If you miss going to your Economics 101 class every other morning at college, well, Bill Gurley is here to fill that void for one day.
For those not familiar with Uber, the company’s surge pricing strategy raises the cost of a ride when demand increases as a way for Uber to encourage more drivers to be on the road when passengers need rides.
It’s important to note that Gurley is an investor and board member at Uber. But, while “many will dismiss these thoughts as naked bias,” Gurley says he has access to a wealth of Uber’s information and has spent many hours thinking about the fundamentals of surge pricing.
“I also have quite a bit on the line, and as a result have spent a great deal of time contemplating the policy as well as the potential alternatives,” he notes.
You should read Gurley’s entire post here, but in a nutshell, the venture capitalist uses the basic laws of economics to explain why the surge pricing strategy makes sense for all parties involved. His most important point is that, contrary to what some of Uber’s critics say, Uber is a true marketplace.
“So why does Uber’s dynamic pricing even exist? The answer lies in understanding that Uber is fundamentally a marketplace, where supply is controlled not by the company but by the legion of independent contractors and transportation providers with whom they work,” Gurley writes.
Gurley, who spoke at the GeekWire Summit last year, notes two functions of surge pricing: To increase supply, and to temporarily intentionally reduce demand.
Gurley points out how hotels, airliners and rental car companies use a similar model that is generally accepted in our society: when supply increases during busy times, they raise prices.
But Uber is different because contrary to those industries, supply is not fixed. During the times when riders demand more availability, like Friday or Saturday nights for example, drivers also would rather not be driving.
“The exact events that increase demand for needing a driver also cause supply to shrink,” Gurley explains. “In these cases the supply curve is moving left at the exact same time that the demand curve is moving right. As a result the need for a price catalyst to increase supply in the Uber case is vital.”
Gurley ends the post by noting how “the majority of leading Internet marketplace companies use dynamic pricing as a solution when confronted with a scarcity of supply,” like Ebay, StubHub, Airbnb, Homeaway and Google Adwords.
“Uber has no intention of abandoning dynamic pricing precisely because it is in the consumer’s best interest, especially when one understands the true alternatives,” he writes.
Read the full post here.