Foreword:

The case is inspired from a surge pricing outage event that took place on New Year’s Eve, 2014-15 in New
York. In that celebratory time period, the demand for rides surged at midnight. The drivers or driver-
partners weren’t enough to meet the increased demand for rides. Driver-partners were busy with their own
celebrations on New Year’s Eve. This lack of supply was accentuated because of a technical glitch at Uber
that resulted in breakdown of surge pricing algorithm for about 26 minutes across the whole city of New
York. When the glitch was resolved in about half-an-hour, riders (customers) still complained that they had
to wait for too long to get rides. Some riders noted that probably there weren’t enough drivers in the location
(drivers are indicated in the Uber app when a rider requests a ride). Some experts claimed that drivers
weren’t drawn to surge demand-zones in proportion to the customer demand. Unsatisfied customers took
to social media and expressed their distress. On the following day, the event was covered by all media
outlets. Uber is concerned about bad press attributed to customer dissatisfaction. It sees itself as the market
leader in ridesharing space and realizes that not being able to fulfill customer demands at such important
events can have adverse strategic implications. The social media cell of Uber has categorically observed
that “surge pricing (practiced by Uber) has an image problem”. Until now, Uber has maintained, time and
again, that surge pricing is an effective tool to bridge the supply-demand gap.

However, this event sparked a debate about the effectiveness of surge pricing as an instrument for balancing
the supply and demand. Does surge pricing always induces enough supply to fulfill demand?

The Director of Uber’s Marketplace Optimization Data has set up a committee to investigate the matter.
Analyze the case as a member of that committee and provide your inputs.

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow
Drivers are independent agents. So they are our customers as much as riders are. We cannot tell the
drivers where to move. We can suggest where we think they might want to move.
—Uber’s Director of Marketplace Optimization Data Sciences

When an area is surging [has a surge price], it just kills demand, and a large fraction of the drivers leave
the area and drive elsewhere… [Surge pricing] is not incentivizing drivers the way [Uber] hoped it
would.
—Christo Wilson, coauthor of Uber pricing study Chen et al. (2015), as quoted in The San Francisco
Chronicle

The on-demand economy is “the economic activity created by online market places that
fulfill consumer demand with immediate access to and convenient provisioning of goods and services”.
The on-demand economy has witnessed explosive growth in recent years due, in large part, to the
emergence of peer-to-peer online platforms that match consumers in real time
with independent workers who are available nearby and can serve consumers at short notice. Leading
examples of such platforms include Uber and Lyft for cabs; GrubHub, Instacart, and Postmates for delivery
of food, groceries, or other items; TaskRabbit and Handy for household services; and Glamsquad and Zeel
for health and beauty services. One study estimated the annual U.S. consumer spending on on-demand
services to be $5.6 billion for cabs, $4.6 billion for delivery, and $8.6 billion for all other services. Given
their growing economic significance, it is important to understand the business strategies of on-demand
platforms and how these platforms can be managed effectively.

A fundamental challenge for on-demand platforms is to ensure that workers are available at the right time
and locations to serve consumers at short notice. On-demand marketplaces are often characterized by
fluctuating demand across market locations. The platforms obtain revenue if demand is met; they typically
receive a commission on worker revenues generated from serving consumers. For example, Uber and Lyft
receive a commission of 20%–25% of their drivers’ revenues. However, consumers can be served at
reasonably short notice only if enough workers are already available nearby, since it can take workers
considerable time to move from farther locations. Therefore, the platform must ensure that workers are
available when and where they are needed.

As illustrated by the opening comment from Uber, this challenge is compounded by the fact that on-demand
platforms do not directly control the workers. To provide on-demand service at attractive price points, many
on-demand platforms rely on what has come to be known as the “gig economy”—a variable workforce of
freelancers who work at their convenience and can be hired on-demand for a single project or task. These
independent workers are attracted to on-demand platforms by the prospect of earning extra income in their

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow
free time and are, hence, willing to work for considerably lower compensation than a full-time worker. For
example, workers for on-demand cabs and delivery service can typically be “anyone with a car”—college
students, people from other professions, or retirees—who are willing to drive or deliver in between their
other daily activities or work. Market research data indicates that Uber drivers associate a lot of value to
this flexibility. All else equal, even requiring drivers to work eight hours at a stretch would reduce the labor
supplied by two-thirds, while regular full-time commitment is practically infeasible. On the upside, these
freelancers are ready to serve consumers at relatively low prices. These freelancers can flexibly choose
when to work and where to work. Consequently, on-demand platforms cannot plan their supply of workers
in advance or directly control worker availability at different market locations.

