Pricing Redux: Customers Behaving Better

Congestion pricing is not, despite its name, the cost of Sudafed at your local Walgreens pharamacy or Boots chemist. It is a time-honoured strategy for charging different prices at different times based on "congestion" in the system. If anyone has driven on the Singapore airport toll road, or perhaps Israel's High-Speed-Lane into Tel Aviv, they know that you pay more, often much more, during rush hour, than in off-hours. For example, the Israeli  road charges 7 NIS (~$2 USD) for the 13km stretch in off-hours, and up to 75 NIS (~$21 USD) during peak hours.

In theory, congestion pricing is about smoothing the flow. During certain times, there is much greater demand for a particular product or service, more than there is available. Charging people more induces them to move to other, cheaper times, unless they really have to use it right now. Airlines do something similar. Monday morning flights on commuter routes - NYC-Washington, or San Francisco-Los Angeles - will always cost more than taking the same flight at 2pm or an a Saturday morning. Business travelers, who earn money from being there at a specific time, pay the premium; leisure travelers are more than willing to sacrifice the time and convenience for the much lower price.

But it is important to understand the value motivations underlying "congestion pricing" as well. By saying, "I am willing to drive this toll road at a later hour because it is so expensive right now," I am really saying, "the value of this road to me at this time is less than what you are charging, so I am unwilling to pay your price." Put in other terms, it is a time-based form of value-based pricing, or price discrimination. Note that discrimination (at least in this context) is not a bad term. It simply means that I can discriminate between two customers. Customer A views my product as worth $20, customer B views it as worth $10. If it were just a stack of paper at the local office supply store, I would have no choice but to charge both of them $10, losing an additional $10 in potential profit from customer A, or charge them both $20, and lose customer B entirely. If I can somehow charge each of them a different price, i.e. discriminate between them, I can earn a total of $30 - $20 from A and $10 from B.

It is rarely mentioned, because the term "congestion pricing" is normally used in the context of a public good or service, even if privately provided, but congestion pricing is time-based price discrimination. We charge you more because it is worth more to you, we charge the other person less because it is worth less to them. People rebel against the idea of charging them more on "their" "public" roads, and so we describe it as smoothing out the traffic. It is, indeed, a benefit of congestion pricing, but it is not the core principle underlying it.

Sometimes, the question is not, "what price do I charge my customers," but rather, "how can I charge the optimal price to each customer?"

In a follow-up, we will look at the positive motivators (rewards) system being explored by a Stanford University scientist.