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Why do Uber debates sound just like partisan debates in Washington? Is this a case where investors have found sharp mangers with innovative ideas who will create clear value to society if they succeed, is this another parasitic attempt to become rich by screwing workers, consumers and eliminating competition, or is this like all those ultra-hyped dot-com bubble startups based totally on hot air that will go away before too long?
Again, this is just intended as an rough outline of some of the things to think about as you continue to cover the story, but please let me know if you have any questions
1. The issue is tomorrow’s Uber, not today’s Uber. Uber’s current consumer reputation is based on serving niche markets in a limited number of large, wealthy urban markets. It has a tiny share of the overall taxi/livery/limo market in those cities, which (based on its publicity) seems much stronger in certain demographics than others (e.g. Silicon Valley, not East Bay; weekend clubbing, not conventioneers). Uber publicity often features quotes from users in wealthy cities (Manhattan, Washington) talking about how much they prefer the nice Uber cars and drivers to regular cabs. But the growing public debate about Uber would not be taking place if its corporate ambition was limited to providing a premium taxicab alternative for wealthy urbanites. That debate is occurring because Uber claims it is currently valued at $18 billion, well into the stratosphere of start-up valuations, and Uber has recently raised the prospect of new investments that could push its valuation above $30 billion. Uber’s financial ambitions could only be achieved with many years of staggering growth, which means becoming wildly different from the company its Santa Clara/Brooklyn customers are familiar with. The question is what does Uber need to do to achieve the massive growth needed to justify an $18 billion valuation, and what kind of company would that be?
2. Tomorrow’s Uber is targeting a stratospheric billion valuation Uber appears to have an army of supporters, and has achieved staggering levels of publicity for a company of its current size, even by dot-com era standards. It is not intuitive as to how $18 billion or $30 billion of economic value could be realized out of the traditionally cutthroat/low-margin urban car service business, and none of the pro-Uber publicity I’ve seen provides any financial/business explanation of how this megagrowth might be achieved. The only attempt at an independent valuation analysis I’ve seen is by NYU Finance Professor Aswath Damodaran. His analysis ignored all the various regulatory/competitive/labor issues that have been raised, accepted every company claim at face value but could only come up with a $6 billion valuation if he assumed that Uber overwhelmed every competitor pursuing a similar business model, grew across the entire globe (not just America and Europe but Malaysia and New Zealand and Egypt) while maintaining the 20% margins it currently gets in Santa Clara and Brooklyn. http://aswathdamodaran.blogspot.com/2014/06/a-disruptive-cab-ride-to-riches-uber.html Cut back some of those assumptions and you’d still have what some people would consider a successful start-up, but 95% of the valuation Uber is claiming would vanish. Similarly a Financial Times article argues that Uber would have to achieve Ebay’s level of growth for 15 years (one of the greatest internet financial successes of all time) to come close to justifying the $18 billion valuation (http://ftalphaville.ft.com/2014/06/10/1873482/uberbay/). Uber is not the first Silicon Valley company whose founders might have been blinded by visions of staggering wealth. But even if Uber management is strongly focused on convincing capital markets it can achieve Ebay levels of growth, it is useful to consider whether anything in Uber’s business model might create sustainable competitive advantages, powerful advantages for consumers, or create any other tangible benefits.
3. What efficiency/consumer/competitive drivers explain expectations of Uber’s extremely rapid growth? Amazon’s valuations were always hard to explain in traditional financial terms (Professor Damodaran’s article explains the hoops you have to jump through to explain the huge venture capital valuations of companies like Pinarest, Dropbox, Airbnb, Uber, etc.) but the logic behind the Amazon business model was always transparent and logical. Internet distribution of books drove major savings from eliminating the inventory and brick/mortar costs of traditional bookstores. Amazon provided a huge new consumer benefit by offering immediate access to almost any book in print. Further savings came from major warehousing/distribution efficiencies, and the potential to use that warehouse/distribution infrastructure to expand into lots of other markets at low marginal cost. Since these specific inventory/warehousing advantages were sustainable (e.g. later copy-cats like Barnes and Noble couldn’t achieve similar efficiencies or service levels) they gave Amazon the potential to achieve long-term market dominance, which was probably the largest driver of its financial valuation as it grew. As noted earlier, despite their intense PR efforts, Uber has not articulated what it thinks its growth drivers will be. How will it be able to provide taxi/livery/limo service at substantially lower cost, so that it can blow away existing providers? How will its service be so demonstrably superior to current providers? How will it sustain any such advantages given the relative ease of copying most efficiency gains in both car service operations and software applications (booking/pricing/scheduling) that support those operations? It is clear that Uber and the people who find the valuation forecasts credible expect a growth juggernaut that will create a radically different company that what exists today—one that can achieve a huge share of the taxi/livery/limo markets in every major city, one can expand to hundreds and hundreds of new cities, and one that can readily blow away existing competitors (as with Amazon and bookstores) and readily blow away and new entrants pursuing similar approaches. What competitive strengths could drive this juggernaut?
