Uber’s surge pricing shouldn’t just be about ‘good’ economics


Vivek Kaul

The two most basic laws in economics are the law of demand and the law of supply. The law of demand basically states that all other factors being equal the price and the quantity demanded of any good or service are inversely proportional to each other. The law of supply states that an increase in price results in the increase of the quantity of the good or service supplied.

These two laws are the heart of the business model of Uber. The price of the taxi-service goes up when the demand is higher i.e. more people want to use Uber cabs in an area than the number of cabs available at that point of time. The company calls this “surge pricing”.

On the face of it this pricing practice sounds normal. It is often compared to airline ticket prices where the prices during weekends, summers, festivals and end/beginning of the year tend to be higher because the demand is higher. Along similar lines Uber prices go up when the demand is higher. Nevertheless, the comparison is not so straightforward.

When the demand is high, the price charged by Uber starts to go up. There have been cases when the price has gone up many times the normal price charged by the company. A December 2014 article in the Time magazine puts the highest multiple ever recorded at 50 times the normal price. This happened in Stockholm, Sweden.

When terrorists took over a café in Sydney in December 2014, the price went up four times its normal rate. A similar thing happened in Toronto, last month, during a massive subway disruption in the city.

The company has a standard explanation for this—the law of supply is at work. Travis Kalanick, the CEO of Uber explained it on his Facebook page once: “We do not own cars nor do we employ drivers…Higher prices are required in order to get cars on the road and keep them on the road during the busiest times. This maximizes the number of trips and minimizes the number of people stranded.”

How good is this argument? As Richard Thaler writes in Mishbehaving: The Making of Behavioural Economics: “You can’t just decide on the spur of the moment to become an Uber driver, and even existing drivers who are either at home relaxing or at work on another job have limited ability to jump in their cars and drive when a temporary surge is announced.”

Further, “one indication of the limits on the extent to which supply of drivers can respond quickly is the very fact that we have seen multiples as high as ten”, writes Thaler. If drivers were actually responding to surge pricing quickly that wouldn’t have been the case.

Research carried out by Nicholas Diakopoulos of the University of Maryland (which was published in the Washington Post) suggested that: “surge pricing doesn’t seem to bring more drivers out on the roads”. What it does instead is that pushes drivers already on the road towards areas with higher surge pricing.

Also, in most cities which have taxi-cabs people are used to paying a fixed rate. Uber is trying to challenge that notion. The trouble is that while it is doing that it ends up with a lot of bad PR, during tough situations(like terrorists entering a city, weather disasters, transport strikes/disruptions) when the surge pricing tends to kick in. While “surge pricing” follows economic theory, what the company needs to realise is that they are charging the consumer more, when he or she is in a spot of bother anyway.

So what should they do? Thaler has the answer: “This insensitivity to the norms of fairness could be particularly costly to the company…Why create enemies in order to increase profits a few days in a year?…I would suggest that they simply cap surges to something like a multiple of three times the usual fare.”
Now that sounds like a sensible thing to do.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column appeared in the Bangalore Mirror on July 8, 2015

Why bosses suck

Around ten days back, I met a cousin who is doing her MBA from a premier business school in the country. She has just finished her summer training and was rather disappointed with her boss (aren’t we all?).

My cousin, of course, goes back to her MBA course and hence, does not need to deal with her now former boss, on a daily basis. But everybody is not as lucky. In fact, time and again research has shown that “people quit their bosses and not their jobs”.

And the tragedy is that most organisations do not address this issue at all. Also, if you are honest enough to highlight this fact in your exit interview, chances are you won’t get hired back by the company in the days to come, if a such situation arises at all.

So the question to ask is why do bosses suck? Many years back, Laurence J. Peter came up with the Peter’s Principle, which essentially states that every person rises to his or her level of incompetence in an organisational hierarchy. So good software coders do not always make for good project managers, once they are promoted. Good teachers do not make for good principals. Good breaking news reporters do not make for good editors. And good batsmen do not always make for a great captain.

This happens primarily because individuals get promoted up the hierarchy on the basis of how good they are at their current job. But once they have been promoted the skill-set required to handle their next job maybe totally different. And they may not have that skill-set at all. This lack of competence creates a problem for those who report to them.

What this means is that everyone is not suited for being promoted up the hierarchy. Nevertheless, people need to be promoted. As Dan Ariely, an Israeli American professor of psychology and behavioural economics, writes in his new book Irrationally Yours: “[The] feeling of progress is very important to our well-being and it provides gratification, self-esteem, and recognition from our peers.” And this feeling of progress comes when people are promoted.

