The future of pricing
How do we know what something is worth?
Dear Friends,
My friend Hugh and I are hosting a winter cycling camp in Oaxaca from February 17-23rd. While it's raining and snowing in the United States, a fun group of cyclists will come down for a week of riding, sunshine, mezcal, and Oaxaca’s famously delicious cuisine.
We’ve been planning it for a while but didn’t know how much to charge. Since we're doing this mostly for fun, we tallied our expenses, added 10% for cushion, and settled on $1,800 per person.
“Wow, that is really cheap!” has been everyone’s reaction. They particularly can’t get over that the price includes post-ride massages, even though it is one of the smallest expenses in our budget.
I wasn’t sure how to price our trip and I wasn’t really out to make money. Mostly, I wanted to see if cycling tours in Oaxaca is something I’d like to pursue further. Then I started looking around. Modern Adventures charges $6,000 for a typical trip to Oaxaca (which I could easily organize for less than $1,000). Backroads doesn’t have any cycling trips in Mexico, but they have something similar in Chile that costs between $6,500 - $9,000 per person.
That blew my mind. How do they get away with charging so much and what is their margin? Should we be charging that much?
Why Uber scrapped surge pricing, but not really
“How do they get away with charging so much?” is a common refrain these days, especially as prices quickly change. It prompted Kamala Harris to accuse grocery stores of intentionally limiting supply to raise prices. It caused the UK’s Prime Minister to express outrage when Oasis fans waited for hours to buy tickets advertised at $200, only to see them jump to $400 due to Ticketmaster’s dynamic pricing policy.1 And it’s behind the Justice Department’s lawsuit against RealPage for providing landlords with information about the maximum rent they could charge at any moment.
Airlines have used dynamic pricing — charging more during peak travel periods — for decades without pushback. But when Uber introduced "surge pricing," explaining to users that fares were higher due to increased demand, people balked. The choice between paying $80 for an immediate ride home from the airport or waiting half an hour for a lower fare annoyed customers. They hated knowing they could pay less by waiting... but they didn't want to wait!
Surge pricing proved so unpopular that Uber and Lyft switched to a new model that is less transparent but more popular. In the new model, they don’t provide context about price fluctuations. Instead, they charge riders based on what they think they'll pay and offer drivers a rate based on what they think they'll accept, pocketing the difference.
Under the old model, drivers received a fixed percentage of the fare, which increased during periods of high demand. In the new model, they separated what the rider pays from what the driver earns. And they stopped explaining price fluctuations. The new model is more profitable for the companies and more popular for customers, even though riders pay more and drivers earn less.
We can expect other companies to follow Uber’s model to maximize their profits without explaining their prices, including media subscriptions.
How much should I charge for a newsletter subscription?
I’m joking! I’m not going to charge for my little hobby newsletter. But if I were as talented and committed as Matthew Yglesias, I could earn more than $1 million a year in subscriptions.2
When Yglesias left Vox3 to start a newsletter on Substack, he didn’t know how much to charge, so he went with his gut: $8 a month or $80 a year. But I only pay $48 a year because I waited for a discount. This, too, is price discrimination, but no one is accusing Yglesias of price gouging those suckers who pay the full rate. In a post about “the coming world of ubiquitous price discrimination,” he writes:
In fact, a lot of price discrimination is implemented this way. If you order McDonald’s through the McDonald’s app and click over to the “Deals” tab, you’ll see various coupons on offer with some variation across time and place. But one coupon that’s consistently there is “20% off any purchase of $10 or more.” Which really just means that the real McDonald’s price is 20 percent lower than the list prices.
(I had no idea! Next time I visit McDonald’s, I’m downloading the app.)
Yglesias’ larger point is that people likes dynamic pricing when they think they’re getting a deal. As long as you can keep it a secret from those paying the higher price, it seems to benefit everyone.
