Uber is still trying to figure out if it's a real business

Opinion Tuesday 30/August/2016 17:57 PM
By: Times News Service
Uber is still trying to figure out if it's a real business

Uber is still losing lots and lots of money, the world learned last week from Bloomberg’s Eric Newcomer. It may even be losing a lot more money than Newcomer was able to tell us about. As he put it in his weekly e-mail newsletter:
We know that Uber has lost at least $1.2 billion in the first half of 2016, but it's definitely more than that. I reported in the story that in the first quarter Uber lost about $520 million, but in the second quarter Uber's losses significantly exceeded $750 million. I think that significantly exceeded bit is getting lost in some of the write-ups. That's the floor. Uber's losses in the quarter were so high that I couldn't get an exact number out of my sources.
There is another word for losses at a startup company: investments. As Eric Paley of the venture capital firm Founder Collective, an early Uber investor, put it on Twitter:
Fair point. It does raise the question, though, of what exactly Uber is investing those billions in, if not kittens. The simple answer is that, as Newcomer put it in his article, "subsidies for Uber's drivers are responsible for the majority of the company's losses globally." To really be an investment, those subsidies should be establishing some sort of competitive advantage for the company. But what exactly would that competitive advantage be?
This is a question that business school professors, who tend to be pretty interested in competitive advantage, have been asking themselves lately. Because I wrote a couple of columns this summer about Uber's competitive position, some have even been e-mailing me about it. Here's Melissa Schilling, a professor of management and organisations at New York University's Stern School of Business:
There are two main reasons for tech companies to lose money early to make money later, and neither of them apply to Uber.
1. Upfront investments in fixed costs that are going to pay off with scale. Tech companies often have to make big investments in R&D and/or production facilities that won't pay off until sales are large (think biotech or Tesla). This is a classic economies of scale argument. This doesn't work in Uber's model -- Uber's fixed costs are low; most of its losses are due to driver costs, which are a variable cost, and drivers aren't going to get cheaper as Uber gets bigger.
2. Subsidising a large installed base to "win" the market. Companies in industries with network externalities (like video games, operating systems, social media) may subsidize the adoption of the installed base (cheap consoles, free social media platforms) with hopes of becoming locked in as dominant, and then make money through other revenue streams tied to the installed base (games, advertising). Uber seems to believe in this model but it has two problems here. First, it's hard to "lock in" because switching costs are low for both drivers and customers. Many drivers are already driving for multiple systems simultaneously! Second, where's the alternative revenue stream? For Uber to continue subsidizing the installed base it has to make money on something else connected to the installed base, and right now it's not obvious what that could be
Uber's short-term answer to the lock-in problem seems to be offering incentives to keep drivers from also driving for rival services such as Lyft or Gett, but that's expensive and may not work. Uber-owned automated cars presumably wouldn't ever switch to another service (at least not before they become sentient), but (1) despite the trial run this month in Pittsburgh, that's probably a long way off and (2) will take many more billions of dollars in investment.
Then again, maybe Uber's plan for profits is of a more old-fashioned sort. This is from Sanford Jacoby, an economist and business historian at the University of California at Los Angeles's Anderson School of Management:
The usual story about Uber is that it's successful because of network effects that create an interaction between the number of customers and the number of drivers. Economists like that story because of its efficiency properties: matching supply and demand. Efficiency means lower fares. An offshoot is that Uber cars have higher capacity utilization, which also reduces fares, as compared to taxis.
There's a quasi-alternative story, which is that Uber draws customers away from taxis by cutting fares (surge pricing gets all the attention but should not). Its cash hoard allows it to do this around the world. Once it's damaged the competition, customers have increasingly fewer alternatives and Uber becomes even more popular. Eventually the loss leading creates a quasi-monopoly and then fares can go up
That last story at least gives Uber a clear path to sustainable profits -- and fits with the company's recent decision to get out of China, where it appeared to have no chance of becoming the dominant player. It also raises lots of questions, Jacoby points out, about federal antitrust regulation and state fair-trade laws that are supposed to prohibit such loss-leading tactics. It's definitely not a feel-good story.
The biggest feel-good story about Uber and its rivals so far is that they have dramatically expanded the market for taking rides in other people's cars. In 2014, NYU Stern finance professor Aswath Damodaron got into a big online debate with venture capitalist and Uber board member Bill Gurley over whether the company would simply displace existing cabs and car services (Damodaron's initial view) or bring in lots of new customers ("When you materially improve an offering, and create new features, functions, experiences, price points, and even enable new use cases, you can materially expand the market in the process," Gurley wrote). In a blog post earlier this month, Damodaron basically conceded defeat on this:
Ride sharing has grown faster, gone to more places and is used by more people than most people thought it would be able to, even a couple of years ago. The pace of growth is also picking up.
So the Uber booster turned out to be right, and the skeptical business-school professor turned out to be wrong -- something to keep in mind when reading the doubting comments of business-school professors and of journalists today.
What we don't know yet, though, is how much of this growth is the result of the real technological and network advantages of smartphone-enabled ride hailing and how much is due to the big subsidies that Uber and its competitors have been handing out (and the advantages they have enjoyed by being regulated less stringently than taxis). As Damodaron pointed out in that same post, it still isn't clear what Uber's business model is. Until it is, the business-school professors are only going to get more skeptical. - Bloomberg View