I am in the middle of writing a book for managers and entrepreneurs about how to make good pricing decisions for their companies. In conducting research for this book, and thinking about pricing issues, I have been struck, time and again, by just how often pricing concepts can help us answer real-life questions that, at first glance, don’t seem to have anything to do with pricing.

Tokyo Taxi 1 by Damon Jah Flickr Licensed Under CC BY 2.0
Source: Tokyo Taxi 1 by Damon Jah Flickr Licensed Under CC BY 2.0

A few weeks ago I was talking with a woman (let’s call her Heidi) who was considering driving for either Uber or Lyft as a second, part-time job (or for both companies, she hadn’t decided that yet).

Now, to become an Uber or Lyft driver, you need to have a fairly new car (although I’ve been in many Uber rides that were at least a decade old), a driver’s license, a clean driving record, and a smartphone.

Heidi had a lot of questions about which costs she should consider in calculating her net earnings. Her questions were:

  • Should she consider her car payment in the calculation? Heidi currently drives a late-model Ford Fusion. Her car payment is $375 per month.
  • What about car insurance? Should that be added in the calculation? Heidi pays $80 per month for comprehensive car insurance.
  • Should the smartphone expense be considered? Both ridesharing companies require their drivers to have a smartphone. She has an Android phone and pays $15 per month for the phone, and her service plan is an additional $50 per month.
  • What other expenses should Heidi include in her calculation?

Now of course, with a quick online search, we can find articles saying things like drivers in Houston make around $13.25 per hour after covering their expenses. But what expenses should be considered in this calculation? That’s the focus of this blog post.

What Heidi really wanted to know is how much she would earn as an Uber driver after all her costs are accounted for. She said her decision would become a lot easier if she could figure out exactly how much money she would net on average per hour.

Understanding Incremental Costs

At first glance, it may seem that Heidi should include all her costs, her car payment ($375), her phone bill ($15+$50 = $65), her car insurance ($80), and even her driver’s license renewal and car registration fees (I don't know what those are, for Heidi). A car, phone, and car insurance are required to drive for Lyft or Uber.

But doing this would be wrong and misleading.

When making pricing decisions, companies use the concepts of incremental costs and irrelevant costs to identify which costs really matter to their pricing decision and which ones don’t. Any costs that are not affected by the pricing decision and remain unchanged are what pricing experts call as “irrelevant costs.”  The costs that do change or are affected because of the pricing decision are “incremental costs.” Every pricing expert will assert that only incremental costs should be considered in the pricing decision and irrelevant costs should be ignored.

Putting this idea in simpler terms: “If you would spend the money anyway, then the cost is irrelevant, and don’t include it in your pricing decision.

Now let’s apply this concept of which costs should be included in the Uber/ Lyft driving decision. It's very useful.

Heidi will have make have to pay for her car, car insurance, smartphone, and cell phone service plan regardless of whether she drives for Uber/Lyft or not.   For her, these costs are all non-incremental and therefore irrelevant to the decision of whether to drive for Uber/Lyft as a second job. She should totally ignore these costs in calculating her net earnings.

So which costs are relevant?

The only relevant costs are the cost of gasoline and the cost of her Ford Fusion’s wear-and-tear from all the extra Uber/Lyft driving.

We can go online and find out exactly how much this will cost per mile of driving for any specific vehicle. For her 2014 Ford Fusion, the cost is $0.48 per mile for operating the car.

This is really the only incremental cost that matters and the one Heidi should use when she is considering her net earnings from driving for Uber or Lyft.  Strictly speaking, even the cost of her smartphone’s battery usage is irrelevant. If she’s like the rest of us, she would be using her smartphone anyway, whether she drives for Uber or Lyft or not. So it does not count.

So using numbers provided by an Uber driver on his blog, here’s how the math would work out for her.

Earnings for a 30 minute ride:

(8 miles x $0.90 + 30 min. x $0.15) x 1.3 surge + $1.65 Rider Fee = $16.86

Net after Uber’s rider fee deduction & commission (which is 25%):

$16.86 – $1.65 Rider Fee – ($15.21 x 0.25) = $11.41

Expenses:

8 miles * $0.48/ mile = $3.84

Net Earnings for a 30 minute ride:

$11.41 - $3.84 = $7.57

Estimated hourly wages

Assuming she remains busy for 50 minutes per hour (with the remaining 10 minutes down time to find the next ride, etc.), her hourly wages would be:

$7.57 *(50/30) = $12.62

In looking at this issue, there are three more points to consider.

  1. The logic and the calculations would be the same if this were to be Heidi’s first (and main) job instead of her second job. As long as she owns her car and smartphone already, their payments shouldn’t be included in the per hour wage calculation.
  2. This earnings estimate for Heidi is the "before tax" estimate. Obviously, she would have to pay income taxes on her earnings to her state (if applicable), and the federal government. (No social security tax because this is her second job).
  3. For someone who doesn’t own a car, or has to buy or lease one just to drive for Lyft or Uber, the economics of driving will be dramatically different. They will earn a lot less money per hour because the lease rate (on a per mile basis) will be an additional cost in the equation. It could add $0.15 per mile or more depending on which vehicle is leased.

The Main Takeaway

The concepts of incremental and irrelevant costs are useful when thinking about any life decision that involves spending money upfront or on an ongoing basis to earn money. When considering costs in any decision, you should only consider costs that are incremental to the decision and ones that will change depending on what your decision is. If your costs are not affected by the decision and would be incurred anyway, then they are irrelevant and should be ignored, even when it seems like they should be included.

About Me

I teach pricing and marketing to MBA students at Rice University. My forthcoming book is The Value Pricing Framework: A Guide to Making Good Pricing Decisions for Managers and Entrepreneurs. You can find more information about me on my website or follow me on LinkedIn, Facebook, or Twitter @ud.

You are reading

The Science Behind Behavior

Should You Become an Uber or Lyft Driver?

The economics will vary dramatically depending on your incremental costs.

When Does Pay What You Want Pricing Work?

It can be effective for last-minute sales & to raise money for charity.

What's the Difference Between Optimism and Hope?

Both are beneficial, but they affect our life outcomes in different ways.