Dynamic pricing by Indian Railways- Story of a failed experiment

Railway reserved berths are always a scarce commodity in India. Trains are always fully reserved and waiting list is long. Indians have accepted this as a fact of life and decided to move on and behave accordingly.

An economist would tell us that,in a Capitalist economy, when the goods are in short supply and demand is rising, the price will move northward thereby leading to drop in demand and hence equilibrium will be established.  In a Socialist economy, scarcity leads to goods being rationed, by consumers in long queue or in many cases goods will be allotted to people who are lucky (by lottery), or influential (by discretion) or robbing. (by corruption or nepotism ).

Recently, Railways started Dynamic Pricing (DP) mechanism on pilot basis in selected routes / trains. Our conventional wisdom says that it should be very successful and would have contributed much to the bottom line of Railways. However, it failed largely and many seats  under this DP route remained vacant. Neither passenger could travel nor railway got money. It ended up as lose –lose proposition.

Going for DP may have an economic rational, but I call these kind of proposals as Theory induced blindness.  Advocates of this pricing mechanism had forgotten certain behavioural aspects of rail passengers and how much they are willing to pay for a service in a particular context.

For decades together, we had an under supply of railway berths and we internalised that fair and just way of allocation is either through queue or through discretionary allocation. DP for railway ticket is not seen as just and fair. Let us try to understand this conundrum through various ideas and concepts of Behavioural science.

1) Utility calculus -

Nobel laureate Richard Thaler had brought the idea of two types of utility, a) Acquisition utility and b)  Transaction utility. Acquisition utility is the one which we are already familiar in Micro Economics.Transaction utility is the difference between price one is normally expected to pay ( ie normal ticket price)which is one’s reference price and the price one actually pays( ie, DP ). For a passenger who booked it under DP, this transaction utility is always negative, as he paid higher price than the normal price.  And so, the whole deal stinks for him.

People who travel in flights are very well aware and adapted to the market based pricing. They consider it as cool to the idea of paying a higher price during peak season /busy route and vice versa.  Since there is no reference price here, one simply can’t calculate the Transaction utility and hence one is happy with a positive Acquisition utility. So, according to his perception, the deal is always favourable.

2) Endowment effect and Loss aversion-

Railways always have a published ticket prices which is acting as a reference point and anything above that price is seen as ‘Loss’. Passengers feel entitled to a particular ‘Terms of the trade’ (ie ,selling ticket at normal price’) which they have accustomed to, and any deterioration from that terms of trade is considered as a ‘Loss’. This feeling of ownership of the conditions is what is seen to have unilaterally violated by Railways by starting to charge more.

3) Sitting next to me, he paid far less?

On further analysis, it seems that it is not just the Dynamic pricing or higher prices that irritates the passenger more, but different set of criterion and rules for different people. In a flight, everybody knows that all the passengers pay different prices, yet nobody feels cheated as all follow the same criterion (of dynamic pricing). Yet in case of railway, a majority people pay a prefixed, lower rate, and few others pay a far higher price for the berth inventory that has gone under DP.

Moreover, a typical flight travelling time is around 2 hours and passengers normally don’t talk about ticket prices hence nobody can know what others paid. People feel they‘lost money’ only when they compare it with others and when they came to know that others paid less for the same.  In a railway journey, passenger often talks openly about the money they paid and hence the man who paid more than the ‘normal’ price, is looked down as a ‘victim of the circumstance’.

Railway may have earned a small fortune due to this pricing policy, but it lost a large amount of goodwill amongst the consumer because of this. It was portrayed as rapacious baniya who is exploiting a ‘good famine’.

4) Why seats go vacant- Ultimatum game-

Consumers are always ready to take a financial hit ( by not travelling or booking flight ticket etc) if they feel that the deal is unfair and thereby punishing the proposer ( ie Indian Railways)  who sells ticket at higher price, by not booking and hence seats remaining vacant. Psychologists refer these kinds of engagement as Ultimatum game and its findings are very clear. People are least willing to accept unfair offers and for proposers, such offers always results in loss.  So is the seats going vacant.

The suggestive reforms in this direction are the following.

a)      It may completely do away with DP.

b)      If it wants to continue DP, it may earmark a whole compartment for dynamic pricing rather than a few seats in each compartment. They can call it as a separate ‘Premier compartment’.

c)       This compartment may be ‘discriminated’ in its favour by having more cleaner toilet, extra cushiness for its rexin or an additional meal/snacks etc to make feel passengers that they are a special customers to be pampered with,  as they paid more.

Learning lesson for Railway-

 DP should be introduced only in a competitive market economy where there are a large number of players competing against each other and people can choose between them and where there is no benchmark price. In a monopolistic market, DP will be seen as greedy and abuse of its monopolistic position. If not reversed immediately, this insensitivity to the norms of fairness could be particularly costly to IR s long term reputation.