Uber’s sustainability as a going business concern
If you haven’t read Hubert Horan’s four-part analysis of Uber, you should head over to Naked Capitalism to get started now. It’s an awesome series, although it’s rather long in aggregate, so here is a synopsis for each part (my commentary indicated by ^)…
Analysis: Uber isn't sustainable as a going business concern (Part 1: The financials)
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Analysis: Uber isn't sustainable as a going business concern (Part 2: Cost structure)
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Analysis: Uber isn't sustainable as a going business concern (Part 3: Innovation & competitive advantages)
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Analysis: Uber isn't sustainable as a going business concern (Part 4: Monopoly power)
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Mr. Horan used that series to evaluate the null hypothesis facing Uber and all of its stakeholders — a dose of healthy skepticism that few have braved. While his nominal objective is “addressing the question of whether Uber’s pursuit of global industry dominance would actually improve the efficiency of the urban car service industry and improve overall economic welfare,” the broad appeal of his work is his thesis, which he himself dwells on throughout: ‘Uber is unsustainable.’
He substantiates that thesis with plenty of objective research and subjective logic. I don’t even necessarily disagree with his conclusion, because, yes, Uber must thread-a-needle to justify its inherit-the-earth valuation. I also don’t necessarily disagree with his criticisms of Uber’s questionable business practices. So, what’s the problem? Why does his analysis warrant my rebuttal?
I’m pushing-back on him because, first, his “objective” begins with two assumptions that he presents as incontrovertible facts:
- Uber’s goal is “global industry dominance”;
- To be successful, a business must improve both industry efficiency and broad economic welfare
Second, the central tenets of Mr. Horan’s argument rely on analogies to Uber’s tech-darling predecessors. Such comps to Amazon, Facebook, Google, Apple, etc. are false equivalencies.
Third, extrapolating the financials of any immature business is folly — whether a seed-stage startup or a growth-stage $63B Uber. Not only is it a penetrating-glimpse-of-the-obvious to say that today’s Uber is unsustainable, but it’s also naive to think any one of us can foresee the future optionality for that business. Who knows what pivots or innovations they’ll dream-up? Nobody!
Sure, every startup can cite this same potential energy. Most can cite optionality. While I do not know if $63B is fair value for Uber, I do know that Uber’s optionality has a higher expected value than almost all comers, because it already has an installed base of almost 16 million paying MAUs. That’s not just proof-of-concept; that’s not just adoption; that’s not just scale or eyeballs… that’s actual monetization.
Yes, Mr. Horan is absolutely right: there is no reason to expect Uber will win the autonomous vehicle race. (In fact, I’ve asserted Google as the favorite.) But again, Tech 2.0 has taught us that the optionality a massive user base enables is one of a network’s most valuable, intangible assets.
In sum, I’m not necessarily bullish or bearish on Uber. I already made my case on that…
“Google still has an aggregate competitive advantage, because they’re a leader in the components that require massive capital outlays [cars & maps], which are major barriers to entry; plus Google has the institutional knowledge, data, and userbase to catch-up on the soft skills [routers & drivers].
“The capital intensity of building an autonomous vehicle fleet cannot be underestimated, especially since Uber’s huge valuation, unprofitability, and cash burn are head-to-head handicaps.
While I might even agree with Mr. Horan’s thesis, I definitely disagree with his process in arriving at his conclusion. He could end-up being right, and he could end-up being right for the right reasons. But, if I’ve learned anything from the investment business, I’ve learned that process is far more important than any individual result. Wins are great, but there’s high variance in a sample size of one. Plus, nobody cares about wins — they’re not worth anything unless you can repeat the feat. Whether you’re an athlete, an analyst, or an investor, a career is worth something, and careers are gilded by repeatable processes.
Now that I’ve consolidated my argument above, I’ll leave my itemized counterpoints below…
“ media coverage presumes Uber is following the path of prominent digitally-based startups whose large initial losses transformed into strong profits within a few years… [empirically, Uber has achieved] no meaningful margin improvement through 2015 [with 2016 progress] entirely explained by Uber-imposed cutbacks to driver compensation. [Plus] Uber lacks the major scale and network economies that allowed digitally-based startups to achieve rapid margin improvement.
All of that could’ve been said about Amazon too, including a lack of network economies. (Remember, he’s the one resorting to such comparisons, not me.)
“ If rapid growth could not drive major margin improvements between 2012 and 2016, there is no reason to believe that Uber will suddenly find billions in scale economies going forward… companies like Amazon, EBay, Google and Facebook had massive operating scale economies because the marginal cost of expanded operations was close to zero. Aggressive pricing fueled the growth that drove major margin improvements and also created major consumer welfare benefits.