One way companies have tried to tackle the “feeling of progress” is by creating more layers in the hierarchy, where an individual gets promoted, gets a new designation, perhaps more money, but is essentially doing the same thing.

As Ariely puts it: “Widespread recognition of the need for progress explains why so many companies have invented titles and intermediate positions for management types (officer executive,… vice president, senior vice president, deputy CEO, etc.)…Companies want their employees to feel that they are making progress and moving ahead even when these steps are not very meaningful…Most companies across all positions, have a list of titles that give all employees the feeling that we are moving ahead on this treadmill.”

The trouble is that this game of “inventing titles” has not done anything to solve the basic problem of individuals rising to their level of incompetence in a hierarchy. In fact, research shows that incompetent bosses know that they are “incompetent” and this makes them aggressive and a “pain in the ass” for the individuals who report to them.

As Nathanael J. Fast and Serena Chen write in a research paper titled When the Boss Feels Inadequate: “A lack of perceived personal competence may foster aggression among the powerful. We base this idea on the notion that power increases the degree to which individuals feel that they need to be competent—both in order to hold onto their power and to fulfil the demands and expectations that come with their high-power roles.”

The researchers further state that: “Power holders who perceive themselves as personally incompetent might display aggression.” And that’s why bosses continue and will continue to suck. Further, organisations not do anything about it.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Bangalore Mirror on June 10, 2015 

Arghhh, Mr Jaitley it’s still not about cutting interest rates

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The finance minister Arun Jaitley is at it again. A recent report in the Business Standard suggests that Jaitley is scheduled to meet public sector banking chiefs on this Friday i.e. June 12, 2015, and ask them why they haven’t cut interest rates in line with the Reserve Bank of India (RBI) cutting the repo rate.
The RBI has cut the repo rate by 75 basis points (one basis point is one hundredth of a percentage) to 7.25% since the beginning of this year. Repo rate is the rate at which RBI lends to banks. In response banks have cut their lending rates by only 30 basis points.
The finance minister wants to know why banks have not matched the RBI rate cut when it comes to their lending rates even though they have cut their deposit rates by close to 100 basis points over the last one year.
The finance minister believes that at a lower interest rate people and companies will borrow more, and banks will lend more. But as I have often said in the past this is a very simplistic assumption to make.
First and foremost a cut in the repo rate does not bring down the legacy borrowing costs of banks. Hence, lending rates cannot always fall at the same speed as the repo rate. Further, data from the RBI shows that as on May 15, 2015, nearly 29.9% of aggregate deposits of banks were invested in government securities. This when the statutory liquidity ratio or the proportion of deposits that should be invested in government securities, stands at 21.5%.
So what does this mean? Banks have way too much investment in government securities. In fact, as on May 15, 2015, the total aggregate deposits of banks stood at Rs 87,39,610 crore. Of this amount around 29.9% or Rs 26,14,770 crore is invested in government securities.
As things currently stand, banks investing Rs 18,79,016 crore in government securities would have been suffice to meet the regulatory requirement of 21.5%. What this means that banks have invested Rs 7,35,754 crore more than what is required in government securities.
Why is that the case? The answer could be lazy banking or the lack of decent loan giving opportunities going around. Clarity on this front can only come from banks doing the necessary explaining.
There are other things that Jaitley needs to consider as well. The bad loans or gross non-performing assets of banks have been going up. As on March 31, 2014, they had stood at 3.9% of their total advances. By March 31, 2015, the number had shot up to 4.3% of the total advances.
The situation is worse in case of public sector banks. As on March 31, 2015, the stressed asset ratio of public sector banks stood at 13.2%. The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7%. The stressed asset ratio of the overall banking system was at 10.9% as on March 31, 2015 and 9.8% as on March 31, 2014.
The stressed asset ratio is the sum of gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. Hence, a stressed assets ratio of 13.2% essentially means that for every Rs 100 given out as a loan, Rs 13.2 has either been defaulted on or has been restructured.
What this clearly tells us is that the situation of the public sector banks has gone from bad to worse, over the last one year. In this situation it is hardly surprising that the banks have cut their fixed deposit rates but haven’t cut their lending rates by a similar amount.
With increased bad loans, they need to earn a higher margin on their good loans, to maintain or increase the level of profits. This scenario has arisen primarily because many corporates have been unable to repay the loans they had taken on.
Banks have not been able to recover these loans. A newsreport in The Economic Times yesterday, pointed out that the RBI is mulling a new rule that will give lenders a 51% equity control in a company, which fails to repay a loan even after its loan conditions have been restructured. Whether this happens remains to be seen. Further, many companies which failed to repay loans belong to crony capitalists who continue to be close to politicians.
Also, it needs to be pointed out that the corporate profits as a share of the gross domestic product is at 4.3% of the GDP, which is the lowest since 2004-2005. (I would like to thank Anindya Banerjee who works with Kotak Securities for bringing this to my notice).
What this tells us is that corporates as a whole are still not earning enough to be able to repay any fresh bank loans that they may take on. In this scenario insisting that the banks cut interest rates and lend is not the most suitable suggestion to make.
The Economic Survey released earlier this year had a very interesting table, which I have reproduced here.

