By John Colley
News that Uber’s 2018 third quarter losses have widened to $1.1 Bn with slowing sales growth, are signs of a much more difficult future for ride hailing. The concept of low cost, easily summonsed, responsive taxi services provided by part time car owner drivers is attractive to drivers, customers, governments, investors and even economists alike. Or is it? The reality is starting to appear much more doubtful and suggests interested parties are going to be significantly less happy.
Uber CEO Dara Khosrowshahi has the almost impossible task of steering the privately held firm towards profitability, whilst at the same time maintaining user growth. Rarely has a business consistently managed to lose so much money for so long. The promised 2019 Initial Public Placing (IPO) means the current performance has to significantly improve and begin to offer the prospect of profits if new investors are to be attracted. Current investors are keen to take profits sooner rather than later and have concerns that stock markets are becoming increasingly volatile which may delay the IPO for a protracted period. Investors may also have other concerns as the ride hailing business model may not be capable of profit delivery. User growth is slowing and losses will top $8Bn over the last two years.
Uber’s Model
The business model relies on a responsive cheap service summonsed by an app. The intention is to create network effects so that the more drivers the greater the benefit to customers through increased responsiveness. The more customers then drivers gain through more fares and less time waiting for a fare. The theory suggests, and indeed investors hope, that this is a ‘winner takes all’ market. To ‘pump prime’ this model Uber offers incentives to both drivers and customers to attract them from other taxi companies and forms of transport. The weakness in the model is that the app has no proprietary software and so can easily be copied. There are also low switching costs for both drivers, many of whom also work for other taxi businesses, and customers who may have more than one taxi hailing app. There is also a problem with the proposed sustainable aspects of the ride hailing model in allowing ride sharing and avoiding the need for car ownership by customers.
Good For The Environment?
Firstly recent research (reported in the Economist 3rd November, 2018) finds that half of all Uber trips directly displace journeys by public transport or walking. In effect half the journeys are creating pollution, congestion and road accidents. Taxi hailing scarcely benefits the shared economy as it is actively displacing shared public transport. Uber may claim to be encouraging use of hybrid and electric vehicles but the proportion of trips by sustainable transport looks disappointingly small. Cities such as New York or London which has 40,000 Uber drivers are considering restricting new taxi driver licences. Worse still the average Uber driver travels 2.8 miles additionally for each paid mile. The number of taxi drivers in London has doubled in 4 years to 120,000 in 2017 and rising. Sooner or later governments will have to start restricting these services.
Stakeholder Benefits?
How about the drivers who are receiving additional income? The problem is that they have been lured into this business with highly subsidised incentives from Uber. However these are are now being withdrawn. Uber drivers are striking in a number of cities due to wage cuts in an attempt to make the firm profitable and in preparation for the looming public offering of the shares. In 2017 Uber lost $4.5Bn; in 2018 it is likely they will lose between $3 and $4Bn. This is unlikely to encourage new investors when the investment banks promoting the sale of the shares are attempting to justify a $120Bn price tag.
Not only will wages have to decrease but prices will have to increase. This is happening quietly in many markets. There has also been the offer of subscriptions to avoid surge pricing. The problem now is that there is competition running similar models in most cities. Higher prices will simply push customers to other ride hailing competitors. Low switching costs can work for and against a business like Uber. Incentives attract customers and drivers rapidly with meteoric growth, whilst both can move rapidly elsewhere if conditions appear more attractive. From zero Uber attracted over 40,000 drivers in London in 4 years. Similarly over that period they created 3.5 Mn customers on the basis of Uber’s own figures. Easy come, easy go! The model is easily replicated therefore anyone willing to invest significant money in attracting drivers and customers is likely to experience transitory success. To make matters worse the battleground is each city so a competitor only needs to select a few cities to take on Uber.
In effect Uber is simply offering low prices and high wages in a highly commoditised market together with substantial advertising. All funded by the shareholders. It could be argued that anyone doing this in commoditised markets will attract significant trade, and indeed lose it once prices are increased. The model may do little more than pass wealth from investors to drivers and customers.
