The political economy of Uber’s multi-dimensional creative destruction

Over the past week it’s been hard to keep up with the news about Uber. Uber’s creative destruction is rapid, and occurring on multiple dimensions in different places. And while the focus right now is on Uber’s disruption in the shared transportation market, I suspect that more disruption will arise in other markets too.

Start with two facts from this Wired article from last week by Marcus Wohlsen: Uber has just completed a funding round that raised an additional $1.2 billion, and last week it announced lower UberX fares in San Francisco, New York, and Chicago (the Chicago reduction was not mentioned in the article, but I am an Uber Chicago customer, so I received a notification of it). This second fact is interesting, especially once one digs in a little deeper:

With not just success but survival on the line, Uber has even more incentive to expand as rapidly as possible. If it gets big enough quickly enough, the political price could become too high for any elected official who tries to pull Uber to the curb.

Yesterday, Uber announced it was lowering UberX fares by 20 percent in New York City, claiming the cuts would make its cheapest service cheaper than a regular yellow taxi. That follows a 25 percent decrease in the San Francisco Bay Areaannounced last week, and a similar drop in Los Angeles UberX prices revealed earlier last month. The company says UberX drivers in California (though apparently not in New York) will still get paid their standard 80 percent portion of what the fare would have been before the discount. As Forbes‘ Ellen Huet points out, the arrangement means a San Francisco ride that once cost $15 will now cost passengers $11.25, but the driver still gets paid $12.

So one thing they’re doing with their cash is essentially topping off payments to drivers while lowering prices to customers for the UberX service. Note that Uber is a multi-service firm, with rides at different quality/price combinations. I think Wohlsen’s Wired argument is right, and that they are pursuing a strategy of “grow the base quickly”, even if it means that the UberX prices are loss leaders for now (while their other service prices remain unchanged). In a recent (highly recommended!) EconTalk podcast, Russ Roberts and Mike Munger also make this point.

This “grow the base” strategy is common in tech industries, and we’ve seen it repeatedly over the past 15 years with Amazon and others. But, as Wohlsen notes, this strategy has an additional benefit of making regulatory inertia and status quo protection more costly. The more popular Uber becomes with more people, the harder it will be for existing taxi interests to succeed in shutting them down.

The ease, the transparency, the convenience, the lower transaction costs, the ability to see and submit driver ratings, the consumer assessment of whether Uber’s reputation and driver certification provides him/her with enough expectation of safety — all of these are things that consumers can now assess for themselves, without a regulator’s judgment substitution for their own judgment. The technology, the business model, and the reputation mechanism diminish the public safety justification for taxi regulation. Creative destruction and freedom to innovate are the core of improvements in living standards. But the regulated taxi industry, having paid for medallions with the expectation of perpetual entry barriers, are seeing the value of the government-created entry barrier wither, and are lobbying to stem the losses in the value of their medallions. Note here the similarity between this situation and the one in the 1990s when regulated electric utilities argued, largely successfully, that they should be compensated for “stranded costs” when they were required to divest their generation capacity at lower prices due to the anticipation of competitive wholesale markets. One consequence of regulation is the expectation of the right to a profitable business model, an expectation that flies in the face of economic growth and dynamic change.

Another move that I think represents a political compromise while giving Uber a PR opportunity was last week’s agreement with the New York Attorney General to cap “surge pricing” during citywide emergencies, a policy that Uber appears to be extending nationally. As Megan McArdle notes, this does indeed make economists sad, since Uber’s surge pricing is a wonderful example of how dynamic pricing induces more drivers to supply rides when demand is high, rather than leaving potential passengers with fewer taxis in the face of a fixed, regulated price.

Sadly, no one else loves surge pricing as much as economists do. Instead of getting all excited about the subtle, elegant machinery of price discovery, people get all outraged about “price gouging.” No matter how earnestly economists and their fellow travelers explain that this is irrational madness — that price gouging actually makes everyone better off by ensuring greater supply and allocating the supply to (approximately) those with the greatest demand — the rest of the country continues to view marking up generators after a hurricane, or similar maneuvers, as a pretty serious moral crime.

Back in April Mike wrote here about how likely this was to happen in NY, and in commenting on the agreement with the NY AG last week, Regulation editor Peter Van Doren gave a great shout-out to Mike’s lead article in the Spring 2011 issue on price gouging regulations and their ethical and welfare effects.

Even though the surge pricing cap during emergencies is economically harmful but politically predictable (in Megan’s words), I think the real effects of Uber will transcend the shared ride market. It’s a flexible piece of software — an app, a menu of contracts with drivers and riders, transparency, a reputation mechanism. Much as Amazon started by disrupting the retail book market and then expanded because of the flexibility of its software, I expect Uber to do something similar, in some form.

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3 thoughts on “The political economy of Uber’s multi-dimensional creative destruction

  1. I’m reminded of something I heard years ago from a man who’d become a millionaire in post WWII Seattle with a home heating oil business. He mentioned that one winter there’d been a weeks long cold snap (normal winter daytime temps are in the 40s) and that several of his customers were located on the north side of Mercer Island, which sits in the middle of Lake Washington (the eastern border of Seattle).

    The ice and snow wouldn’t melt on their steep driveways down to their houses, so he couldn’t get his trucks close enough to the houses to fill their furnaces’ tanks. He hired several high school football players to carry fuel in five gallon cans from his trucks down to the homes, so his customers wouldn’t lack heat.

    Someone asked him, ‘Did you charge extra for that?’. He, almost offended, said, ‘Oh no. People remember things like that.’

  2. Of course, ride-sharing is a fraudulent business model. Not only does it not pay for any municipal business permits while operating their supposedly “business taxi dispatch”, they also cut corners on local taxes, on commercial insurance (and no, that gap policy that they offer doesn’t cover all that needs to be covered), etc. It is a criminal enterprise that creates unfair, unethical and unlawful business environment. If they want to compete – they need to play by the rules and laws, same ones that thousands of small transportation businesses abide by daily.

  3. Have you considered the alternative in which neither the ride sharing industry nor the taxi industry have such onerous and burdensome regulatory requirements? Rather than saying that ride sharing should not exist, what if instead the taxi industry is not required to purchase municipal permits etc.? That’s a legal environment more conducive to benefiting consumers, and to innovation.

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