A series of in-depth and mostly critical articles by Hubert H in Naked Capitalism has added to the discussion of Uber’s business model. This post takes a closer look at the central claim. Does it stand up to scrutiny?
Uber and its investors are, and always have been, set on world domination.
This is the main thrust of Hubert’s argument. Having pointed out Uber’s large and ongoing losses, Hubert explains why the economies of scale that applied to businesses like EBay and Amazon do not apply to Uber. He concludes that Uber cannot grow into profitability and that they know it. He makes an emotive case that Uber is an unaccountable vehicle for the rapacious billionaires of Silicon Valley, whose strategy is to use unfair subsidies to undermine the profitability of existing taxi businesses, causing them to collapse. Once the competition has been removed Uber will raise its prices. Customers will have no other ride-hailing transport provider to turn to. At the same time Uber will lower driver pay rates. Drivers will have no alternative employer and so no choice but to acceded to Uber’s demands. Uber will be hugely profitable.
These are dramatic claims. Could any large business act in such an unprincipled manner? It is naive to believe that businesses, responsible as they are to their shareholders and not to general public, do not use all the legal tactics at their disposal to overcome the competition. However monopoly is one area where the authorities have a point of view and they are not in favour.
Traditional taxi firms have something of an unsavory reputation when it comes to business practices, deserved or not. It seems at least possible that the very firms Uber is targeting have themselves used marginal practices in the past. They are not innocent victims that need protecting as though unable to protect themselves.
What are the challenges to Hubert’s claim of deliberate predatory business practice on the part of Uber?
Is it conceivable that a large business could consider using pricing to undermine the profitability of a competitor and drive them out of business?
Yes, for sure. In the 1980’s the UK telecoms market was monopolised by British Telecom (BT). To say they had a poor reputation for customer service would be an understatement. The UK Government therefore encouraged new entrants, one of which was called Mercury. It was backed by a number of big businesses (Barclays, Cable & Wireless, BP) and was well funded. FMJ contributors consulted with senior managers at Mercury at the time. This suggested it was reasonable to take their challenge seriously. They could undercut BT’s prices, gain market share and make a profit. They were small but growing quickly.
The management at BT didn’t seem to be doing much if anything to counter the threat of the new entrant. They were asked, confidentially, why, when Mercury seemed a creditable competitor, they seemed complacent. The answer was somewhat chilling. BT was deliberately lulling Mercury into a false sense of security. They were allowing Mercury to anticipate growing revenues and profits and thus to take on a large workforce, win some significant customer contracts and make large investments in premises and equipment. Once Mercury was fully committed and at risk, BT used its commanding market position to drop its prices and undermine Mercury’s profitability. Mercury struggled on for 10 years or so, reducing its workforce and selling its assets as it gradually slipped out of public view. BT remains what is effectively a monopoly supplier in the UK.
It is not impossible to believe that Uber’s plan is to become a monopoly supplier, but is it likely?
No it isn’t. Can you imagine the discussion with a potential investor?
- Uber “We plan to undermine the competition and become a monopoly, then we can raise prices and decrease wages. We will make a fortune.”
- Investor “Um, I am an unprincipled arch-capitalist and I like monopolies, although I wouldn’t say that in public. Tell me more.“
- Uber “We will enter the taxi market in a city, pay our drivers more than the existing taxi firms and charge the customers less. It will be compelling and we will grow quickly.”