The subscription service to avoid surge pricing is aimed at increasing switching costs. This is intended to avoid the haemorrhage of customers who when faced with surge pricing go to a competitor, possibly never to return. The idea of surge pricing is to equate supply and demand at times when demand exceeds supply such as large events. The surge pricing translates to higher driver wages which is intended to incentivise increased supply. Hence the model is the darling of economists. However if competitors do not adopt a similar approach then customers either pay the premium and grumble, or they exit to a competitor.
Investors
Investors have contributed $22Bn to Uber, a significant element is Saudi Arabian money via the Japanese SoftBank. Much of it has been used to subsidise driver wages and customer fares to kick start network effects. How many customers and drivers will stay? What is Uber really worth? Ironically SoftBank is also bank rolling competitors such as Lyft, Ola, Didi Chuxing and Grab. Clearly they have been trying to resolve some of the wars of attrition which are destroying shareholder funds by distributing to drivers and customers worldwide in the form of incentives. Uber has pulled out of China in favour of Didi Chuxing, and South East Asia in favour of Grab, they have also exited Russia. However the war still goes on in India in which Ola and Uber share the market roughly equally. Large amounts of money on both sides are being ‘invested’ in a war of attrition. At some stage a truce will need to occur.
Diversification
As growth in the taxi hailing business diminishes then to justify the bankers valuation Uber has to find more early stage investments such as food delivery, shared electric bikes and scooters, and autonomous vehicles. These could justify raising money and distract attention from the inability of the taxi ride hailing business to be profitable. One has the impression this is not going to end well for investors.
Autonomous Vehicles
Uber’s development of autonomous vehicles is a major diversification as Uber may know about providing taxi services but little about making and controlling cars. Several car manufacturers plus Google are developing similar technology. Why does Uber need to compete here rather than form a partnership? It will be a number of years before the driver no longer has to supervise the technology and only at that point does it become viable. In effect then Uber will be replacing cheap drivers who loan their vehicles with dedicated expensive vehicles which will need financing. It is really not clear how this will play out as an industry or whether Uber will be a prime beneficiary from autonomous vehicles.
UberEats
Home delivery of takeaway food appears to be the next attritional battle approaching the investors. This requires three way network effects all of which may need some initial incentives. Takeaway food outlets want to be listed on the website to provide more trade, customers need to be attracted to visit the website wanting responsive and reasonably priced delivery, and delivery people are required wanting plenty of work and remuneration. In the U.K. UberEats has around 10% of this market with Just Eat having 80%. Uber may need to ‘invest’ substantially to win this war. Indeed it may be more economical for them to buy Just Eat which is listed and in the FTSE100 so far from being a bargain. It is reported that Uber are negotiating to buy the loss making Deliveroo for in excess of $2Bn. Deliveroo has around 10% also of the U.K. market and again has a model which is far from proven. It could well be another model which does not work when profits have to be made.
The IPO is being brought forward apparently due to increasing market turbulence. However the longer the IPO is deferred the more progress on loss reduction will be expected and that is looking difficult. In effect we are seeing more ‘development opportunities’ becoming the focus of investment to obscure the reality that the taxi hailing model may never make money. Indeed the taxi industry has always been low margin and that situation looks likely to continue.
Uber has historically been highly secretive with its data, releasing little to the public. An IPO will bring an end to this approach as substantial data has to be released. At least we will then know the true position of Uber.
When profits are necessary the reality of ride sharing is far less attractive to the various stakeholders than originally envisaged. Driver incentives are ending and customer fares are increasing. Network effects with low switching costs may not be the recipe for success many hoped. Disappointment is only set to intensify once the model needs to make money in a highly competitive industry traditionally known for low margins and little profit.
About the Author
John Colley is Professor of Practice in Strategy and Leadership at Warwick Business School where he is also an Associate Dean for the MBA. Following an early career in Finance, he was Group Managing Director of a FTSE 100 business and then Executive Managing Director of a French CAC40 business. Currently, he chairs two businesses and advises private businesses at board level. Until recently he chaired a listed PLC.
