Case Analysis – 1200 words – APA format and scholarly sources

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Why Can’t Uber Make Money?

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By any measure, Uber’s seven-year entrepreneurial
journey has been extraordinary. No venture has ever
raised more capital, grown as fast, operated more
globally, reached as lofty a valuation — or lost as
much money as Uber.

Last month, Uber reported a third-quarter loss of
nearly $1.5 billion, bringing its 2017 year-to-date red
ink to $3.2 billion. Losses of this magnitude are
clearly not sustainable, and call for an explanation of
why Uber has been unable to rein in ballooning costs
and what it will need to do to survive, let alone
prosper.

Much of the recent discourse on Uber has focused on
the numerous unethical and possibly illegal corporate
behaviors that continue to dog the company, six
months after founder Travis Kalanick resigned as
CEO. But while the reputational damage from
Kalanick’s win-at-all-costs ethos has certainly not
helped Uber’s cause, it has masked a far deeper
problem facing the company. Uber’s elephant in the
room is that its business model is fundamentally
broken. To understand why, it is useful to assess
Uber’s business model in the context of the history of
the taxi industry.

Shortly after launching an app-hailing black car limo
service in San Francisco in 2010, Uber founders
Garrett Camp and Travis Kalanick recognized the
potential to disrupt the $100 billion global taxi
industry. After all, this heavily regulated sector had
seen little innovation over the prior century, leaving
customers to cope with an expensive, inconvenient
service that rarely seemed available when most
needed. Enter Uber, who incorporated widely
available technologies – GPS, Google Maps and
mobile computing – into a well-designed app to
create a customer pleasing, smartphone-enabled
urban transportation service.

Not only did Uber offer enhanced urban mobility, but
it was usually cheaper and more convenient than taxis
as well. Ride hailing and payment processing were
fully automated and Uber was priced well below (30%
or more) comparable taxi services. With
better/faster/cheaper service, Uber became an
immediate hit with consumers, emboldening the
company to expand rapidly. To recruit drivers in
Uber’s two-sided market, Uber promised high pay
and flexible working hours as a compelling value
proposition to independent contractors looking to
supplement their income.

Venture capitalists were enthralled with the bold
ambition of Uber’s disruptive business model, and
eagerly jockeyed for the right to invest in the growing,
if unprofitable enterprise. Uber raised a record-
setting $11.5 billion through 18 funding rounds,
ultimately valuing the company at $68 billion. Flush
with cash, Uber raced to launch operations in 737
cities across 84 countries, delivering over 5 billion
rides as of this writing.

There’s a lot to like in this story, except for one thing.
The taxi industry that Uber is seeking to disrupt was
never profitable when allowed to expand in
unregulated markets, reflecting the industry’s low
barriers to entry, high variable costs, low economies
of scale and intense price competition — and Uber’s
current business model doesn’t fundamentally change
these structural industry characteristics. It is indeed
ironic that Uber’s fierce determination to avoid
regulatory oversight condemns the company to
unprofitable operations that the taxi industry
experienced during its pre-regulatory era.

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To see these parallels, a little history is in order. The
first gas-powered taxis appeared in New York City in
1907, and began replacing horse drawn carriages in
for-hire service. Taxicabs gained momentum when
the affordable Ford Model T was introduced shortly
thereafter, ushering in a wave of new low-price taxi
operators. This posed a serious threat to incumbent
taxi companies wedded to higher cost automotive
fleets, which precipitated violent protests in many
major metro areas in support of regulations to
severely constrain new entrants to the taxi market.
Sound familiar?

Although a few cities legislated restrictions on the
permissible number of taxi operators, the largest U.S.
taxi market – New York City – remained largely
unregulated well into the 1930’s. With the onset of the
Great Depression, many unemployed workers turned
to the taxi industry to try to earn a living. The
resulting oversupply of taxis led to a collapse of fares,
as taxi companies and drivers competed in a race to
the bottom to attract additional customers. Driver net
income and taxi company profits evaporated, the
quality of drivers, cars and passenger safety
deteriorated, and taxi oversupply exacerbated
congestion on city streets.

This historical experience exhibits several parallels to
Uber’s current business model, presaging the
company’s dismal financial performance. The pre-
regulated taxi industry was characterized by bounded
demand, abundant supply, relatively undifferentiated
service quality, extremely low barriers to entry, low
customer switching costs, high variable costs and
virtually no economies of scale. Many of these same
conditions exist today for Uber and its competitors in
the shared-ride market. While both then and now,
consumers benefitted from low fares and short wait
times, structural industry characteristics precluded
profitable operations in both unregulated eras.

