why I oppose Zero Rating as well, whether paid or unpaid – it tends towards creating pockets of disconnected users per telecom company and while this is valuable for the telecom company and the applications and sites that are zero-rated, it reduces the total utility of the public internet, as a whole.

Devika deviated a bit from the crowd. This is what she said:

That said, it does not mean that ISPs should be restricted from entering into contracts with content providers. If Flipkart wants to undertake a joint marketing initiative with Bharti Airtel, it should be allowed to so. For example, Flipkart can give benefits to Airtel from sharing their customer base. To be extremely clear, such collaborations should not hinder access to any other internet sites. This will maintain a level playing field for all content providers.

Anupam, too, differed, and argued that customers need to be given choice:

If a person runs his business solely based on international VoIP calls and doesn’t mind paying extra for ensuring reliability and speed, he should be able to access that privilege. Or, for that matter, a Facebook or Twitter addict who wants these apps to be quick such that they can post real time selfies, should be able to choose these apps over say, apps which give real time updates on political happening in Nicaragua. Thus, people can be given a choice as to which data packets have to be prioritized within their limited bandwidth

And Pavan argued that competition is alone not sufficient:

However, if  the internet is a public good – will competition ever be sufficient to ensure the vibrancy of the network? Will competition be sufficient to improve the effective network size? I would argue that it might fall short of the mark. Thus, regulations that enforce net neutrality may be necessary to prevent ‘walled gardens’ from springing up.

As you can see, our opinions at the end of the meetings all differ. But you can also see that the posts are all well-argued, implying that at the end of the meeting we all had a reasonable degree of clarity. And that is what made it a brilliant brainstorming session.

Now if only all other brainstorming sessions were to be as good! Oh, and it’s a long post already but here are some #learnings on what makes for a successful brainstorming session:

  • Open minds on behalf of participants
  • Mutual respect, and giving everyone a chance to speak
  • No overbearing participants or moderators, leading to a freewheeling debate

As you can see, all these are similar to what makes a multiplayer gencu successful! But brainstorming has a specific agenda, so it’s not a gencu!

CHF and Irreversible policies

This is a coming together of two (or maybe three) blog posts that I wrote last week. First, on Thursday, I wrote about irreversible policies and the kind of lasting damage they cause. Essentially I had written that any policy needs to be “reversible” in that it should be easy to undo in case it is causing damage.

On Friday, and on Sunday, I wrote about the move in the Swiss Franc that caused havoc in the financial markets worldwide. Traders worldwide did not expect the Swiss National Bank to undo the cap the way it did on Thursday, and as the market found its level, traders lost heavily. Some FX houses which had not taken enough collateral from its clients also ended up going under.

Now, as Adithya remarks in the comments, a central bank ought to be reliable and predictable in its responses, and be able to build trust in the traders. Thus, Adithya argues that the sudden removal of the cap by the Swiss National Bank was a bad move.

However, putting together the blog posts referenced above, the problem is that the cap on the Swiss Franc in the first place was itself bad policy. It was bad policy in that barring certain circumstances (such as the natural weakening of the Franc against the Euro), it could never be undone without creating lasting damage in the financial markets.

Assuming that the policy had to be reversed one day or another (some people have argued that the SNB should have never reversed the cap, thus practically forever pegging the CHF to the Euro. But the SNB, as a central bank, cannot be faulted for wanting to control its own monetary policy), the sad fact of the markets is that whenever the cap was going to be removed, or the SNB announced that the cap was going to be removed, the markets would react in an extreme fashion. Unless the Franc naturally depreciated against the Euro (in which case the cap could have been quietly done away with) it was guaranteed that reversing the policy was a bad move.

It is hard to believe that the SNB was unaware of this irreversibility when it made the policy back in September 2011. The only defence that one can think of is that the SNB effectively overestimated the performance of the Eurozone, and consequently the Euro, in the time between 2011 and now. As this estimate came to be unfounded, it was forced to inflict pain.