To operate effectively under such market conditions, on-demand platforms often adopt a two-pronged
approach. First, they invest considerable resources to forecast supply and demand patterns ahead of time,
and share these forecasts with the workers. For example, Uber uses advanced algorithms to forecast the
need for additional drivers at each market location based on historical patterns, holidays, weather, current
local events, and traffic. Uber shares these forecasts with drivers through a mobile application, and
encourages drivers to move to locations where a shortage of drivers is expected. The mobile application
displays a map highlighting market locations that are likely to need additional workers. Locations are
marked yellow, orange, or red to indicate the likelihood and extent of the need. Uber instructs workers as
follows: “Use this info to your advantage by heading toward surging areas to receive nearby ride
requests” Uber Help (2016).

Second, many on-demand platforms employ a form of dynamic pricing known as surge pricing. Under
surge pricing, there is a set regular price for the entire market region. However, depending on the prevailing
supply and demand conditions, the platform can increase the current price at a given market location to be
higher than the regular price; this higher price is referred to as a surge price. To implement surge pricing,
the market is split into several smaller regions or “zones,” and the platform periodically updates the current
price in each zone. Consumers learn the current price in their zone at the time that they connect to the
platform to request service. Surge pricing increases drivers’ revenues as consumers pay more to avail the
ride. Surge pricing in a location also indicates to the driver that the demand is booming in that area. There
is evidence to suggest that surge prices play an important role in shifting drivers from low-demand locations
to high-demand locations. Workers typically have access to “surge heat maps” that display the surge prices
(and market forecasts) in their zone and in adjacent zones. Platforms employing surge pricing include Uber,
Lyft, Postmates, Instacart, and Handy. Data indicates that the percentage of time that surge pricing was
used on Uber’s platform in four major U.S. cities to be as follows: 14% in New York City, 17% in Los

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow
Angeles, 25% in San Francisco, and 28% in Chicago; The figures can even be higher in downtowns and
prime business areas.

The conventional rationale for these platform strategies is quite straightforward. Sharing market forecasts
with workers encourages workers to be available where they are needed the most. Surge pricing is expected
to work in two ways. First, by pricing out consumers who have lower willingness to pay, a surge price
efficiently allocates or “rations” the limited supply of workers to consumers who value them the most.
Second, because a surge price increases workers’ compensation in that zone, it should attract more workers
to move to that zone from adjacent zones, thus reducing the extent of shortage in supply.

But contrary to conventional wisdom, it is found that a surge price, on an average, did not attract as many
new drivers as Uber would expect. This sentiment is also reiterated by Christo Wilson in the opening
remarks of the case. However, the director of Uber’s Marketplace Optimization Data Sciences does not
believe that surge pricing is inadequately equipped to attract driver partners to ‘surge’ locations. However,
in light of the recent conflicting evidence, s/he has set up a research committee to investigate this matter
further. A market research firm, A.C. Nielson, is also sanctioned to assist the committee with relevant
primary data and insights.

You are a member of this committee. It is March, 2019.

The committee has decided to study two locations in New York City, namely, Manhattan and Bronx
County. Manhattan hosts many business conventions and is a bustling center of economic activity in New
York City. The forecasts provided by the market research firm indicate that demand for rides in Manhattan
surge during the lunch hours. The Bronx, in comparison, is a slow and sleepy town. Bronx is rich in culture,
music and sports. The lifestyle, as a consequence, is comparatively slower and steadier in Bronx. Its demand
for rides is usually stable. As a consequence, the supply of drivers (freelancers/ gig economy) is usually
stable and enough. Thus, there is not much need for surge pricing. The committee is convinced that these
two locations are representative of two extremes that are possible vis. a vis. demand pattern during the
12:30-13:30 (24- hours) time period. 13:00 -14:00 is the lunch hour. Working professionals in Manhattan
go out to grab their meals or run some quick errands at 13:00 hours. The market research firm also confirms
that 13:00-14:00 is a ‘surging’ period, especially in Manhattan. The effect of the surge during 13:00-14:00
is negligible in Bronx. The committee has selected two time intervals for the study, namely 12:30-13:00
and 13:00-13:30. The market research firm estimates that the demand patterns observed in Manhattan and
Bronx during the 12:30-13:30 time period can be classified on the basis of customer’s willingness to pay
for the ride in terms of regular and surge demand. Regular demand can be estimated by the following price
response function: 𝐷𝑟 = 500 − 40 𝑝𝑟 where 𝐷𝑟 is the regular demand and 𝑝𝑟 is the regular price.

