Hiding in plain Sight: Surge pricing and strategic providers

Abstract Many on‐demand service platforms employ surge pricing policies, charging higher prices and raising provider compensation when customer demand exceeds provider supply. There is increasing evidence that service providers understand these pricing policies and strategically collude to induce artificial supply shortages by reducing the number of providers showing as available online. We study a stylized mathematical model of a setting in which an on‐demand service platform determines its pricing and provider compensation policies, anticipating their impact on customer demand and the participation of strategic providers, who might collectively decide to limit the number of providers showing online as available. We find that collusion can substantially harm the platform and customers, especially when the potential demand is large, and the supply of providers in nearby regions is limited. We explore two pricing policies that a platform could employ in the presence of (potential) provider collusion: a bonus pricing policy that offers additional provider payments on top of the regular compensation and the optimal pricing policy that maximizes the platform's expected profit while taking strategic provider behavior fully into consideration. Both policies feature a compensation structure that ensures that total provider earnings increase in the number of providers available, thereby encouraging all providers to offer their service. We show that both policies can effectively mitigate the impact of potential provider collusion, with the bonus pricing policy often performing near‐optimally. As it might be difficult for a platform to accurately estimate the propensity of providers to collude, we numerically evaluate how platform profits are affected if the pricing policy is designed based on possibly incorrect estimates of the providers' propensity to collude. Our observations suggest that a platform should design its pricing policy under the assumption that all providers are strategic and consider collusion, as the losses associated with implementing such a policy in settings with minor risk of collusion are limited, while the potential losses from failing to consider rampant collusion can be significant.