The news of the Indian Railways introducing surge pricing for Rajdhani, Shatabdi, and Duronto trains attracted wide media coverage. But another news, coming around the same time, of state-run Hindustan Petroleum Corporation, experimenting with dynamic pricing at its selected retail fuel outlets, didn’t find similar coverage. Both these new items actually give us a peep into what will become a commonplace in our society in a not-too-distant future.
Although recent popularity of the term surge pricing is due to the cab aggregators, the concept itself is not new. It has been practiced for many years now, and is fairly pervasive in markets for both goods and services. In the service industry, the notable examples of surge pricing are (a) peak-load tariffs charged by electricity suppliers and (b) special tariffs charged by hotels during certain times of a year.
In defence of surge pricing
If supply of a service were completely flexible in a short-term, that is, the supply could adjust seamlessly to variations in demand, there would be no need for surge pricing. This would be an ideal situation. In reality, however, the supply side is not that flexible in the short-term. Given an inflexible supply, a fixed price would often result in excess demand or excess supply of a service (demand and supply would match only by accident). Both these situations are sub-optimal. An optimal situation is one where price is flexible enough to match demand with supply. Flexible price may also result in higher revenue to suppliers in case of excess demand and lower revenue in case of excess supply.
In a competitive market, where users have option to turn to different suppliers, competition itself will ensure that higher revenue collected from surge pricing goes to cross-subsidise lower revenue during off-peak period, and that none of the suppliers is able to fleece users. So, in markets where surge pricing is practiced, it is important to ensure that such markets are competitive and that suppliers do not indulge in anti-competitive practices, such as price discrimination based on the users’ profile or tacit collusion among suppliers. This not only brings a responsibility on the government but also requires the government to use sophisticated strategies to monitor and decipher anti-competitive practices.
Surge pricing by Indian Railways
Is there a good rationale for surge pricing by the Indian Railways, which is a public monopoly? Being a public monopoly, the Indian Railways faces no market pressure to either improve efficiencies or reduce fares. It can get away by charging whatever fares it wants to. But being a public enterprise, it is supposed to act in the best interest of its users.
The transportation services provided by the Indian Railways are characterised by fixed supply in the short-run. Introducing surge pricing—10% of fare increase for every 10% of berth sold—on its premium trains is meant to bolster its revenues. It could have doubled the fares on these premium trains but it decided instead to go for a step-wise increase for high-end passengers who have both ability and willingness to pay.
Justification of increased revenues depends on how it chooses to deploy those additional revenues. If those additional revenues end up funding its inefficiencies then probably it doesn’t make sense to go for surge pricing. If, on the other hand, such revenues are deployed to improve passenger amenities in these premium trains then surge pricing is not only justified, but also passengers wouldn’t mind paying more for it. Even so, I think, the railway authorities could have sequenced the introduction of surge pricing better. Had better passenger amenities preceded the introduction of surge pricing, it would have made such pricing more palatable to the public and wouldn’t have invited widespread public criticism as it did.
Surge pricing is not new to the railways. It is already charging different prices for differentiated services depending on passenger amenities. Even for undifferentiated services, it is applying a crude form of surge pricing as is the case with Tatkal rail reservation. But the surge pricing is not as widespread as it could be. Not just in the Indian Railways but also in the metro trains. The fare in Delhi metro, for example, remains unchanged irrespective of the time or day of travel. Compare this, for example, with the metrorail system of Washington DC which has fares for peak hours different from off-peak hours as well as on federal holidays. Further, it has one day pass that is valid for one day of unlimited travel. Similarly, it has seven day pass that is valid for a week of unlimited travel. This is not all, the metrorail discounts fares for school children, the disabled and the elderly.
A sophisticated pricing strategy is one that not only achieves revenue goal but also diverts passenger traffic from peak hours to off-peak hours, and meets certain social goals as well. Such a sophisticated pricing also has an unintended benefit. Guess what? Of making users smarter.
The author is a development economist, formerly with the Bill & Melinda Gates Foundation and the World Bank