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow
Surge demand, on the other hand is observed to be less elastic to price variations and is estimated by 𝐷𝑠 =
800 − 20 𝑝𝑠 ; where 𝐷𝑠 is the surge demand and 𝑝𝑠 is the surge price. Market research firm observes that
both Manhattan and Bronx observe regular demand pattern during the first period, namely, 12:30-13:00 but
the situation changes in the second period, namely, 13:00-13:30. In the second period, Bronx experiences
regular demand but Manhattan experiences surge demand.
The market research firm also observes that drivers usually do not move across regions. There is a set of
drivers that register themselves at a particular location, usually close to their homes and serve the customers
in that region. The estimates indicate that an average of 325 partner-drivers are registered and available at
both locations initially. The research firm also observes that the requests for inter-region travel are minimal.
People prefer to take other means of transport to commute between Manhattan and Bronx. Customer
demands are similar in mileage in every area
and take up entire duration of the time period i.e. a driver can serve only one customer demand in any
period. Uber charges 25% of the driver revenue as platform profit and the remaining 75% of the driver
revenue goes to the driver.

The sequence of events is as follows.

By 8:00 AM Uber sends the daily forecast of customer requests to all registered drivers in both counties of
New York. Its data science team also knows the number of drivers serving in each area.
The following events occur:
1. Consumers requiring on-demand service in a region in that time period join the platform.
2. Next, the platform sets the price for plausible customers in both regions.
3. As a response to the set prices in both regions, drivers decide whether to stay in their current zone
or to move to the adjacent zone in the hope of making more money (the forecasts for the evening
slots are available to them in the morning itself). The decision to move to other zone can only be
taken in the 12:30-13:00 slot. Serving a customer consumes the entire period in which the demand
has arisen. It costs the drivers $8 to move from Bronx to Manhattan and vice versa.
4. If a driver decides to stay in the region where s/he is registered originally, s/he serves customer
requests in both time periods.
5. If a driver decides to move to another region, s/he cannot serve customer requests in the first time
period as s/he spends time travelling to the new region. The driver in this case serves customer
requests only in the second time period.
6. Consumers decide whether to request service on the basis of proposed price. Finally, the platform
matches consumers requesting service with workers in the same zone who are available to serve

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow
 consumers. All drivers are rational and maximize their respective expected utility or profit (without
discounting) over two periods.

The committee has narrowed down the following list of questions. Answers to these questions may help
the committee to understand the effectiveness of surge pricing in the referred locations. With the help of
the following questions, your committee will submit their report to the director whether surge pricing is
effective in stimulating enough drivers to move Bronx to Manhattan (during the surge period) or it falls
short of bridging the supply-demand gap!

Questions for discussion

1.
a) What are the unconstrained (when supply of drivers is abundant) regular and surge prices in Bronx
and Manhattan? Or alternatively, what is the pricing policy targeted at extracting surplus by
exploiting a customer’s need for a ride?
b) What are the corresponding unconstrained customer demands in regular pricing and surge pricing?
c) What is the revenue of the platform in both periods and across both regions when supply of drivers
is unconstrained? This is referred to as the benchmark revenue.

2. The conventional role of surge pricing is to balance supply and demand. The prices of the rides are
determined in view of the available riders in a region.
a) What is the constrained regular and surge prices applicable in Bronx and Manhattan considering
the supply of the drivers in their respective regions.
b) Do you think the surge price in Manhattan can induce enough drivers to move from Bronx to
Manhattan to meet its demand? How many drivers do you expect will move?
c) Do enough drivers move from Bronx to Manhattan? If yes, the report is good news for the Director.
If no; why do you think that should happen?
d) Can Uber enforce movement of drivers from Bronx to Manhattan to meet the surge demand?
Discuss the possibilities.

The case is developed by Dr. Himanshu Rathore and Prof. Suresh Jakhar for use in the course on Revenue Management &
Dynamic Pricing at IIM Lucknow