4. Why would a Uber/independent contractor approach be economically superior to the traditional taxi/livery/limo approach? Uber is not a transportation company, it is a software company interposing itself as a middleman between taxi/livery/limo consumers and independent contractors who provide the actual services those consumers want. If you believe Uber can achieve Amazon/Ebay rates of growth, you have to believe this whole business model works, the software/middleman component can’t grow unless its drivers can drive traditional companies out of the market. And you not only have to believe that it works in some markets for some categories of consumers, you have to believe it is so overwhelmingly superior to the longstanding model (where car service companies buy their vehicles, hire drivers as employees and deal directly with consumers) that those existing companies will soon be as obsolete as bookstores, or shrink to a marginal role, like cinemas. But traditional business logic suggests that the economics of the existing companies should have huge advantages over the Uber/contractor model.
(1) today’s car service companies should be able to purchase cars, maintenance, training and insurance much more cheaply than hordes of isolated individuals; it is virtually impossible to grow rapidly and displace existing companies if your costs are uncompetitive (2) Uber publicity often highlights the “efficiency” of using wasted, idle car capacity (i.e. drivers who use their personal car to carry Uber passengers on weekends to earn extra cash). But Uber could not possibly become a major competitor if it depended on casual, spare-time capacity. Uber competitiveness and growth depends on drivers willing to buy vehicles and operate them in Uber service full time and Uber fares will need to cover the full costs of these vehicles. A recent study showed that the vast majority of Manhattan Airbnb rentals were not spare-time use by transient owners, but were apartments used exclusively as Airbnb rental units (contradicting similar Airbnb claims about “efficient use of idle capacity” claims). (3) given their market knowledge and control over vehicles and drivers, existing companies should be much better at tailoring capacity to the overall level of demand in market and to the normal fluctuations in demand (due to weather, conventions, special events, etc.) than the Uber model where none of these are proactively managed. (4) while Uber PR often highlights the app that serves as the customer interface, this type of software (and the scheduling software behind it) isn’t a sustainable advantage because it can be readily copied by competitors; the cab company I use in Phoenix also has a software group that produced a nice app, but doesn’t claim a multi-billion dollar valuation because of it. (5) taxi drivers in most parts of the world are extremely poorly paid; Uber can’t survive if its driver compensation is even lower, and one presumes it will have to pay a lot more than current rates if it wants to grow rapidly; Uber’s middleman/software fee (its only current source of revenue) comes right out of the driver’s earnings so it is already facing a difficult tradeoff between revenue and growth (6) Service reliability is critical in any transportation business, and is extremely critical to the person who needs to be driven to their6:30am flight; a taxi/limo company controls the cars, maintenance and drivers that determine reliability; one presumes Uber reliability will be worse because it won’t directly control any of those things. Uber claims to be rigorous about weeding out drivers who receive negative ratings but one presumes that taxi and limo companies also weed out drivers who get multiple complaints; over time there is no way Uber can employ all the better drivers without paying them significantly more than its competitors. (7) Uber uses “variable pricing” as opposed to fixed-in-advance taxi/livery/limo rates; this can work for airlines where the discount fares are sold weeks/months in advance and there customer can be virtually certain that the ticket will be honored, but how does variable pricing work when it starts to rain, and demand for service suddenly quadruples? Perhaps a workable variable pricing strategy can be developed that will produce more revenue for Uber but I assure you, it won’t be popular with consumers, and Uber can’t achieve megagrowth if consumers think they are getting gouged from time to time. (8) every local car service market is different in terms of demand patterns, existing competition and the labor market drivers will be drawn from, so there will be costs (and failure risks) each time Uber expands to a new city, and much bigger costs for each new country. This is why you don’t see national taxi companies—the fact that you ran a quality, efficient cab service in Denver means nothing if you decide you want to expand to Minneapolis and compete against the companies that already know the local market very well. Ebay and Amazon faced zero costs expanding their services across America and very small costs expanding internationally. So why would anyone presume that Uber could expand nationally/internationally as rapidly as Ebay and Amazon?
