Surge Price My Latte

Along the lines of price discrimination (Econogist explanation here), let’s talk about surge pricing. Surge pricing is a pretty effective way to capture customer’s willingness-to-pay (WTP) in an instantaneous fashion. Economists and proponents of free markets love surge pricing, as it ensures that the individual who wants the good (a ride) the most will receive it. Surge pricing is particularly beneficial for the producers—drivers and Uber headquarters—who are able to capture some consumer surplus. Given the efficiency of this mechanism, why don’t more businesses practice surge pricing?

Of course, Uber’s innovation is relatively new, so in the future we may see more surge pricing in everyday life. But imagine if coffee shops charged more during peak morning hours and less in the evening. It must be noted that surge pricing is one of the most hated parts of Uber, but that hasn’t stopped customers from using it. Small businesses probably do not have the leverage to effectively surge price their services, but larger chains are well positioned. (Side note: imagine if all the independent coffee shops and/or companies in a given industry could band together to make surge pricing standards. It would be really cool, but I think they also call those "cartels", and they are very frowned upon.) Starbucks could increase the cost of morning coffees and decrease prices after 4 pm, and they probably wouldn’t lose a terrible amount of business. In a lot of areas, there are few independent coffee shops and Starbucks or Dunkin Donuts are the only options (aside from gas stations). Customers who are addicted to coffee will be rather price inelastic (not very sensitive to changes in price), and potentially not impacted by the change.

The genius of “surge taxing” what are (arguably) luxury goods would be a lack of regressive incidence. See, most “flat” taxes (explanation here) end up being regressive, because they take up a larger share of poor people’s incomes. A 2% tax on coffee is negligible to someone making $100,000, while it could be rather major to a person making $20,000. As it happens, few people making $20,000 are drinking Starbucks regularly, so if they raised their prices, they would be effectively targeting middle to upper class individuals. Starbucks would be practicing price discrimination via market segmentation and temporal discrimination. They would be segmenting the caffeine addicts versus casual coffee drinkers at the same time they captured surplus based on time of day. In the morning, people want caffeine more (higher demand, have you seen the lines at Starbucks in the morning?), leaving companies an opportunity to take advantage of their sleep-deprived clientele.

The term “take advantage of” makes it seem like Starbucks customers will be badly off, but as I mentioned before, the clientele trends towards wealthier than that of Dunkin Donuts or 7/11 coffee. Surge pricing could both increase company revenue and improve the treatment of low-income workers. People patronizing popular restaurants, ordering food for takeout, or buying coffees at coffee shops will usually have more free income than the individuals providing these services. Instead of paying restaurant staff minimum wage, imagine if popular upscale restaurants “surge priced” during peak dining hours, such as on weekend nights. The clientele of these places would most likely not be burdened or dissuaded from dining based on an extra “peak hours” service change. The restaurant can make a bit more, and the waiters and waitresses scrambling to serve a packed restaurant will be compensated. Most diners don’t tip more during busy hours, but it makes sense they would be obliged to. The same goes for times at a coffee shop when the baristas and cashiers are working frantically.

I view this interesting theory of surge pricing to be a kind of privately-enacted wealth transfer. If companies stopped relying on cheap labor (and outsourced, etc.) to make money, and instead began to more effectively price their goods to meet the maximum WTP for various customers and groups, most would be better off. I say most because obviously some customers would be paying more money for services than they would have before, but if the prices exceed their willingness to pay, they will simply go elsewhere and allow an individual who wants the item more than they do to take their place.

The drawbacks to this plan include that the individuals who might create such policies like to please their well-off clientele (well-off compared to the service workers that run their businesses), and are likely well off themselves. There are few fully compelling reasons to irritate customers in order to pay seemingly expendable and talentless workers more money. Also unfortunately, many, many jobs staffed by the lowest paid workers would not be eligible to effectively perform this plan. Taxes at fast food establishments would certainly be regressive, as wealthier people do not eat fast food very often. Only “luxury” industries could surge price their goods without fear of majorly regressive incidence.

Most of all, businesses would have a harder time identifying just when to surge prices. They would not be nearly as successful and precise as Uber in doing so, for they use instantaneous evaluations of how many people are requesting rides (demand) and how many drivers are available (supply) to determine if surge pricing is needed. Services based totally online are much better positioned to surge prices—Amazon or online retailers charging more for shipping around Christmastime, for example. Coffee shops and restaurants would rely on vague approximations of busy hours, and in doing so, capture less consumer surplus than a more precise (online) service could.

Even if customers accepted surge pricing, not all would be perfect. The ideal usage of surge pricing / price discrimination in businesses would involve using extra revenue gathered to improve life for the people suffering most from “surge” hours—the service workers. You have probably gathered that the least of my concerns is finding ways to return more value to Starbucks shareholders (or make owners of popular restaurants wealthier, etc.). Of course, this plan has the added benefit of doing so, but most importantly could lessen the reliance that businesses currently have on cheap labor.

Cheap labor is the critical feature that drives American economic growth and the accessibility of low-cost goods. As it happens, the people receiving these low cost goods are probably not those who need the money (savings) most. I am suggesting that (*gasp*) we increase the prices of non-necessity goods for wealthier consumers (basically, people who can afford $4 coffees and meals out often) to capture more consumer surplus and subsequently compensate workers better while maintaining the same or better profit margins. As I mentioned before, this idea benefits people who have little bargaining power or voice in the process of determining prices. Thus, it has not come to fruition—instead, the focus remains on pleasing customers and trying to squeeze the most value out of the lowest paid staff you can find.

So, for now, we can breathe out a sign of relief that GrubHub doesn’t charge more money for delivery around dinner time, that Starbucks isn’t preying on your caffeine addiction, and that the hot restaurant in town isn’t charging 20% extra for a 7 PM reservation. Don’t get too confident that this way of life will be around for long. We can only hope that when businesses wise up to the benefits ($$) of surge pricing and price discrimination, they will pass along some of the gains to their workers. But who am I kidding, since when have companies ever passed along the value from efficiency and profit gains to their employees? 

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