Uber’s Unique Type of Market Clearing
Uber’s Plan to Lose Money on Each Transaction and Make It Up in Volume, Annotated
The article tries to explain Uber’s unique business model and offers an analysis to why it might not be sustainable in the long run. The optimality of market clearing prices is defined as “prices: For any set of market-clearing prices, a perfect matching in the resulting preferred-seller graph has the maximum total valuation of any assignment of sellers to buyers”. Uber says that their plan is to “choose to use incentives, such as promotions for Drivers and consumers, to attract platform users on both sides of [their] network, which can result in a negative margin until we reach sufficient scale to reduce incentives” and that they will generally choose to match these incentives, even if it results in negative margin, to compete effectively and grow their business”. The writer argues that it is one of Uber’s tactics to engage in price wars and see if they could drive their competitors out of business. It is because in-order to match these incentives, it would cause Uber a lot of money and put them in at a big loss. In short, the article believes that Uber is trying to do this so that their competitors will eventually stop selling their products below cost.
This links to the concept of market clearing prices. In this specific scenario, the buyers and sellers of the service are the passengers and the drivers. The drivers being the sellers and the passengers ordering the service being the buyers. The article perfectly summarizes this transaction between the buyers and sellers as:
Some platforms let sellers and buyers name their own prices — eBay, for example — but one of the functions Uber provides is setting ride prices. Uber has two core goals when it sets prices: One is to ensure that there are roughly equal numbers of buyers and sellers in any given place — there should be enough drivers to serve the people trying to call an Uber now, but not so many drivers that they mostly sit idle — and the other is to set a wide-enough spread between fares and driver pay so that Uber makes a profit.
Normal business models would increase the price of the service when demand is greater than supply and lower the price to the “sellers – drivers” when the supply is greater than the demand; however, Uber’s tactic is different. Uber aims to incentivize the both the sellers and buyers through ensuring “enough supply (“driver incentives”) and cut consumer prices to generate enough demand (“consumer discounts”). That is, Uber gets the market to clear by selling below cost; it focuses on clearing the market and sets aside the goal of making profits”.
This is very interesting to see. Uber is actually trying to incentivize both their sellers and buyers to create a perfect matching which produces the maximum possible sum of payoffs to all sellers and buyers. Although Uber maximizes both the payoff for the sellers and the buyers, the cost of maximizing the payoff results in a tremendous loss for Uber. This method of clearing the market is ineffectively and costly. There has to be a better tactic to clear the market. Perhaps a new algorithm or putting less into incentivizing both the sellers and buyers. However, I have to admit that it is very difficult, especially with so many competitors out in the market such as Lyft trying to undercut Uber. Although the market is cleared, Uber is not able to get any of the benefits and instead is the one “paying” for the market to achieve market clearing. This is definitely unsustainable, therefore, maybe market clearing shouldn’t be Uber’s main goal. Or even if it is important to clear the market, in-order to achieve a bigger picture or reach a long-term goal, maybe a better algorithm can help.
http://nymag.com/intelligencer/2019/04/ubers-plan-to-lose-money-on-each-ride-make-it-up-in-volume.html