I can think of other issues as well, but these are very simple, basic questions about Uber’s potential competitiveness. It would appear to be less efficient than existing competitors in terms of vehicle costs, maintenance, training, understanding local demand/competitive conditions and tailoring capacity to those conditions. It would have to pay more money to drivers for many years to have any hope of growing at the expense of those existing companies. Uber’s potential customer interface and variable pricing advantages would appear to either be limited to narrow niches, easily matched by competitors, or an obstacle to rapid future growth. All of articles and posts from Uber’s PR machine talk about the potential to become a growth juggernaut; none explain specific, powerful, sustainable competitive advantages that might fuel that growth, or how those drivers are scalable enough to fuel rapid national/international expansion.
5. Is Uber trying to “disrupt” a backward/inefficient industry? There are several problems with the “Uber as heroic disruptor that will deliver huge benefits to consumers once the lazy, inefficient incumbents have been vanquished” meme that runs through much of the pro-Uber campaign. The most important, discussed above, is that no one seems able to provide a plausible explanation of the huge competitive advantages that would allow Uber to vanquish the incumbents. Taxis/liveries/limos have not become bloated with inefficiencies while they were exploiting consumers with excessive oligopoly fares all these years. The second is the problematic conflation of new technology/good existing technology/evil, and the PR efforts surrounding it. Amazon’s competition with brick/mortar bookstore was not a battle of good vs. evil. Amazon worked to convince consumers that it could provide a new/better service at lower cost; it did not mount massive PR efforts to glorify its corporate heroism or denigrate the evil, reactionary booksellers. Uber’s campaigns also badly misrepresent the role of “new technology”, which in this case is just its consumer app and scheduling software. Apps are not “heroic new technology”, no company has ever received a multi-billion dollar valuation because of a neat app, and Uber’s app appears to be a minor (if not totally insignificant) part of its overall business model. Amazon’s rapid growth and consumer popularity is driven by a wide range of very efficient business practices; its consumer interface is quite good, but a very small piece of its larger success. The third problem is that while there are obviously unpopular, inefficient aspects of current taxi/livery/limo operations, the ones Uber attacks tend to be very localized (rent-seeking medallion owners in the handful of cities where these are very expensive) or aren’t problems Uber would solve it grew to become a dominant industry player (occasional no shows and filthy cabs, the small risk of rip-offs and other bad driver behavior). The simple solution to artificial medallion values is to issue a lot more medallions. However, while eliminating medallion ownership as a barrier to entry would get a lot more cabs on the street, unfettered open entry would also drive driver wages down to even lower levels and would expose consumers to higher risk of no-shows, filthy cabs and rogue/incompetent drivers. The solution to those service problems is much stricter rules about maintenance, training, driver screening and liability insurance. But those are the exact types of evil regulatory constraints that Uber is most keen to disrupt. The fourth problem is that that Uber (like most highly valued Silicon Valley startups) clearly hopes to achieve the market power that comes with sustainable industry dominance. Uber, like other high growth companies, might create some temporary benefits (i.e. forgoing profits with low prices or higher driver wages while they try to drive existing competitors out of business) but the dominance it is seeking is fundamentally incompatible with the interests of consumers and workers. The whole point of industry dominance is to create pricing power and huge leverage over suppliers than can be exploited once a virtual (Microsoft, cable TV) or stable oligopoly (airlines, cell phones) is in place.
