Adventures with marginal pricing, auto edition

By Felix Salmon
July 2, 2012
Brian Chen has the news today that Uber is rolling out a cheaper version of its service:

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Brian Chen has the news today that Uber is rolling out a cheaper version of its service:

Uber’s convenience comes with a cost. People are paying not just for the service, but also the gas used by the big sedans. That’s where hybrid vehicles will help bring down the price: drivers will spend less time and money fueling up…

In San Francisco, for example, the hybrid cars will cost $5 for the base fee, and then $3.25 a mile after that. By contrast, the town cars cost $8 for the base fee and then $4.95 a mile.

A quick back-of-the-envelope calculation shows that this has very little to do with the amount of money that drivers spend fueling up. Compare a Prius (51 miles per gallon) to an Escalade (10 miles per gallon): if gas is $3.78 per gallon, that puts the cost of gas per mile at 7.4 cents for the Prius and 37.8 cents for the Escalade — a difference of 30 cents per mile. Whereas Uber’s price for the Escalade is a premium of $1.70 per mile.

What’s more, since the drivers of these cars can’t pick up hails on the street, they have a lot of downtime waiting for the next gig. As a result, it doesn’t really cost the Escalade driver extra money if she ends up having to refuel once a day rather than once a week. Obviously, the fuel costs are higher — but the opportunity cost of her time is negligible.

Here’s Chen:

The company convinced its car-service partners to buy a total of 50 hybrids just for customers coming through Uber — a sign that drivers are making money with the start-up.

But of course it’s more complicated than that. If drivers were happy with the money they were making with Uber, then they’d stick happily with what they’ve got. In order to be persuaded to switch over, they have to believe that they’ll make more money in a hybrid than they would in a sedan. And that’s despite the fact that “in general”, according to Uber’s Scott Munro, “hybrids will cost 30 to 40 percent less than Uber’s black town cars”.

If that’s the case, then if you compare a sedan driver and a hybrid driver, the hybrid driver will need to be making three trips for every two the sedan driver makes, just to end up with the same amount of money. In order for the hybrid to be more attractive than the sedan, and taking into account the fact that at the margin you’d rather make fewer trips than more trips, a typical driver would realistically be hoping to double the number of fares she was getting before she was happy switching to the cheaper car.

But I suspect that the real relationship here is not between Uber and its drivers, so much as it is between Uber and car-service companies. Any given driver might well prefer to continue driving a sedan, rather than being moved over to a hybrid. But the car-service companies make money on every fare, and so their best interest is served just by increasing the total number of fares, rather than the average income received per driver per day.

As a result, I suspect that this move is going to decrease Uber drivers’ take-home income, on average, rather than increase it. As you might expect, when prices drop. But it will increase income for both the car-service companies and for Uber itself — and it will increase the total number of Uber drivers.

It’s easy to sign up with Uber if you’re a company; much harder if you’re a single driver. The Uber model is that Uber contracts with the owners of capital, who then employ the labor needed to provide the service. And once again, the rich will end up making more, the not-rich will end up making less, and the rich will present the whole thing as a victory for all concerned.

But there’s something else going on here, too, which is the way that companies love to push the idea that we’re paying for extra costs, even when we’re not. Uber sedans are more expensive than Uber hybrids because Uber reckons that’s the way it can best maximize its revenues and profits — not because the sedans are significantly more expensive to drive. Another example of this? Gas stations which offer different prices for cash and credit.

I like this idea, in theory, because gas prices are the most salient prices in America: we’re much more conscious of how much gas costs than we are of how much anything else costs. And if the price for gas on credit is significantly more than the price for cash, then that will help drive home just how big those credit interchange fees are.

Except, gas stations have no particular reason to charge just the interchange fee as a premium. Is the difference 10 cents a gallon? That’s about 3%, which is at the high end of credit interchange fees. After that, it’s all just pure profit for the gas station — and sometimes the difference can be as much as 2 dollars a gallon.

