Why Swifties, holidaymakers and the hygienic should cheer for surge pricing

11th April, 2024

The “Wendy’s Dave’s Triple” is a fast-food offering that stacks two possessives and three hamburgers. I am not sure how easy it is to swallow in either regard, but what has really been sticking in people’s throats is the prospect of surge pricing at the Wendy’s fast-food chain. 

A few weeks ago, the new CEO of Wendy’s announced that the company would be installing new digital menu displays that would allow “dynamic pricing” — that is, changing the price of products in real time. A minor backlash erupted, and Wendy’s patiently explained that they would, of course, not be charging higher prices in busy times. Instead, they might be charging lower prices at quiet times, which is a distinction to ponder.

This is by no means the first such drama. A quarter of a century ago, Douglas Ivester, then chief executive of Coca-Cola, mused about vending machines that would raise the price of Coke on a hot day. He quickly backtracked after an outraged response, although reportedly these vending machines are the latest trend in Japan, so the brilliant Mr Ivester was merely ahead of his time.

Not only is dynamic pricing unpopular, there is even an argument that it is illegal. One legal scholar, Ramsi Woodcock, argues that surge pricing (dynamic pricing by a less popular name) violates US competition law and that the courts should ban it.

I disagree. There is a danger that dynamic pricing might blunt competition by making price comparisons more difficult. But consumers are already so irritated by the practice that the risk is not that we have too much dynamic pricing, but that we have too little.

The basic case for dynamic pricing is simple: it’s the same as the case for the price mechanism in general. In most markets, people are keen to sell when the price is high and buy when the price is low. And at the right price, supply and demand match perfectly.

If the price is either too high or too low, then there are missed opportunities to trade. We might see a queue of eager buyers but shortages of products to buy. 

The most obvious cost of such mismatches is the queue. If I credibly promised to give away £20 to everyone who formed an orderly line in Piccadilly Circus, people would keep joining that line until it was so long that people were being paid £20 to queue for £20 worth of time. I would have achieved the self-defeating miracle of giving away a small fortune without managing to help anybody except the lucky few who joined the queue early.

The same logic applies if I was offering any product or service at £20 below the market price. The time wasted by the queue incinerates the potential value of the bargain, and what the seller loses, the buyer fails to gain.

Of course, not every underpriced product is rationed by queue. Some are rationed by political or social connections. Some are rationed by chance. That is also inefficient. Maybe it’s a rainy night, and everyone would like to get an underpriced taxi home, but only some people also have the option of catching a bus? Those on the bus route are just as likely to get lucky with a passing cab as those who face a five-mile walk in a downpour. If the taxis were more expensive and hence less scarce, those with the choice of catching the bus would be more likely to take it. 

That is the case for the price mechanism in general. But what’s true for prices in general is also true for the price of hotels on the weekend that Taylor Swift is playing a concert in town, of flights on the first day of the school holidays and of toilet paper in the first week of a pandemic. If the price doesn’t adjust, then the result isn’t efficient. Nobody likes to feel that they are being ripped off (so the haters gonna hate) but a sharp increase in the prices of these products would immediately produce the kind of adjustments that any reasonable person would want. If Taylor Swift is playing in Seattle one weekend, it would be a good idea for people who aren’t Swifties to holiday either on a different weekend or in a different city. 

You can tell a similar story about childless holidaymakers, and for people who already have spare toilet paper but might as well pick up more just in case. We are outraged that the price increase squeezes more money out of people who are keen on Taylor Swift, a late July getaway or a clean bottom. We tend not to realise that the price surge gently encourages those who can make alternative arrangements to do just that.

Little rides on the nothingburger question of whether Wendy’s might vary the price of junk food. But if more supermarkets used digital labels to vary the price of food, shifting food near its sell-by-date and warding off shortages of hotly demanded produce, the world would be a less wasteful place.

And there is a market in which the fate of the planet turns on dynamic pricing, namely electricity.  Electricity demand varies a great deal depending on the weather and the time of day, and increasingly electricity supply also fluctuates depending on the sun and the wind. The cost of offering customers a static price for electricity is enormous: it requires huge overcapacity in general, and overcapacity of fossil fuel plants in particular, because gas turbines are well suited to coping with brief spikes in demand.

Part of the solution is obvious: encouraging electricity users or their smart devices to draw less power at peak times, and batteries or other forms of energy storage. The basic way to fund storage? Allow the battery to buy electricity when it’s cheap and sell it back to the grid when it’s expensive. All this is much easier with dynamic pricing. We have a planet to save, after all.

Written for and first published in the Financial Times on 15 March 2024.

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