6. Is Uber trying to distract attention from a deliberate strategy of labor exploitation? Since no one can provide plausible Uber growth theories based on major productivity/service improvements, one must consider the possibility that Uber management’s growth strategies may be at least partially based on drivers it would not want to publicize. The labor exploitation hypothesis suggests that Uber not only hopes to avoid paying higher costs that might be needed to attract drivers away from competing companies, but hopes to actually achieve driver costs lower than what existing companies face, by exploiting significant information dissymmetries. One key is Uber’s “independent contractor” approach, whereby those drivers provide the vehicle, vehicle maintenance and liability insurance. As mentioned earlier, traditional business logic suggests that this approach could not work because existing companies could always get much better rates than individuals acting in isolation. In these situations Uber has shifted the full vehicle capital risk (normally borne by a taxi company) to the driver; this allows Uber to grow without raising much capital, but there is no evidence that drivers are being compensated for their (collectively) large capital contribution, or the risk that Uber exercises it rights to suddenly terminate the contract of the person who had purchased a vehicle on its behalf. Similarly, the typical taxi/limo driver may not understand the true maintenance/depreciation costs of intensive commercial use as well as professional fleet managers, and multiple reports indicate Uber drivers do not always understand the requirement to purchase commercial insurance with significantly greater liability coverage than their personal policies (carrying paying passengers would invalidate their personal policies and violate laws in most cities). Some drivers may be willing to explore Uber options given the poor pay and conditions at other companies, but if the capital and insurance costs at Uber are not clearly covered by much higher passenger revenues (i.e. if net “pay” at Uber isn’t clearly higher than what taxi operators pay) than the Uber approach will be unsustainable. Uber might forgo its software charges in order to increase net driver “pay” in the near term as it tries to put existing companies out of business, but if it eventually was able to become the car service company it would likely regain the leverage to force labor to bear much more of the costs and risks currently borne by taxi/limo operators.
7. Is Uber trying to distract attention from deliberate regulatory arbitrage? Car service regulations fall into four major categories—minimum business standards/consumer protections (requirements for adequate financial resources, commercial vehicle and driver licensing, maintenance, driver screening and training, insurance, clear advance notice of fares, meter inspections, etc.), market entry rules limiting the specific services (taxi/limo) companies can offer and the number of vehicles that can serve each market, and labor law provisions (minimum wages, benefit and tax rules for full time workers, etc.). While there are a handful of cities with particularly problematic regulations (such as medallion based entry restrictions that transfer huge economic value from operators to medallion holders), most are designed to protect against the risks consumers might face in a totally unlicensed world, and to provide minimum recourse for consumers who might injured in an accident or harmed by a rogue driver. Operators are also constrained by insurance companies, who can adjust rates based on evidence of vehicle maintenance, driver training and similar factors. Uber appears to be pursuing a deliberate strategy of regulatory arbitrage; they appear to want to be able to evade rules they find inconvenient, but still want those rules to be imposed on their competitors.
(a) Uber’s regulatory arbitrage of minimum standards and consumer protections centers on the confusion caused because neither Uber (a software company) or its “independent contractor” look like the taxi/livery/limo companies, and thus both Uber and its drivers can insist that they have no obligation to obey those financial/insurance/safety rules. People can get into taxis and limos in every major city confident that the local government would not permit that vehicle to operate without adequate insurance and commercial licenses and knows that regulators would revoke the operating rights of companies that refused to pay valid claims for accidents or other serious problems. Uber customers have no way of knowing if they have the vehicle meets local insurance/maintenance standards, no recourse against Uber if they are injured in an accident or has been ripped-off by a driver have (since it will insist it is just a software company), no regulatory protections, and must bear the full burden of pursuing the “independent contractor”, who is not registered anywhere and may or may not have the insurance or financial resources to resolve a valid claim. http://www.businessweek.com/articles/2014-03-14/uber-tries-to-convince-drivers-and-lawmakers-theyre-covered
(b) Even where car service companies are free to set their own rates, jurisdictions require these rates to be clearly published in advance and strictly obeyed to protect consumers from drivers suddenly demanding more money if they’d like to actually get to the airport. Uber’s variable pricing software appears to evade these protections, and there is growing anecdotal evidence of Uber customers finding their bookings have been cancelled at the last minute by drivers who can make a lot more from new bookings at surge pricing rates. (c) Medallions and similar regulatory entry restrictions usually focus on taxis (vehicles that can be waved down on the street) rather than limos and vans (which must be preordered). However these distinctions have always been blurred since—aside from airports and very dense places like New York—most traditional taxis are preordered, and non-taxi operators (Uber, limos) are regularly seen soliciting passengers that have not preordered. While one can question the need for entry barriers or taxi/limo restrictions, there is no justification for allowing Uber or limo companies free access to airports of other taxi markets while continuing to impose entry, pricing and licensing rules on taxis that Uber and the limos do not have to meet. (d) Uber’s “independent contractor” approach arbitrages labor laws that its competitors must obey, although misrepresentations about full time workers can undoubtedly be found at many existing companies.