- Investor “So you have done the research, existing taxi firms are very profitable and you can pay more and charge less, but still make a profit?“
- Uber “Ah, no. They make slender profits. Our strategy is bolder than that, we expect to lose money. Lots of money.“
- Investor “Oh. How much do you expect to lose?“
- Uber “Billions of dollars.“
- Investor “Heck. Well, that is bold. How long do you think this will take, one or two years?“
- Uber “Several years.“
- Investor “But having entered a city and crippled the dominant taxi firm, that firm will have to pull out of all the other cities it operates in, and we can then move in?“
- Uber “That would be nice, but no. There are no dominant taxi firms across multiple cities, much less across multiple countries. No, we have to knock them out one by one.“
- Investor “How many cities are there with taxi services, say those with more than 100,000 population?“
- Uber “295 in the USA, over 4,000 around the world.“
- Investor “Oh, that is a lot. How about cities with more than 500,000 population, there can’t be many of those.“
- Uber “Over 800 around the world.“
- Investor “If I understood correctly from your earlier comment, each of those cities will already have at least one large taxi firm who would be a competitor?“
- Uber “Yes, that is why we need to knock them out.“
- Investor “We need to knock out 800 competitors one by one by paying higher wages and charging lower prices for several years?“
- Uber “You make it sound like a bad thing. We don’t have to do them all at once.“
- Investor “Oh, goodness, is that the time? I must be going, my black cab is waiting.“
A more likely scenario for the initial pitch would be:
- Uber “Taxi firms are old fashioned. They expect customers to call in advance or to flag down a taxi in the street. We can create an app that knows where the cars are and where the customer is and bring them together on demand. The customers will prefer it and the back office function will be streamlined and more efficient.”
- Investor “I can see that, but where will you get the cars from, isn’t it a huge investment?“
- Uber “Did you know that most cars are idle 90% of the time? Valuable and expensive assets sat doing nothing.“
- Investor “No, I didn’t know that. So you will encourage car owners who are short of money, but who have spare time, to drive for you?“
- Uber “Yes and no. They will drive, but they’ll drive for themselves, we will just provide the app that connects the customer who wants a ride with a driver who is prepared to give them one.“
- Investor “I thought taxi firms are heavily regulated?“
- Uber “Taxi firms are regulated, but on demand app providers are not.“
- Investor “Ah, clever. But really, you will be a taxi firm as you will decide the fares, select drivers, enforce standards, charge the customer and own the brand.“
- Uber “But it will be plausibly deniable. By the time they realise what we are up to it will be too late, customers will prefer an on-demand and cheaper service and there will be no going back.“
- Investor “How long will it take and how much will it cost?“
- Uber “It won’t take long to create the initial app, though building out the infrastructure and branding will be expensive. Each city we enter will require start-up funding. So we expect significant losses for several years, depending on how quickly we decide to scale back moving in to new territories and instead cash in on established markets. Once established we will charge the same rates as existing taxi firms. We will have lower back office costs and no vehicle asset charges or risks. It will be very profitable.”
- Investor “Does this business plan scale? We like plans that scale.“
- Uber “Yes, once we prove it works in say, New York, we can expand into London, Paris, San Diego, Montreal and so on. There are 800 cities around the world with populations of over 500,000.“
- Investor “Where do I sign?“
Uber has been in New York since may 2011, nearly 6 years. Have they killed the competition?
If Hubert was right you’d expect Uber to have a significant impact in key markets, and indeed, it is easy to find stories of taxi firms struggling, like this Bloomberg article or this one from San Francisco. Uber, and to a lesser extent Lyft, are mentioned as a factor in articles on the decline of traditional taxi firms.
However there is a deeper question. Does Uber undermine the underlying structure of a traditional taxi firm or does it only challenge the sometimes byzantine business and regulatory secondary markets that have layered themselves over the traditional firms?
New York’s authorities require transport companies to provide details of the number of vehicles operating and the number of trips they provide. This not only provides some insight into Uber and Lyft’s scale in New York, but also provides a comparison with the traditional Yellow Cab businesses. The picture it paints is not as straightforward as Hubert might predict.
This graphic is taken from the 2017 Driverless Future Report by the consultancy Arcadis. The number of Yellow Taxis is limited by the number of licences issued by the city authorities, called medallions. The graph suggests there are somewhat less than 14,000 Yellow Cabs (13,586 to be precise), just over 10,000 Lyft vehicles and over 30,000 Uber cars. Instinctively you would assume the number of trips serviced would be in relation to the number of vehicles. This is not the case.