To “fix” this problem eighty years ago, New York City
(and many other major metros) made a political
decision to favor taxi companies and drivers at the
expense of city residents. The Haas Act of 1937
established a licensing system, requiring a medallion
for every taxi in New York City, and made it illegal to
operate without one. This proved highly lucrative to
the government, which sold the medallions in public
auctions, and to successful bidders who could operate
comfortably with the assurance of tight controls over
competition.

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Originally, New York set a limit of 16,900 taxi
medallions, reducing that number to 11,787 after
World War II. Fifty years later, the medallion cap was
inched up to 11,900, and today, remains capped at
13,587. In contrast, absent regulatory oversight, the
current number of shared ride cars operating in NYC
has swelled to well over 60,000.

The impact of regulations arbitrarily capping taxi
supply in NYC has been significant. While the
population of New York City grew by 20% since the
passage of the Haas Act in 1937, over the same period,
the regulated cap on taxi medallions shrank by 20%.
As a result, consumers have been subjected to longer
wait times, higher fares, deteriorating vehicle quality
and shoddy service, while incumbent taxi operators
enjoyed escalating profits and soaring medallion
values.

This is clearly evident in the secondary market for
NYC taxi medallions, which serves as leading
indicator of expected industry profitability. Between
1975 and 2013 (largely pre-dating Uber’s entrance),
medallion prices in NYC increased by over 2,700%,
far outpacing the growth of the Dow Jones stock price
index.

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But Uber’s aggressive NYC launch in 2011 ushered in
a return to unregulated car service expansion,
dramatically improving urban mobility at lower
prices, but dragging the industry back to an era of
profit-killing competition. Not surprisingly, NYC
medallion prices collapsed, from a peak of $1.4
million in 2014 to as little as $150,000 three years
later. And, in sharp contrast to the growing value of
taxi medallions prior to Uber’s launch, the stock price
of Medallion Financial Inc. — a publicly traded
company which finances and trades in taxi medallions
– collapsed by 85% over the past five years, while the
Dow Jones stock price index appreciated by 47%.

In historical context, Uber’s extraordinary losses are
thus not just a case of growing pains of an ambitious
Silicon Valley startup, but a reflection of the deep
structural deficiencies in ride-hail industry
economics. Prior to artificial regulatory supply caps,
the unregulated taxi industry was unprofitable and
subject to growing concerns over negative
externalities. Uber is now facing the same relentless
drag on its P&L.

Supporters of Uber’s unfulfilled potential often point
to Uber’s first mover advantage, strong network
effects, asset-light business model, continued revenue
growth and adjacent business expansion
opportunities as reasons to expect a near-term
turnaround. But none of these factors reverse the
fundamental weaknesses in Uber’s business model.

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For example, conventional wisdom has held that Uber
would enjoy a global winner-take-most outcome
because of their outsized balance sheet and strong
network effects. But to the extent that network effects
exist, they are local, not global. For example, the fact
that Uber enjoys an 89% market share in Tampa,
doesn’t help them in Portland, where Uber’s market
share is trending below 50%. In fact, Uber has
struggled to achieve market share leadership in many
large foreign markets, including China, India, SE Asia
and Brazil. Moreover, while network effects do exist
within each metro market, the benefits are
significantly weakened by extremely low switching
costs, which enable drivers and riders to utilize
whichever ridesharing service offers the best deal on
any given trip.

While Uber’s business model has created enormous
value for consumers, propelling the company’s rapid
growth, its extremely aggressive pricing simply
doesn’t generate enough revenue to deliver attractive
compensation to drivers and sizable profits to
shareholders. By pricing its services 30% or more
below comparable taxi fares and then retaining 25%
of gross bookings for itself, Uber has squeezed the
revenues available to compensate drivers, who are
ultimately responsible for providing the labor,
equipment, maintenance, insurance and fuel to serve
consumers. There is nothing in Uber’s business model
that promises to reduce the factor costs of its
ridesharing service, nor are there inherent economies
of scale that would lower unit operating costs with
continued growth.

This leads to an inherent conflict between the
business objectives of Uber and its drivers. Uber’s
revenues are directly proportional to the number of
trips it can facilitate, and thus the company has
strong incentives to continuously scale its business.
Drivers of course want to maximize their revenue per
hour worked. But as Uber continues to recruit drivers,
the revenue potential per driver inevitably declines.
As the highest revenue-generating neighborhoods
become increasingly saturated, new drivers are forced
to seek less attractive service territories to find
customers.