The counter claim that there may be regulations are poorly administered or fail someone’s cost/benefit calculus is irrelevant—Uber has not proposed regulatory reforms, does not appear the least bit interested in a level competitive playing field, and appears focused on gaming existing systems for their private advantage.
8. Traditional business analysis raises serious doubts about Uber valuation and growth potential. If one applies typical business school analytical criteria (focused on issues such as technology and process innovation, competitive advantages from sustainable cost efficiencies or superior customer service, the coherence and scalability of business models and the potential for future market growth, and expansion into other complementary markets) it is difficult to understand why anyone would see Uber as a likely candidate to achieve the stratospheric long-term growth that would be needed to justify the huge valuations that the company and its supporters seem to expect. Uber clearly appears to have won a degree of acceptance among customers with high disposable incomes in large, wealthy cities, but that sheds no light on the plausibility of Uber’s ambition to radically disrupt and transform the car service industry and to become that industry’s dominant worldwide player. The Uber business model appears to involve higher vehicle capital costs, higher maintenance costs, poorer capacity utilization, and less knowledge of local market conditions that existing business models, and would likely also face higher labor costs throughout the years until its hoped for industry shakeout had been achieved. The potential advantages cities by Uber’s publicity appear to be ones that competitors could readily match (smartphone apps) or that depend on labor exploitation (drivers willing to absorb vehicle capital costs and risks without full compensation) and/or regulatory arbitrage (failure to pay necessary insurance and licensing costs that its competitors must pay). There is no clear link between the tens of billions in financial value and any tangible new economic (efficiency/service) value that Uber is creating, and there is reason to be concerned that some of that value depends on the destruction of existing economic value (safety and consumer protection) and wealth transfers from labor. The value of today’s (highly fragmented) industry primarily resides with the people that provide capital (vehicle) financing and manage how those assets are utilized in the marketplace. Uber’s only contribution to the industry value chain is booking/scheduling software, but it is attempting to capture all of the value contributed by those financing and operating people. A major portion of Uber’s prospective valuation assumes it can wipe out existing suppliers and achieve a sustainable market dominance. This would not only secure its ability to capture value currently held by labor and other parts of the business/supply chain, but would facilitate significant wealth transfers from consumers through pricing power and the ability to further weaken safety and consumer protection rules. But since there does not appear to be any basis for expecting that Uber could achieve enormous sustainable competitive advantage over existing operators, there is no apparent reason to expect any of the major market disruption/dominance aspects of its valuation to be achieved.
9. Uber’s massive PR/propaganda efforts and its aggressive attacks on regulators, competitors and journalists tend to support the hypothesis that its growth/valuation objectives are highly unrealistic. If the business analysis outlined here was substantially wrong, and Uber’s growth/valuation objectives were based on highly credible new sources of competitive advantage, then one would expect Uber to devote major effort to lay out reasoned arguments and evidence supporting its business case to the capital markets. Those markets know there have been a huge number of well-publicized startups whose founders harbored dreams of staggering wealth but had business plans that could not withstand any objective scrutiny. If Uber was convinced it had a powerful plan, it should welcome scrutiny from independent financial analysts and respectfully engage financial analysts and journalists who might have questions or concerns. Instead, Uber has mounted a massive PR effort that ignores the substance and approach of business startup cases, and treats the company’s development as a no-hold-barred political campaign. Instead of explaining how today’s niche business would be transformed by a decade of Ebay-level growth, or addressing any of the other questions that investors might have, Uber’s PR emphasizes soundbite claims about current service (quotes from Silicon Valley tech workers who love the app or from rich Manhattanites who like Uber cars better than yellow cabs). To distract from business issues like cost competitiveness or the scalability of growth, Uber’s uses explicit political propaganda based on ideological/tribal hot buttons. Originally these focused predominately on Silicon Valley/financial industry/libertarian slogans (“industry disruption” calling regulation “anticapitalist taxi protectionism”, emphasizing the heroic nature of Uber’s new technology) that might engender group affinity but were totally free of actual substance (taxicabs are not the price-gouging oligopolists that technologists like to disrupt, protections for Medallion holder wealth is only found in a handful of cities and Uber has done nothing to threaten them; the regulatory requirements for insurance and commercial licenses that Uber directly threatens are not “anti-capitalist”, Uber’s apps are not cutting-edge technology). Uber recently hired former Obama advisor David Plouffe to broaden its political propaganda efforts. But its initial propaganda targeting wealthy, Democrat-leaning customers in cities like New York and San Francisco (Obamacare is a good thing!) is just as much of a substance free distraction from actual business questions as its quasi-libertarian rants (Obamacare will have zero impact on whether Uber can successfully kill off existing car service companies). Whether one is a die-hard libertarian or a major Democratic fundraiser, there is simply no compelling reason that those partisan/ideological preferences should lead you to become a dedicated supporter of this one private company in this particular market and a dedicated opponent of all the private companies it competes with. But Uber remains strictly focused on PR positioning and propaganda-type messaging, and shows no interest in helping investors better understand its growth potential, or helping consumers or suppliers understand why an Uber-dominated industry would be in their interest.