Top Reasons for stalling across ownership

Source : CMIE

What the table clearly shows is that a lack of funds is not one of the main reasons for the 585 stalled projects in the private sector. In case of the 161 stalled government projects, the lack of funds is the third major reason. Hence, there are other reasons which the government needs to tackle, in order to get these projects going again. Lack of finance is clearly not a main reason.
Further, the high interest rates on post office savings schemes put a floor on the level to which banks can cut their fixed deposit rates and in the process their lending rates. This is something that the public sector banks can do nothing about.
To conclude, what all these reasons clearly suggest is that Arun Jaitley and this country would be better off if we got rid our fixation for lower interest rates being a solution to reigniting economic growth. There are other bigger things that need to be sorted out first.

The column originally appeared on The Daily Reckoning on June 9, 2015

Do seatbelts save lives?

john nash

Mathematician John Nash on whose life the movie A Beautiful Mind is based, was recently killed in a car crash. Nash and his wife Alicia were sitting in the back seat of a cab and were not wearing seatbelts. The couple were ejected from the car when it crashed into a guard rail.
The driver of the car escaped death because he was wearing a seatbelt. Chances are that the Nash couple would have survived the crash as well if they had been wearing seatbelts.
Nevertheless, the question to ask here is do seatbelts really save lives? It needs to be borne in mind here that I am not just talking about the individuals in the car, but also about those who are walking on the road.
As Steven E. Landsberg writes in
The Armchair Economist—Economics and Everyday Life: “Back when seat belts (or air bags or antilock brakes) were first introduced, any economist could have predicted one of the consequences: The number of car accidents increased. That’s because the threat of being killed in an accident is a powerful incentive to drive carefully.”
What Landsberg meant here was that drivers drive less carefully once they know that their cars are safer. If the cars are less safer, then there is an incentive for drivers to drive more carefully, else they are likely to end up dead or be seriously injured. With a seatbelt, the chances of surviving an accident go up and this leads to drivers driving less carefully. And this makes their cars more dangerous for the people walking on the roads.
In fact, Landsberg jocularly told me in an interview I did with him a few years back, that: “If I took the seat belts out of your car, wouldn’t you be more cautious when driving? What if I took the doors off? So if we really wanted to reduce the number of driver deaths, the best policy might be to require every new car to come equipped with a spear, mounted on the steering wheel and pointed directly at the driver’s heart. I predict we’d see a lot less tailgating.”
In fact, John Adams, an emeritus professor at University College London has carried out research in this area. His findings suggest that making the use of seatbelts compulsory in 18 countries either led to no change or an increase in road accident deaths.
What is interesting nonetheless is that wearing seat belts leads to a reduction in the number of driver deaths. Nevertheless, because the drivers feel safer with the seatbelts on, they are likely to drive more recklessly. And this leads to an increase in overall road accident deaths because the number of pedestrian deaths tends to go up.
Also, seatbelts do not save many driver lives either. At least, that is what research carried out by Professor Dinesh Mohan of IIT Delhi suggests. As he writes in a research paper titled
Seat Belt Law and Road Traffic Injuries in Delhi, India : “An estimated 11-15 lives may have been saved in Delhi per year due to current levels of seat belt use out of a total of 1,800-2,000 fatalities per year on Delhi roads. This amounts to less than 1% reduction in total fatalities due to road traffic crashes in Delhi because a vast majority of crashes comprise vulnerable road users and motorised two-wheeler riders.” Given that Mohan’s paper was published in 2009, this finding is a little dated though.
To conclude, what all this tells us is that “people respond to incentives,” which is the fundamental principle of economics and as Landsberg writes: “when the price of accidents(e.g., the probability of being killed or the expected medical bill) is low, people choose to have more accidents.” And that is something worth thinking about.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Bangalore Mirror on June 3, 2015