By John Colley
This article assesses the necessary conditions for effective platform strategy by considering the evolution of the ride hailing industry and Uber’s late entry to China. Conclusions include the consequences of being slow in markets dominated by network effects and the importance of local knowledge and connections. Attrition-based competition may arise as a consequence of the ease of raising funds.
After just two years in the Chinese ride hailing market, Uber chose to leave after losing undisclosed sums by at least $2Bn. Uber was a late entrant to China in 2014. Following a battle with incumbents Didi Chuxing, it was forced to negotiate an exit due to mounting losses and increasing shareholder pressure. The Chinese Uber position was sold to Didi Chuxing in return for 17.7% of their business. It remains unclear whether this holding ultimately has any real value. At that time, Uber CEO Travis Kalanick was also Chairman of the Chinese operation and had a personal interest in the business. In 2017, he was subsequently unseated as CEO of Uber following a plethora of PR and legal crises. Business strategy was also a significant concern. Since the exit from China, Uber has similarly withdrawn from Russia and South East Asia. The battle in India with Ola is also resulting in major losses and there are unconfirmed reports of negotiations there too.
What can be learned from this debacle about both “platform strategy” and “doing business in China”?
What does this tell us about leadership in a Silicon Valley business world awash with cash, where raising funds appears easier than generating profits?
China’s taxi market
In China, Uber’s real problem was their late arrival and competitors’ consolidation to form a powerful coalition of Didi Dache and Kuadi Dache from which emerged Didi Chuxing. Didi had backers with deep pockets in Tencent, Alibaba, sovereign wealth fund CIC and Apple. A consequence was Didi claiming an 80% market share with Uber a comparative minnow in China. Taking on an established business with a dominant market share and vast resources in their home market is highly risky, without a better product or ability to attack poorly-serviced niches. Uber had started in 2009 but did not enter China until 2014. Five years is a significant lag in a world of platform start-ups where late arrival usually creates an impossible position.
Uber had other problems. It lacked local connections and knowledge, both of which are critical in many Asian markets, in China particularly. In China, Uber employed 600 people which is inadequate given the size of the market and the number of cities requiring connections to be established. There, product adaptation is critical due to local requirements such as cash, language or differing modes of transport. Uber, like many U.S. companies, is keen to have a standardised approach. This normally keeps costs down but does not entirely address local need. Instead of local adaptation, U.S. businesses tend to support with enormous marketing and promotion budgets. The objective is to adapt to the demands of the product. Uber’s strength of having an international app is also their weakness; it requires a high degree of standardisation.
As an inward looking country, China may not have understood Uber’s potential benefits for the ride hailing market. China wants technology and employment from western companies and are keen to see benefits being retained internally. Uber brought little of either as their app is not proprietary, and in the Chinese context, 600 employees is not significant. However without Uber’s competition, it is fairly certain that Didi will cut driver subsidies and increase customer fares. There was some evidence of this following the merger of Didi Dache and Kuadi Didi. Competition is necessary to ensure both users and drivers get a good deal. Competition also usually stimulates demand through high levels of promotion and low fares. This in turn creates more driver employment and cheap and efficient transport. With Uber gone, demand is much more likely to flatten out. There will be opportunities no doubt for local firms to fill niches, as a virtual monopoly supplier may lose its competitive edge.
In highly competitive Chinese markets, foreign firms are realising that margins are thin. The lure of enormous volumes in a rapidly expanding market draws western firms. However, they are often ill equipped to compete in such different markets. Uber chose not to use local partnerships and local knowledge to forge connections. This can be imperative in many country markets. However, in China, where many western firms do use partnerships, they may make more progress. The major risk though is that instead of buying out the local partner, they sell out to them leaving their expertise and technology in China. SABMiller experienced this when disposing of the Snow beer business which had 20% of the market but with narrow margins. Politically, the government has a significant say in the future of industries and the ultimate trajectory of western firms in China.
Platforms and Network Effects
Technology investors are not only flush with funds but they are also targeting new platforms. Platforms create markets by linking buyers and sellers efficiently. First mover advantage followed by rapid expansion is generally viewed as critical to long-term success. This initially involves incentivising the participation of both buyers and sellers. The participation of more sellers attracts more buyers which in turn attracts more sellers. These are termed as two-sided network effects like in the case of Amazon, Airbnb, and virtually all other platforms. As there are high levels of transparency, price competition should be fierce. Facebook is another example, in which a social network infrastructure has been constructed. This offers the opportunity to connect with a large number of people and deters users from moving to other social media platforms. These network effects create a “winner takes all” end game in which the first mover, backed by appropriate levels of resource, win. Late entrants need to move very rapidly to minimise the time the first mover has sole access to the entire market. They achieve this by investing much greater resource and creating novelty features which might attract users away from the first mover. Even in these circumstances, the second mover has a major uphill task.
