An ‘Uber’ Problem for Cities: Balancing Innovation with Regulation

Travis Kalanick is no stranger to corporate fisticuffs. The tech entrepreneur brought down the wrath of the film and music industries after starting a peer-to-peer service in 1998 called Scour, which was similar to Napster in that it allowed consumers to swap digital media files with each other. Two years later, filmmakers and TV producers sued his company for copyright infringement to the tune of $250 billion. Scour went out of business.

Kalanick later developed a content delivery system that he called his “revenge business” because, ironically, some of his former entertainment industry foes ended up becoming clients, according to a February article in Fortune. While this company, Red Swoosh, initially ran into financial problems, it would be sold for $15 million to Akamai Technologies in 2007 — but not before Kalanick became so destitute that he had to move in with his mother. Fortune described the 30-something UCLA dropout as “brilliant,” but “brash and headstrong” and “happy to charge off a cliff with an innovative idea.”

He seems to be charging headlong off that cliff again with his latest venture, Uber. The three-year-old San Francisco start-up provides private car service — mostly using a fleet of higher-end vehicles, including sleek black Lincoln town cars but also taxis — to customers who love the site’s white-glove service and do not mind the premium pricing. Riders summon the cars using a smartphone app. But the company also has attracted the ire of municipalities such as New York City, San Francisco, Boston, Washington, D.C., and Chicago. Officials in those cities say Uber’s service runs afoul of local rules designed to ensure pricing transparency and public safety, among other allegations. Moreover, Uber is also fighting a lawsuit filed by taxi companies.

Recently, a task force of the International Association of Transportation Regulators representing 15 U.S. and Canadian cities said it is planning to release a set of guidelines aimed at reining in smartphone livery services such as Uber, a recent article in The Wall Street Journal reported.

And that’s a shame, according to Andrea Matwyshyn, a Wharton professor of legal studies and business ethics and an Uber fan. “It is one of the most innovative technology companies to come along in a long time,” she says. “It is one of the darlings of Silicon Valley.”

Uber is striving to modernize an entrenched industry and bring it, however reluctantly, into the digital age. The site has harnessed the power of collaborative consumption to match available car seats with willing riders, efficiently and in real time, using a mobile app. It also employs dynamic pricing that fluctuates depending on the supply of cars and rider demand. After a ride is ordered on its app, a map pops up showing the vehicle’s location and estimated time of arrival. The user sees the driver’s face, phone number and customer rating. Once the ride is over, Uber charges the user’s credit card, including a 20% tip. The receipt is emailed. There is no fumbling with wallets in the dark, no waiting for change and no need for lightning-quick mental math skills for calculating gratuity.

There are plenty of Uber fans, but many city governments are not amused. In Chicago, the site is facing both a regulatory crackdown and a lawsuit. Matwyshyn suggests that cities are treading dangerous ground. “If Chicago wants to send a message that it is tech-friendly, regulating a company such as this in an arbitrary way and allowing traditional constituents like the taxi lobby to win the day can be read by outsiders as a climate hostile to technology entrepreneurship,” she says. Moreover, cities are sending mixed messages to tech entrepreneurs if municipal officials are investing in building office space for them and offering financial enticements at the same time that they are cracking down on companies like Uber, Matwyshyn adds.

Officials, on the other hand, say they have to obey the law to ensure public safety. “It is understandable that people don’t like to have regulations meddle with their daily lives, but regulations are used to make sense out of chaos and to protect the consumer,” wrote Washington, D.C., taxi commission chairman Ron Linton in a Washington Post editorial that appeared in January. Linton organized a sting operation earlier this year by hiring an Uber vehicle and then fining the driver for multiple violations, including not disclosing an hourly rate before the ride starts as the law requires.

Indeed, Uber passengers do not know the final cost of the ride until after it is over because the service not only takes into account the distance and duration of the trip, but also uses dynamic pricing in which rates change depending on supply and demand conditions. Such a fee structure, among other things, has lit up the web with consumer complaints. A two-mile trip from the Upper East Side in Manhattan across Central Park to the Upper West Side one recent weeknight showed rates starting at $27, with a multiplier of 2.5 due to high demand. Taking a cab for the eight-minute trip would have cost less than $10, although the rider would have had to settle for a car with less panache. “This isn’t a company for everyone, the same way that high-end chocolate isn’t for everyone,” Matwyshyn notes.

Uber’s “surge” pricing is the subject of lawsuits, more due to lack of transparency than the prices themselves. In Chicago, taxi and livery services companies are suing Uber for consumer fraud and other allegations. The city of Cambridge, Mass., is suing for illegal use of GPS technology to gauge mileage and time spent in Uber vehicles as a way to calculate fares. Only U.S. government-approved, installed taxi meters can be used. This is one of the rules being advocated by the international regulators group.

But there is a case to be made for dynamic pricing, according to Shawndra Hill, a Wharton professor of operations and information management. “I think it is fine as long as people are willing to pay. It’s not like there aren’t alternatives,” she says. “It’s a great example of applying new technology to predict demand in an old industry.”