- Amazon did not have zero marginal costs in scaling;
- Facebook didn’t have positive gross margins when it was scaling… it didn’t even have a revenue model;
- Today, Uber’s economies of scale & network effects come from supply/demand liquidity & ridesharing, which are redoubled by the potential of driverless cars
“ Drivers, vehicles and fuel account for 85% of urban car service costs. None of these costs decline significantly as companies grow.
Really? There are no scale advantages here; no opportunities for Uber to negotiate bulk discounts? No chance that an automaker would cave-in on the Prisoner’s Dilemma and offer wholesale, buyer, or lessor discounts to Uber drivers? No chance that Uber would commercially hedge fuel costs, then offer drivers gas cards? Think that one through.
“ To evaluate [Uber] one needs to consider the entire (corporate+driver) business model since neither… can work in the marketplace unless both… can achieve reasonable earnings.
This is the Multistakeholder Theory, which many businesses have disproven. For example, in a nod to Microsoft Windows, Bill Gates once defined a “platform” as a business that creates value, but retains less of that value for itself relative to what other stakeholders (like users & developers) reap. Gate’s definition of a platform is the opposite of rent-seeking. In contrast, Apple’s App Store defied Gates’ theory — as have many others — by creating market inefficiencies. In the App Store’s case, Apple won a race to scale with a closed platform that locked-in developers and captured a substantial share of the economic gains.
While Uber has taken Apple’s approach, the window is closing on the conditions that enabled its rise: both the market inefficiencies (e.g. free money/abundant capital or disruption of taxi medallion system) and the scale opportunity (e.g. low barriers-to-entry have allowed competition to catch-up & chip-away marketshare).
“ Uber not only lacks the major cost advantage that a company seeking to drive incumbents out of business would be expected to have, but actually has higher costs than traditional car service operators
Again, this is unconventional, but it’s not unfounded. Specifically, Uber’s strategy of being the high-cost disruptor defies Christensen’s classic Disruption Theory (i.e. low-end disruption). In these circumstances, the competition is for superior user experience — as opposed to price wars.
This is another example of Uber being analogous to Apple, whose iPhone disrupted Nokia from the high-end.
“ Two of the primary narratives constructed to “explain” Uber’s growth were that it was pioneering the development of the “sharing economy” and the “on-demand economy… The alleged basis of the “sharing economy” was that cars were only used 56 minutes a day on average, and that “ridesharing” companies like Uber were creating huge value by exploiting the 97% of the time when cars were idle. This ignored the fact that the overwhelming majority of personal items had much lower utilization, and that “sharing” businesses had existed for decades [like tux, bowling shoes, or car rentals, for all of which the cost of renting] is substantially greater than the comparable cost of direct ownership.
The crux of the sharing economy is tech enabling peer-to-peer commerce – lowering prices by eliminating middlemen’s cut (i.e. disintermediation).
“ the timing of taxi demand is highly inelastic, (people want a cab at a very specific time) so [surge pricing] fares will not change demand patterns, improve taxi utilization, or increase total revenue… this does nothing to increase total taxi supply, but merely redistributes drivers to higher fare areas.
This is categorically wrong. Surge pricing is explicitly an acknowledgement that taxi demand is inelastic, so it’s addresses that problem with a supply-side solution that empirically works: surge pricing incentivizes increases in driver supply to meet increases in cyclical demand.
“ Uber’s business model, if proven successful, could be readily replicated in other industries
— vs —
“ the magnitude of funding required to subsidize the many years of predatory competition required to drive out more efficient incumbents… The growth of Uber reflects a massive failure of capital markets who have been reducing overall economic efficiency by reallocating resources from more productive to less productive uses.
Uber’s model cannot be replicated. This is a contradiction to one of this article’s own assertions (which I too have insisted previously) that the innovation at the heart of Uber was outspending its competitors & incumbents – something enabled by an abundance of capital during QE/ZIRP, which funding conditions were ephemeral.
The race Uber ran was to achieve scale before the window closed on abundant capital. Given Uber’s massive valuation and rising rates, it’s likely that that window has now closed. So, has Uber finished the race to scale in time? I’d argue that they have. Uber has a huge user base across a wide geographical footprint. Uber also has substantial revenue. What are the benefits of all that? I don’t know — nobody knows yet. But, to repeat, the optionality from such critical mass is valuable.
If that’s not good enough of an answer for you, try this: Could Uber cut a global deal with a major automaker tomorrow? Yes. Is such a deal enough to outflank local taxi dispatchers? Yes. Has Uber shown the willingness and capability to execute on such a deal? Yes.