That isn’t a condign surcharge; it’s price gouging. And even a relatively common 20-cent surcharge is basically a convenience or ignorance fee, a way of extracting extra money from people who don’t have the cash or who don’t realize how much extra they’re paying. The rate of paying-with-plastic ranges between 60% and 100%, which means that realistically what we’re talking about here is essentially a bait-and-switch: attract customers with a low headline price, and then charge them a higher one.

Part of modern life is the way in which we naturally gravitate towards easy and automatic ways of paying. If you give Uber your card number once, you never really need to pay at all; you just find the charge on your credit-card statement. It’s certainly convenient — but it also allows Uber to charge quite enormous sums for what they provide. And similarly, at the gas pump, we just want to swipe our cards and get out of there, rather than faffing about with cash. And so there’s an incentive for companies like Uber and gas stations to inexorably increase the implied convenience fee we get charged for using easy payments methods — even if those payments work out cheaper for them. (After all, it would cost Uber a fortune if we paid our drivers in cash and then Uber had to try to reclaim its share from those drivers.)

My radical new universal payments system would help a little bit here, since it would make it impossible for vendors to claim that the more convenient payments method was somehow more expensive for them. But it wouldn’t solve the deeper problem, which is that the more painless payments are, the less we feel the pain. And so merchants will always find ways to charge us more now, if we’re not going to really feel how much we paid until much later. And then, when customers start revolting at the high prices they’re paying, the merchants will act like they’re doing us a favor by offering an inferior and cheaper option.

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Comments
7 comments so far

Seems like the much simpler explanation here is simple price discrimination. Some people don’t find a ride in a hybrid an inferior option to a sedan. Some people do and so Uber will find a way to segment the market and charge more to those willing to pay more even when the cost of providing that service is not that much higher.

Similarly on the labor side, some drivers will be willing to, at the margin, drive more trips to earn a little more money. Others will be less willing to do so. The drivers who are willing will choose to drive the hybrids.

Posted by albertsun | Report as abusive

The cost of owning and maintaining an Escalade is more than a Prius, so you can’t just use the cost of gasoline. I’d bet that an Escalade might cost as much as 2x the Prius to operate, so the Escalade is actually priced lower per mile relative to the cost of owning and operating it.

Posted by KenG_CA | Report as abusive

Hey, your radical payments system looks a lot like mine! (See the comments here.) Anyway, you’re free to take it and run with it…all I want is a way to do a free interbank cash transfer in the USA. If having your rather more distinguished name on the thing makes the policy change more likely, great.

Posted by Setty | Report as abusive

Hey, your radical payments system looks a lot like mine! (See the comments here.) Anyway, you’re free to take it and run with it…all I want is a way to do a free interbank cash transfer in the USA. If having your rather more distinguished name on the thing makes the policy change more likely, great.

Posted by Setty | Report as abusive

Sorry for double-posting that. I’m not sure what happened. Anyway the link I was pointing to, which didn’t come through, was: http://blogs.reuters.com/felix-salmon/20 12/03/29/the-stranglehold-of-payments-ne tworks/

Posted by Setty | Report as abusive

Is it possible credit interchange fees are higher for gas stations? They are a major site for CC fraud, and I have one card which gives me 3% cash back at gas stations specifically, which implies they are getting at least that much from the vendor.

I am not sure if maintaining the CC infrastructure at the pumps factors in the expense; stations that give discounts for cash around here also give discounts for debit cards, but maybe they make you come into the station to run the card.

And I was under the impression that CC servicer agreements forbid charging different prices for CC and cash transactions. Is that not true anymore?

Posted by AngryInCali | Report as abusive

Well Uber drives Town Cars, not Escalades. And there’s a reason Town Cars (and Crown Victorias) are popular with fleets.. they take a beating, last forever and are actually *cheap* to maintain (cheap, old-fashioned parts, and easy to work on). It’s doubtful that a Prius is much cheaper than a Town Car to maintain if it’s running in commercial service on potholed San Francisco streets. So price discrimination it is… the $3.25 is getting awfully close to the regular taxi rate of $2.75 (+ flag drop, does Uber have that?)

Posted by mikan | Report as abusive
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