These business model dynamics underscore the bleak
earnings outlook for Uber drivers. A recent
study found that Uber’s net driver compensation in
three US major metropolitan areas in late 2015 was
only $8.77 – $13.17 per hour, and this was before
Uber instituted significant fare cuts in 2016. Uber’s
low and declining pay has been a leading cause of
Uber’s low driver satisfaction and growing turnover,
both in absolute terms and relative to its main
competitor, Lyft.

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There are two possible remedies to improve driver
compensation, but both alternatives would
undoubtedly harm Uber’s already tenuous economics.
Uber could raise fares at its current revenue sharing
split, or increase the driver share of gross revenues.

Given the structural characteristics of the ride share
industry – limited perceived product differentiation,
fare transparency, low consumer switching costs and
loyalty, and intense competition– Uber has been
understandably reluctant to unilaterally raise fares. In
fact, Uber and Lyft have been engaged in a race to the
bottom on fare cutting and price promotions,
reminiscent of the pre-regulatory taxi industry of
yore. But urban transport demand isn’t elastic, so
ridesharing price cuts have harmed driver
compensation, which was the issue at the heart of the
heated argument between Travis Kalanick and an
Uber driver last year, that became a viral media
sensation.

As for raising drivers’ revenue share, Uber and its
drivers are locked in a zero sum game that leaves little
room for generosity on either side. In fact, Uber’s
temporary profit margin improvement in 2016 (albeit
still yielding steep losses) was primarily driven by its
decision to cut driver compensation rates.

From its inception, Uber has consistently favored
consumer satisfaction over driver welfare – for
example, evidenced by its longstanding reluctance to
allow in in-app tipping, which even now is poorly
executed – which has taken a heavy toll on driver
satisfaction and retention.

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Recent studies have indicated that Uber’s U.S. driver
churn has sharply increased this year, to rates as high
as 96%. Needless to say, it’s hard (and costly)
to maintain double-digit growth rates, when only 4%
of mission critical, de facto employees stay on the job
for more than a year. As a result, Uber has been
forced into perennially aggressive recruitment efforts,
offering signup bonuses that can run well in excess of
$1,000 (on top of normal compensation) for new
drivers.

There is little reason to expect near term relief in
Uber’s escalating driver recruiting costs (including
the expense to maintain hundreds of physical
“greenlight hub” locations that provide onboarding
support) in the coming years, especially since Uber
faces vigorous competition from other enterprises
also recruiting part-time drivers, including Lyft,
Instacart, DoorDash, Postmates, Grubhub and
Amazon Flex.

Multiple management missteps have further hindered
Uber’s performance, fueling growing distrust from
customers, drivers and regulatory agencies. But
Uber’s existential challenge remains its broken
business model, which is increasingly testing the
patience and confidence of its investors. At its current
burn rate, Uber cannot survive more than two years
without additional injections of capital, which is
highly improbable at anything like its current
valuation.

From the beginning, Uber made a calculated bet that
it could achieve global domination, wiping out both
incumbent taxi companies and competing shared ride
providers, to be able to exercise monopoly pricing
power in hundreds of metropolitan markets. But it
now appears Uber has lost this bet in its headlong
rush into an industry that has historically exhibited
low profit potential.

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Uber is hardly alone in its sisyphean quest for
profitability. Every major ridesharing company in the
world is still experiencing steep losses after five or
more years of operation, including Lyft (U.S.), Ola
(India), 99 (Brazil), and Didi Chuxing (China).

In Didi’s case, the company continues to lose (and
raise) money despite its dominant market share, after
buying out Uber’s Chinese operations 15 months ago.
But reaffirming the low barriers to entry in this
sector, other well capitalized competitors (UCAR,
Meituan) have stepped up their operations,
prolonging profit-killing competition for passengers
and drivers in the Chinese ridesharing market.

There are undoubtedly defensible segments of the
global rideshare market that can currently sustain
profitable operations. And in the foreseeable but
distant future, autonomous vehicle technologies may
improve industry economics. But for now, CEO Dara
Khosrowshahi will need some serious soul-searching
to rethink Uber’s soaring ambition and penchant to
win-at-all-costs in all markets. On its current course,
Uber’s bridge to global domination is simply a bridge
too far.

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