Here is Uber’s own explanation of its pricing structure: “[Employ] fixed or capped pricing, and you have the taxi problem on NYE (New Year’s Eve) — no taxis available with people waiting hours to get a ride or left to stagger home through the streets on a long night out. By ‘raising’ the price, you ‘increase’ the number of cars on the road and maximize the number of safe and convenient rides.”

But a common complaint among users is the sticker shock that they get after seeing the bill once the ride is over. Asked to explain why Uber is not more upfront, CEO Kalanick told TechCrunch.com in August that “people don’t like high prices. That’s just a natural thing. But we’ve made it pretty clear at this point…. People have to take responsibility for purchases.”

An attitude that puts economics and technology first has grated on consumers and established institutions, such as the transportation industry, that Uber wants to disrupt. Rivals including Hailo and Limos.com are learning from Uber’s missteps by starting a dialogue with municipalities to figure out how the businesses can operate legally in the area before launching a service. “Our approach is not confrontational,” Hailo chairman Ron Zeghibe told DCist.com in September. “You need to work with the powers that be.” Wharton’s Hill agrees: “Do first, ask forgiveness later? That’s risky.”

Uber should have started out by holding dialogues with officials and enlisting the help of intermediaries who know the market and have deep connections to handle the human relationships, Matwyshyn says. “Things go more smoothly when you have a buy-in by all relevant constituents,” she notes. “There is respect [one bestows] by acknowledging the existing [political and business] structure.”

But Uber has at least one high-profile government supporter: FCC chairman Julius Genachowski. In a speech on broadband policy in Washington in September, he said regulators must do their part to encourage competition and innovation and not “erect roadblocks.” He took pains to mention Uber. “There’s a debate right now in Washington about rules that could discourage the innovative on-demand car service company Uber. Not hard to guess which side I’m on — I’m on the side of innovation,” the chairman said.

Ask First? Or Apologize Later?

So why did Uber choose not to approach city officials first and perhaps avoid the legal hurdles? “They were concerned it would be too slow and regulators might very well say ‘no,’” suggests Kevin Werbach, a Wharton professor of legal studies and business ethics. Cities such as New York contend that Uber might not be operating legally because the company violates several cab regulations, which ban pre-arranged rides, automatic charging of tips and refusal of fares even if the taxi is en route to pick up someone else. Uber discontinued its taxi service in New York, but kept its higher-end fleet.

“Start-ups in that situation need to decide whether to work inside the system or try to disrupt it,” Werbach says. “There is likely to be a tradeoff between peaceful coexistence and speed of deployment. One option, sometimes, is to partner with an establishment player.”

Uber’s response to these hurdles includes trying to enlist the help of its customers. “Sign our petition!” it said in a recent blog post as Chicago’s proposed regulations threatened to ban Uber’s black car service. “Save Uber in Chicago!” As for the lawsuit filed by taxi companies in the same city, Uber said in an October blog post that its technology platform “is and has always been legal in Chicago, and despite another transparent attempt by the taxi industry to shut down transportation alternatives, Uber will continue to offer its application to connect Chicagoans to high-quality transportation providers.”

But such clashes can be examples of “tech entrepreneurs leading with their technology instead of their people skills,” Matwyshyn says. “While that works easily in the San Francisco and Seattle market, it doesn’t work as well in less tech-savvy markets, such as Chicago, Washington, D.C., and New York.” Indeed, Uber has a strong fan following in the Bay Area. “For techies in the San Francisco area, Uber is a godsend,” Werbach notes. “They often have money, and these are services they can write off” on their taxes.

Uber CEO Kalanick, too, has intimated that some cities just do not get it. “We did the best we could to get more yellows on the road but New York’s TLC (Taxi and Limousine Commission) put up obstacles and roadblocks in order to squash the effort,” Kalanick wrote in an October blog post to announce that Uber was ending its taxi service in the city. “In the meantime, you can try UberTAXI in more innovation-friendly cities,” such as Boston and Toronto.

Former New York taxi commissioner Matthew Daus, who is leading the effort for the regulators’ task force, bristles at characterizations that city officials want to impede innovation. He told the Journal that “regulators really resent being branded as cronies and anti-technology. It couldn’t be further from the truth. But they have to do their job and make sure it’s safe, customers aren’t being ripped off and people aren’t being hurt.”

Meanwhile, Wharton management professor Ethan Mollick says disruption has a good and bad side. “Creative disruption is good, but old structures exist for a reason,” he notes. In some situations, “there are things you should look for besides inefficiency.” In public transportation, for instance, regulators also have to guard riders against such offenses as a driver’s racial bias in picking them up or the driver’s refusal to drive to certain neighborhoods. “Silicon Valley can overlook these things” when developing a new product or service, Mollick adds.

In the end, however, cities have to realize that their roadblocks are temporary at best and that there is no stopping innovation, Mollick states. If Uber does not succeed, Mollick predicts that there will be another company to replace it. The next level of tech start-ups will learn from the first movers and make the service work. He notes that Pandora and Spotify have learned from the mistakes of other music-sharing tech companies that ran afoul of the recording industry.

“If it’s not (Uber), it will be somebody else,” Mollick says. In the long run, “bullying won’t work.”

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