The belligerent, arrogant posturing in much of Uber’s PR also logically fits the hypotheses presented here. Uber is trying to create the impression that it has already created an unstoppable juggernaut that existing competitors have no hope of withstanding. David Plouffe claims “change is inevitable” but the underlying message is “resistance is futile”. Since it needs to convince investors and competitors that it cannot possibly be slowed by petty bureaucrats and their silly insurance and licensing rules, it attacks all regulations as fundamentally corrupt and openly brags about their refusal to obey cease and desist orders. http://online.wsj.com/news/articles/SB10001424127887324235104578244231122376480 This not only hits ideological hot buttons, but it signals local governments that any attempt to enforce existing regulations will be countered with ugly, expensive political conflict. Since Uber’s growth plan depends on totally dominating the car service industry, it needs to convince investors that it cannot be threatened by other new entrants like Lyft, Sidecar and Gett, and this explains ongoing efforts to sabotage those companies.
Uber’s massive PR efforts are designed to create an “alternative reality field”; it wants public perceptions of Uber to limited to its depiction of a battle of good vs. evil (cutting edge-technology vs the corrupt regulators protecting backward, inefficient taxicabs), to the soundbite claims of a superior product (what a great app!), to the rabid support of its ideological/tribal supporters, and ideological sympathetic coverage in the business press, and the perception that nothing could possibly prevent its rapid growth and competitive success. More importantly, Uber needs to prevent any public discussion based objective evidence about technology or efficiency or competitive advantage; subjecting Uber to objective scrutiny would not reveal serious deficiencies but would highlight the purely emotional/tribal nature of what they have been presenting to potential investors. Thus it comes as no surprise that Uber has been going to great lengths to undermine any journalists or financial analysts willing to challenge the alternate reality it is trying to establish. http://www.buzzfeed.com/bensmith/uber-executive-suggests-digging-up-dirt-on-journalists
10. Does Uber have a legitimate business model with legitimate growth prospects and a legitimate valuation? These remain open questions. It is noteworthy that Uber has not managed to achieve press overage and public discussion wildly out of line with the prior public interest in the taxi/livery/limo providers or the actual importance of Uber’s attempt to enter that market, while managing to frame the discussion in ways that exclude consideration of any of the issues (actual efficiencies, competitiveness or revenue/profit performance) needed to answer these questions. It is readily apparent that Uber’s owners are strongly focused on becoming spectacularly wealthy, and in pursuit of that wealth fully intend to destroy hundreds of other companies, and the livelihoods of the investors, employees and suppliers they support. The question remains—will this improve or damage the economy as a whole? If Uber can achieve a valuation of tens of billions without compelling evidence of major productivity achievements or sustainable competitive advantages, it would beg basic questions about the capital market ability to benefit society by reallocating capital from less productive to more productive uses. If the investment case for Uber depends heavily on factors such as labor exploitation, regulatory arbitrage, artificial wealth transfers from the rest of the industry’s value chain, or the strong expectation that it can exploit pricing power and rent-seeking opportunities once it drives existing competitors out of business, that would raise questions as to whether the venture capital and investment banks involved here were complicit in activity designed to damage the overall performance of the US economy.