The rideshare company Uber took losses of 1.2 billion dollars in just the first half of 2016. This loss may come as a surprise to many people. Uber was founded in 2009 and has since become a hugely popular service, now available in two hundred and nine cities across the United States and in eighty one countries. The company was reported to be worth 62.5 billion dollars in 2016, making it worth more than General Motors Co. and Ford as well as eighty percent of the S&P 500. Yet still many are saying that Uber is destined to fail, that its losses sustained in 2016 are only the beginning. How could that be?
To start, some view Uber as being in a high expense/high capital business. In order to have enough drivers it must hire people who do not have cars. According to Erik Gordon, a professor at the University of Michigan’s Ross School of Business, this means that Uber has to finance the purchase of cars for these drivers and it ends up racking up high expenses in the process. Uber doesn’t simply buy cars and ship them out, however. New drivers in need of a car can make use of various partnerships Uber has to rent, lease, or buy a car of their own. Uber recently partnered with GM’s new ride sharing service, Maven, which will allow Uber drivers to rent and use cars flexibly on a weekly basis.
A larger concern that seems to be shared more widely is that Uber is operating in a market without any barriers to entry. Uber’s product is an app, one which already has been successfully duplicated. It has already seen the downside here in the emergence of its largest competitor, Lyft. In this market consumers are looking for a ride that is cheap, fast, and lacking the unpleasant aspects sometimes found using a taxi service. That means there are few things that can set firms apart in the ride sharing business. Uber can try to be faster and provide a more pleasant experience, but these factors are largely dependent on the drivers they hire, all of whom work to the beat of their own drums (one of the reasons people are drawn to drive for Uber). That just leaves the price factor. Uber can lower their fares and try to attract more customers away from their ride sharing competitors and taxis, and they have done so multiple times now. This creates a bit of a vicious circle, however. Uber’s competitors can only respond by dropping their rates to match or beat Uber’s. In this back and forth, rates would eventually drop to merely equal costs (mostly made up of fuel costs).
According to Dr. Joe Sulmona, a transportation strategist and economist based in Vancouver, this “destructive competition” could spell huge trouble for firms like Uber. Destructive competition drives prices so low, at some point it comes apart because people can’t make a living at it, he says. If this happens, Uber will lose drivers and those that remain will have very little incentive to operate with any safety or reliability. Once it becomes clear to consumers that Uber is not to be trusted, that will spell the end.
Sources:
https://www.marketplace.org/2016/08/30/economy/why-uber-will-fail-according-one-economics-professor
http://www.geekwire.com/2015/6-reasons-ubernomics-fatal-customers-mass-transit/
https://www.bloomberg.com/news/articles/2016-08-17/an-expert-in-valuation-says-uber-may-have-already-peaked
http://www.reuters.com/article/us-uber-gm-maven-idUSKBN12W4ZZ
15 Comments
Is there any data to suggest that Uber would raise its profits if it only hired drivers that supplied their own vehicles? I understand that they would lose out on the corresponding market share, but would their higher profits be enough to make that a worthwhile decision? Or would competitors like Lyft benefit from less Uber drivers to the point where it is not a profitable decision to lower the amount of drivers?
While the name brands such as Uber or Lyft might not survive, I doubt we will see the end of the type of service they offer until self-driving cars become widely adopted. The demand for the service that Uber offers will remain strong as it has revolutionized the way people can go out in cities. It eliminates the need for designated drivers, can get you places faster than public transportation, is available throughout the entire night (while public transit might stop at midnight or 1AM) and avoids the uncertainty of having to find and flag down a taxi. It is a lot more convenient to simply call an Uber whenever you are ready to go out than to have preset plans if you were to order a car service in advance. Furthermore, features like fare-splitting and choosing the size of the car make the process of going somewhere in groups a lot easier especially when the groups are dynamically changing. All in all, I believe my generation is a big fan of the service that Uber and Lyft provide and will continue to patronize the companies. Obviously, that does not mean the companies will generate profit and survive, but if they fail than there will definitely be demand for a new entrant to emerge.
I have called for taxis many times; Uber is not an innovator. However, in many cities there are multiple taxi companies, and that hurts response time because you can only access one dispatch network. That obviously can be changed through a joint app plus PR so potential users know about it.
When comparing Uber and Lyft, 75.8 percent of Lyft drivers agreed that they were satisfied with their driving experience, while only 49.4 percent of Uber drivers said they were satisfied. This could be because Lyft drivers earn about $1.82 more per hour because of Lyft’s higher base rates and payouts for drivers along with in-app tipping. If Uber were to allow for a similar tipping service, would the company be receiving less pushback from its drivers?
http://www.theverge.com/2017/1/18/14311540/uber-lyft-drivers-satisfaction-survey-rideshare-guy
One interesting development in the cases of companies like Uber and Lyft is how self-driving cars could affect the market. Self-driving cars may take years for people to feel comfortable and driving around in them, but imagine if Uber/Lyft partnered with say Google so Uber wouldn’t have to hire drivers, they would just use these self-driving cars. Uber may not last until that innovation hits the streets but one can see how self-driving cars could cut costs dramatically for these ride-sharing services
Uber is big enough at this point where they possibly could be able to drive rates low enough to be able to outlast the other companies. Having said that, since there are no barriers to entry, this will just keep happening. It has undoubtedly revolutionized the taxi service, that coupled with its already huge market share and company value, I think it can stick around and be okay, but I don’t ever see it completely dominating the market.