The policy lesson from this is that when you are forming policy, you need to account for all possibilities, and make sure that the policy needs to be reversible with a high degree of confidence. This, you may note, is a stronger condition compared to what I had proposed in my blogpost on Thursday.

Finally some sensible Uber regulation

Ever since Uber launched, regulators worldwide haven’t had a clue as to how to regulate it – it has been such a big disruptor in the taxicab market. Some countries and cities have taken to banning it outright (the list is too long to post links here). Others (such as some states in India) have tried to get Uber to register itself as a “taxicab company”.

The problem with all these regulations is that the Uber model (being replicated by firms such as Ola and TaxiForSure in India) is a fundamental gamechanger. As I have written in this earlier post, the on-demand model propagated by Uber implies that a number of the inefficiencies in the taxicab market don’t exist any more. In this context, trying to regulate it by moving it back to the earlier (extremely inefficient) model is extremely regressive. The right way to regulate is to create a level playing field for taxicab aggregators (which includes Uber) and move the market to a regime where the new technology-enabled efficiencies are made good use of.

And that is precisely what Los Angeles has done. In a rather progressive move (which ought to be copied by other states and cities and countries), the city has decreed that all city-based cab operators need to offer app-based booking services. The interesting bit in the regulation (see link above) is that drivers who fail to install the e-hail app are actually going to be fined.

What this will lead to is that the local taxi market is itself going to become more efficient which should definitely increase both profitability for the local cab industry and also availability of local cabs to the people of LA. What this will also do is to give people of LA a choice between using Uber and the traditional taxi app, which will lead to an improvement in Uber’s service levels. As things stand now I don’t see any downside from this LA regulation.

I hope the model succeeds in LA and other cities see the brilliance of the model and accept the efficiencies brought into the market thanks to this model and adopt similar regulation. I see this kind of regulation coming into the Bangalore market though the backdoor though. Ola already helps match auto rickshaws to customers and now TaxiForSure is also getting into that market. Will this mean that autos won’t have to line up for hours together in front of Lalbagh gate for passengers arriving in the city by bus?

Oh, and LA is not the first city to implement regulations requiring taxis to be “hailable” via an app. When I visited Singapore in November 2013, I found that cabs in the city worked the same way. Locals had an app which they would use to call taxis. The problem there though was that the app was only available to locals (your android/iOS had to be registered in Singapore for you to be able to even install the app), which made it a nightmare for us tourists to move around.

Oh, and while on the topic, a good revenue source for companies such as Ola or TaxiForSure would be to provide the technology backbone to cities that are seeking to use app-based hailing services for their cabs.

 

Irreversible policies

Some policies are so badly designed that they become irreversible. Take, for example, the “5/20” rules for airlines in India. For an airline registered in India to fly abroad, it needs to have been in operation for 5 years and have at least 20 aircraft. The rule is silly, and the government wants to change it. But established players say that changing the rule will be unfair to them, for they have sunk costs in order to comply with the rule and want newer competitors to go through the same.

Now, given that the airline industry is dynamic in terms of firms going in and out of business, there will always be new firms and old firms in the market. And given that the rule is fundamentally senseless, there will be proposals to change it at many points in time. Now, notice that the arguments that today’s established players are making can be made at all those points in time! In other words, if you were to postpone changing the rule because older airlines are going  to be unhappy, you are giving reason to postpone the rule change indefinitely!

When you design a policy, you should keep in mind that there is a chance that changed market environments might render it useless/absurd (as for the 5/20 rule, it was absurd from inception!). Hence, you need to consider how easy the rule is going to be to dismantle when it goes past its use-by date. If such a “poison pill clause” doesn’t exist in the rule, then it will be very difficult to undo and the absurdity will propagate into perpetuity, causing much more damage than necessary!

Then again, if the rule has been framed due to the influence of bootleggers (the 5/20 rule definitely has indications of that, and it is hard to identify any “baptists” who could have backed the rule), then the bootleggers are likely to prevent any such “poison pill clause” from being put in. Such are life.