Whilst Facebook, Amazon, and Google have the capacity to make enormous financial gain by dominating a market with their platform, Yahoo, LinkedIn, Twitter, and Snap Inc (Snapchat) have all struggled to monetise their user base. Twitter has only recently started to make money from being President Trump’s main communication channel for policy. This has drawn more advertising income.
The core belief for ride hailing is that users want cheap and responsive transport. Responsiveness means that suppliers generally require a large fleet of taxis providing constant availability. As self-employed drivers want large numbers of fares and to minimise down time, they are attracted to a firm that maximises the number of fares. In return, Uber, through low customer pricing, attracts more trade and in this way attracts more drivers. There is some evidence that Uber pays drivers less per trip but the sheer volume of work more than compensates the driver.
Ride Hailing Investments
In the case of ride hailing apps, investors are backing a number of start-ups with big money generated from becoming winners across global markets. Examples include Uber, and Lyft in North America, Didi Chuxing in China, Grab in South East Asia, and Ola in India. Investment has now vastly exceeded $50Bn in the industry. Uber has raised $22Bn in 18 funding rounds,1 whilst Didi Chuxing has raised $15Bn. The huge sums of investment have resulted in battles of attrition across the globe where ride hailing businesses incentivise recruitment drivers and subsidise customer fares. The intention is to achieve the “winner takes all” position then cut the subsidies once the competitors have left. The consequence of this strategy is that Uber lost $4.5Bn in 2017 and is a long way from convincing the market of its $68Bn valuation unless it can rapidly curtail haemorrhaging cash. Uber plans a share placing in 2019 so that the investors and founders can start to realise some of their paper gains.
In an attempt to resolve this situation, Softbank has invested around $20Bn in various ride hailing providers, with $9Bn in Uber and significant investments in Didi Chuxing, Ola, Lyft, and Grab.2 Since then, there has been some market withdrawals to reduce the various battles of attrition raging across the globe. Softbank has offered the view that Uber should consolidate back to North America and Europe. There it has strong positions and more transparent and accessible markets in which local knowledge and government contacts are less critical.
Will the Winner Really Win?
The major concern for all ride hailing apps is that there are low switching costs for both drivers and customers. It costs little for a customer to have two or three ride hailing apps on their phone and select the cheapest and most responsive. Similarly, drivers often work for several taxi companies at the same time they are genuinely self-employed. Should a “winner” emerge and attempt to increase fares, customers may look to other apps, and the speed with which drivers can also transfer may mean that local competition arises again. This could be a problem for Didi Chuxing in China.
The reality is the relative ease of raising funds to invest in platform strategies is financing wars of attrition between competitors with similar offerings. Some cannot hope to win. Being first is important followed by rapid development of local knowledge and connections and coupled with the finance to move rapidly with major substance. If not, first to markets dominated by network effects then new players may have to wait for changes in technology before they can meaningfully compete. If local players can move first and raise funds, their advantage of local knowledge and rapid movement should allow them to win the battle. Didi Chuxing has 52% of the global market, although most of it is in China. Grab and Ola have strong positions in their home markets and are ranked third and fourth behind second placed Uber. Uber has a presence in over 70 country markets, over twice the number of Didi, Grab, and Ola.3 Outside of North America, Uber has been first to many European markets where it has strong positions, which suggests long-term dominance. However, it has arrived later in Asia where local competitors may have already created dominant positions. One suspects that Uber will have to consolidate to little more than Europe and North America if it wants to make money as the 2019 IPO approaches.
The ease of raising funds for platform funding is contributing to futile competition in the ride hailing industry. Some incumbents have such strong positions with network effects, funds and local knowledge and connections a new entrant has little prospect of success. There are lessons for other developing platform investments.
Entrepreneurs who start and develop platform businesses are rarely the right people to take them forward into rapid growth and eventual maturity when cultural values, ethics, structure, and processes matter.
Finally, China is a difficult market for western businesses where local knowledge and connections, technology and employment are important necessities to compete effectively. Competitors move rapidly to copy products and compete whilst many are government owned and do not have to make profits. It is not a level playing field but some western businesses do flourish in China. However, many western businesses are still pondering their losses and considering their options.
About The Author
John Colley is Professor of Practice in Strategy and Leadership, Pro Dean, at Warwick Business School. Following an early career in Finance, John was Group Managing Director of a FTSE 100 business and then Executive Managing Director of a French CAC40 business. Currently, John chairs two businesses and advises private businesses at board level. Until recently he chaired a listed PLC.
1. “Uber Fundraising”. https://en.wikipedia.org/wiki/Uber
2. “Softbank to Switch $20Bn ride hailing stake into Vision technology fund.” Financial Times. https://www.ft.com/content/87e31a34-47d8-11e8-8ee8-cae73aab7ccb
3. “Uber is still the leader in global ride hailing”. The Drive. http://www.thedrive.com/tech/22362/uber-is-still-the-leader-in-global-ride-hailing-report-says