The upsides of dynamic pricing
No one seems to mind that the cost of flights varies depending on demand. But the idea of paying more for chicken at Kroger during high demand riles them up:
The Economist defended the unpopular notion that “In an ideal market, prices reflect the willingness of consumers to pay.” I tend to agree, though I understand the psychology of why people hate it. Here in Oaxaca, I overpay all the time. I’m certain that the woman who sells me avocados at the local market charges me more than others, but they’re still a bargain compared to California prices. Some people complain that foreigners drive up food prices in Oaxaca, but in reality, foreigners pay premium prices while local vendors make more money. Dynamic pricing is as old as haggling, though it remains unpopular.4
As for me, if I keep organizing winter cycling tours in Oaxaca, how will I decide whether to charge $2,000, $4,000, or even $8,000? Should I only target those who can afford premium rates? Or should I offer discounts to cyclists who would like to join but can’t afford the full price?
My guess is that dynamic pricing becomes the norm. Just like landlords and retail stores use AI software to optimize pricing, customers will counter with apps like Karma to find the best deals. Affluent shoppers will drive up inflation by paying more than necessary. Meanwhile, budget-conscious buyers will hunt for discounts and digital coupons, ultimately paying less. We'll live in a world of varied pricing, which may annoy some but benefit the greater whole.
🧰 A useful tool
Thanks to my robot editor, Claude. For $20 a month, I get access to its Projects feature, allowing me to train my robot editor to provide personalized feedback based on my instructions. For those interested, Jacob Anderson has published a handy how-to guide. Claude said some nice things about this week’s newsletter, but nudged me to:
👏 Kudos
Kudos to the impressive cyclists who completed the grueling 500-mile Badlands gravel race in Southern Spain. I’d love to give it a try next year. Who’s down?
🎵 A sticky song
Speaking of Spain, I can’t stop listening to Bang by the Spanish group Melenas. I’ll see them live next month in Mexico City at KEXP’s El Sonido Live show. Let me know if you’ll be there.
Have a great weekend!
David
Harris isn’t the only one flirting with price controls; Starmer promised: “We’ll grip this and make sure that tickets are available at a price that people can actually afford.” Meanwhile, after seeing the demand (and how much money they’ll make), Oasis decided to add two more shows, which will likely lead to cheaper tickets overall.
Heather Cox Richardson reportedly makes more than $5 million from her Substack!
Where I’d guess he made around $250,000 per year
In Finland and Switzerland, traffic fines are based on the driver's income. Last year, a Finnish multimillionaire was fined $135,000 for driving 30km/h over the speed limit. His response? "It's how it goes." Such income-based policies would be a tough sell in the United States, where it's acceptable for CEOs to earn 350 times more than their typical employees, but not to charge more than a 28% tax on capital gains.
OK the Oaxaca cycling trip looks like a dreamy wonderland of a week! I'm seriously considering although the Oct 31 deadline and price sounds tough, the website and photos are so enticing. Question: how many miles do you think you'll cover in a single day?
Another area where dynamic pricing is spreading is in energy prices.
"Time of use" (TOU) pricing is where utilities divide up the day into periods, often called "on-peak" and "off-peak" or some variation, and charge different rates for energy consumed during different times. "On-peak" hours are often 6pm-9pm on weekdays, when wholesale energy prices, and the stress on the grid, is highest. Under TOU, consumers are properly incentivized to shift their consumption to off-peak hours. Rather than running my dryer at 7pm, I'll run it late at night or early in the morning to avoid paying higher energy prices. This benefits me as the consumer, but it also helps the grid.
TOU has climate & health benefits, too; some of the dirtiest (and most expensive) sources of energy are peaker plants, which are dispatched only in the most desperate times when load demand is spiking. If you can avoid turning these on by shifting demand to off-peak hours, you emit far less carbon and harmful air pollutants.
People tend to dislike TOU pricing and prefer flat rates. Flat rates distort the true cost of energy, though, and I think it's good for pricing to reflect true costs and provide more information to consumers.