Indirect Spending and Uber's Self Interested Surges

The farther people get away from handing over cash, the less inclined they are to count their dollars closely.  Nowadays stores need to accept credit cards because very few people carry sufficient amounts of cash, but when stores started to accept credit cards and agreed to pay the fees it was because they realized that customers would buy a lot more when cash didn't change hands right away and utilizing a credit card was more convenient than offering and managing store credit. Academic studies have long found this to be the case as well. The introduction to a 2001 paper by Prelac and Simester, Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay, lays out some of the history.

"Since the 1970's there has been growing evidence supporting the frequently heard conjecture that credit cards encourage spending. For example, it is known that peoplewho own more credit cards make larger purchases per department store visit (Hirschman  1979), and that restaurant tips are larger when payment is by card (Feinberg 1986). There  is also evidence that credit card users are more likely to underestimate or forget the amount spent on recent purchases (Soman 1999). Perhaps the most compelling evidence, however, is that offered in an experimental analysis of the effect by Feinberg (1986). In that investigation participants were asked how much they would be willing to spend for various consumer products in a setting where credit card paraphernalia ostensibly unrelated to the task were displayed on the experimental desk. He found that by so decorating the experimental setting, he could boost hypothetical willingness-to-pay estimates by 50± 200%, relative to the estimates of a control group. We refer to this increase as the credit card premium."

If the mechanism for increasing the willingness to pay isn't liquidity but the indirect nature of the transaction, then making the transaction even more indirect should increase the willingness to pay even more. It's a large part of why subscription models and cellphone based payment systems are so popular these days. Consumers like the convenience and companies like the additional spending. The most talked about startup taking advantage of indirect spending is Uber, in which consumers just call a car on their phone and don't have to deal with inputting their credit card after the first time. They don't even have to look at the final price of the service as they leave the car if they don't want to look at their phone - the bill still settles.

However, things sometimes come to a head when the indirect spending is so high that consumers feel ripped off afterwards. Uber calls their prices during periods when supply is low relative to demand "surge pricing."  After NYE and a few snowstorms, times when prices need to rise for supply to meet demand, the consumer hangover has been enough to generate articles about the issue in the NYT  (Hat Tip: Huey K), among other places. Uber's justification is that without their dynamic pricing there would be shortages. But as the NYT mentions, an entity moving pricing up and down to accommodate demand in real time is very different from facilitating a real market where the bidding price of the consumers and the asking price of drivers are transparent to each other. Exposing just how much a price increase brings in new drivers would go a long way towards reducing consumer anger over high prices.

And given that Uber takes a 20% cut of their 7x surge prices (Lyft's cut remains the same when they raise prices), they are anything but a disinterested broker trying to optimize supply and demand - surges mean profits. The combination of consumers being disconnected from the payment process and pseudo monopoly pricing power is a dangerous one, as many people have found out the day after NYE. Frequent users of Uber should hope that competitors such as Lyft remain viable in the face of Uber's price cuts to their discount service. It would be interesting to see how profitable a business utilizing convenient indirect payments could get in the absence of effective competition.