JARGON!!! – Bertrand competition.
The next big question which could decide the future for Uber could be whether or not they are able to dominate ride-hailing market in India. This summer they were shouldered out of China by Didi Kuaiche (with a little government encouragement), a market they were banking on controlling in order to launch into similar emerging economies.
In the China case Uber didn’t do its homework and pushed a stand-alone app instead of one integrated into WeChat, which has the main online payment platform. That also meant there was no need to have a credit card, or to figure out a new interface. In other words, Uber’s software was second-rate.
I think that in order for Uber to survive in the long-run, they need to expand into other markets. While there are substantial benefits for consumers, Uber is hemorrhaging money at an alarming rate, if they are able to increase the number of consumers they reach, they may be able to last longer.
Uber is the first player in the industry, and it seems that first players in industries now are more aware of the importance of innovating to keep a comparative edge. I agree with Pierce that Uber needs to expand into more markets, and develop a stronger core business model in the process.
Does Uber have a lower cost structure? The more they move into owning cars, the more they will look like a traditional taxi company, albeit national in scope. But it’s unclear there are any scale economies to their business model. Traditional taxi companies already do “fleet” purchases so get good prices. Uber can’t do much better. And Uber pays their drivers more. Is that sustainable?
Similarly, what is the price elasticity of demand? My sense is that it is not particularly elastic, so that lowering prices (which can be in the form of cleaner cars) won’t expand the ride share market much. In other words, the only way Uber can expand is by “buying” customers from existing alternatives such as Yellow Cabs. But if Uber does not have a lower cost structure (once they need to own / finance cars), then ultimately they cannot sustain their current share.
Indeed, Uber is probably over-spending on vehicle costs and driver incentives that may not have a lasting impact. However, there is some upside potential in a coordinated ride-share model such as the one used by Uber and Lyft. The main benefit of Uber’s model does arise from its economies of scale, deriving not from cheaper vehicle or personnel costs, but from operational efficiencies. Uber’s operations are managed from a central database that enable it to calculate not only profit-maximizing prices on an extremely targeted level, essentially taking advantage of price discrimination to shift consumer to producer surplus, but also help it optimize vehicle utilization and flow. Compared to a traditional model of yellow taxis, who compete with one another in a manner that is sub-optimal for the entire network, Uber attempts to adjust the payout share for individual drivers in a way that aligns the incentives of its drivers with that of the company’s profit maximization.
On another note, yes Uber is incurring great losses, and its biggest cost is the fee it pays out to drivers. According to the Bloomberg report, driver subsidies account for a majority of the losses in 2016. Leaked documents from the first half of 2015 show that Uber paid $2.72 billion to drivers. By comparison, Uber lost only $72 million to price cuts and promotions. However, Uber’s long term plan is to get rid of its drivers all together and base their business on driverless car technology. Do you think that when this technology becomes safe and reliable the industry of cabbies will end?
1: Yes, conceptually there are EOS. The empirical question is how big those are. Two pieces of evidence: that others have successfully entered with good apps suggests that the back-end fixed costs are not a significant barrier to entry. Second, those also suggest operating costs rise with size, enough that being national in scope rather than regional is not a big advantage. Can’t one operator watch over 200+ cabs in a medium-sized city, since at any given time a fare proportion will be cruising full [or sitting idle outside a favorite coffee shop] and not need much attention?
1a: Brand recognition is definitely useful, but my strong suspicion is that most users are local. Those who aren’t arrive in the airport, easy to focus ads visible to people as they get off the plane. Note that when my wife or I have gone to LA we buy seat on a ride-sharing van when we buy our airplane tickets. Inexpensive, particularly compared to alternatives when you’re heading somewhere 90 minutes from LAX or the Orange County airport.
2: Autonomy is a nice story but it won’t be readily available until 2030. Furthermore, Uber will have to substitute people cleaning cars and other overhead functions for drivers [such as monitors who can step in when there’s a problem]. The cost savings will not be all that great early on, and in the transition stage costs will actually rise. (Remember that while planes can fly themselves, they have both a pilot and a copilot! Uber has deep pockets, at least for now, they can’t afford a high-publicity autonomous incident, so initially they won’t even be driverless.) Can Uber lose money at its current rate for another decade?
Query: in the past taxi medallions were rationed in most cities, so that there was a form of monopoly. One response in NY was the rise of limousine services, “gypsy” cabs that could not legally (and practically, since there was nothing to indicate they were a taxi) pick up someone on a street corner. You had to call for one, or go to a major hotel where there would always be one or more. But what strategic options do taxi companies have? Won’t they face pressure to consolidate their dispatch services under a single company, with their own app? Of course entry lowers monopoly profits, but fares are regulated. I don’t know the industry to know whether they’ve been lowered in some cities.
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