The majority of trips are provided by Yellow Taxis; from a peak in early 2015 of 425,000 per day, dropping to 325,000 in mid-2016. Uber climbs from 75,000 trips per day to 180,000 and Lyft from zero to 30,000 over the same time period.
This graphic questions Hubert’s claim that Uber does not increase the size of the market. Over one year the number of rides per day has increased by around 10%.
As can be seen, the Yellow Cab market share has been on a roller-coaster. It dropped rather sharply from May 2015 to September 2015, but then recovered, before dropping again, then recovering, then dropping further in mid-2016. With considerable fluctuations, Uber’s trend line is up, with a big fall in early 2016 and a rather flat trend in the spring of 2016. Lyft shows a slow but steady upward trend.
The graphs support one of Hubert’s assertions, that the utilisation of Yellow Cabs is way above Uber or Lyft. 14,000 Yellow Cabs provided 325,000 daily rides at the end of the time period, 23 rides per day per vehicle. Uber’s equivalent was 6, whilst Lyft’s was 3. It seems obvious from these figures that Uber and Lyft drivers are only occasionally active. If Uber’s utilisation stayed the same, but Yellow Cabs disappeared, Uber would need 84,000 unique vehicles to provide the same service level.
What do the graphs tell us?
It is hard to extrapolate too much from the graphs as it is possible that Yellow Cab use may recover, as it has before. However it seems reasonable to conclude that Uber and Lyft have expanded the market and have impacted Yellow Cabs market share, but have not replaced or dominated them and do not look like doing so in the immediate future, even if they could the number of part-time drivers they would require is very large.
This is against a background in which Yellow Cabs are very constrained in their ability to react to ride-sharing. Uber is competing with an industry with its hands tied behind its back. They cannot increase the number of cabs, they can’t alter rates, they can’t increase utilisation due to the regulatory model. Rather than Yellow Cabs per se being the victim of ride-share, it may well transpire that the current ownership, financing and regulation of Yellow Cabs will be the victim. The traditional taxi model, untrammeled, could perhaps fight off the ride-share threat. We will never know. There are other changes that will impact the market long before Uber undermines Yellow Cabs.
An interesting study by MIT, with help from Cornell, suggests that using modern routing algorithms, just 3,000 vehicles could service the demand for taxis in New York City. This compares with the current 54,000 vehicles. It would require that customers share their rides, something that is assumed will not happen as the delays to being picked up and the extended travel time while the vehicle makes multiple drop-offs would deter passengers. However the models show that, using new techniques, the additional pick-up delay and the extra travel time would each be in the order of 3 minutes. The study does not go on to estimate the reduction in taxi fares such a scheme could support.
Self-driving vehicles are widely expected to be available in the next 4 to 5 years. There is a growing body of opinion that they will not evolve slowly from existing cars to be sold to private buyers but will instead spring fully formed into a market for commercial fleets. These commercial fleets will sell Mobility As A Service (MaaS) to the public. This will start in urban settings, where the market is largest. They will compete directly with existing taxi services and will have a significant cost advantage, they won’t need to pay drivers’ wages. They will be clean (electric drive) and will be safer than cars driven by humans. If the MIT study is correct, they can be fewer in number, intelligently routed, integrated into other modes of transport and cheaper.
A separate post reviews whether Uber can become one of those MaaS providers, but it seems certain that they will not have the 2021 taxi market to themselves simply because they caused some degree of disruption to an already doomed traditional taxi model in 2016.
If Uber’s strategy is to destroy the traditional taxi firms, become a monopoly and exploit that position, they are not doing it fast enough. The disruption of the traditional model over the last 5 years by Uber will seem as nothing compared with the change that is to come in the next 5 years. Uber is under just as much threat as Yellow Cabs.