This is the first of a four-part series on Uber’s past and future. Today’s article focuses on identifying the root causes of Uber’s deep losses to date.
- Why Uber May Never Be Profitable — June 2, 2019
- Are There Quick Fixes To Improve Uber’s Profitability? – June 3, 2019
- What Else Can Uber Do In The Short- To Medium-Term To Reverse Its Steep Losses? – June 4, 2019
- Can Uber Ever Deliver The Transformative, Profitable Future That Its CEO Has Promised? – June 5, 2019
May was a tough month for Uber. The company that had lost more money, faster than any venture in history, added the distinction of having destroyed more shareholder value in its first two days of trading than any IPO in history – by a wide margin.
In response, Uber CEO Dara Khosrowshahi sent a letter to employees, striking a decidedly somber tone.
There are many versions of our future that are highly profitable and valuable, and there are of course some that are less so… Sentiment does not change overnight and I expect some tough public market times over the coming months.
Khosrowshahi’s candor was admirable, but his appraisal could hardly be reassuring to thousands of employees whose stock options are under water, and who now find themselves working for a company that is neither profitable nor growing.
To calm nervous investors, Khosrowshahi has been doing his best to provide assurances of a bright future, emphasizing:
- Uber is well positioned to penetrate a $12 trillion addressable market.
- Uber’s platform is poised to become the Amazon of transportation
- Other companies like Amazon and Facebook also had rocky IPOs (and look at them now)
But Khosrowshahi’s vague promises and selective comps neither explain why Uber has been so singularly unprofitable, nor clarifies how the company will finally achieve profitable growth in the years ahead. Investors are clearly not buying the CEO’s palliatives — and for good reason — as I ‘ve described in prior commentary.
To fill the company’s void on future guidance, this column addresses the first of four questions Uber should have answered prior to its broken IPO.
- What are the root causes of the Uber’s deep losses to date?
- Are there quick fixes to improve Uber’s profitability?
- What can Uber do in the short- to medium-term to reverse its steep losses?
- How and when can Uber deliver the transformative, profitable future that its CEO has promised?
What are the root causes of Uber’s deep losses to date?
The short answer is, a fundamentally flawed business model.
From its inception, Uber’s ex-CEO Travis Kalanick fervently believed his company would transform urban mobility on a massive global scale, based on six key assumptions.
- Uber’s asset-light business model and strong network effects would yield huge economies of scale and an unassailable first mover advantage in each of the markets it entered.
- Uber’s prodigious fundraising would give it ample reserves to drive competition from the market and establish global monopoly control and pricing power
- Uber’s scale advantage and sophisticated AI algorithms would power a superior service, translating into shorter wait times for passengers and drivers, and improved driver productivity, which in turn will allow Uber to achieve the trifecta of low fares, attractive driver compensation and corporate profitability.
- With consumers on its side, municipal governments would be unwilling or unable to restrict its ever-expanding operations, even after recognizing that Uber’s business priorities conflict with public policy goals for sustainable, efficient modes of public transportation and adequate compensation for a large and growing sector of city employment.
- Product line extensions would provide profitable growth opportunities to offset lingering losses in the core ridesharing business
- Over the longer term, the combination of available funds from capital markets and retained corporate earnings would fund a seamless transition to autonomous vehicle operations, promising an even more utopian future.
But Uber’s first five assumptions have already proved demonstratively false, while the last still remains to be seen in the distant future.
In August 2017, Dara Khosrowshahi was hired to replace Travis Kalanick, inheriting the company’s deep losses, flawed business, model, fractious board, dysfunctional culture, dwindling cash reserves and a raft of legal woes. Four months later, Khosrowshahi made a Faustian bargain with Softbank that solved, at least for the moment, all but the first two challenges.
With Softbank’s $9 billion investment, Khosrowshahi was able to reconstitute and unite his board, preempt the threat of a Softbank investment in archenemy Lyft, and gain the breathing room needed to instill new cultural values. In return, Uber promised to reward early investors (including major VC’s on the board) by allocating the vast majority of Softbank’s cash to buying back existing shares, while mollifying remaining shareholders with a commitment to take the company public in 2019.
Khosrowshahi kept his promise on IPO timing, despite being unable to stem Uber’s chronic deep losses or to address the crippling weaknesses in the company’s business model.
- Undifferentiated service
- Low customer and driver loyalty
- Limited economies of scale
- Weak network effects
- Virtually no recurring revenue or customer lock-in mechanisms
- Intense price competition to attract riders
- Perennial need for sizable incentive/bonus payments to recruit and retain drivers, given widespread driver dissatisfaction with compensation
- Low barriers to entry and relatively abundant access to capital, sustaining intensifying competition in all of Uber’s major markets for core platform services
- Need to compete against public transportation that is inherently cheaper than ridesharing, and heavily subsidized
- Subject to growing scalability constraints in major metro areas – bounded by limits on available road space and driver supply
- Regulatory threats concerned with recouping the costs of Uber’s negative externalities (congestion, emissions) and/or to ensure adequate compensation for a growing body of city workforces.
Uber has not been able to achieve advantaged economies of scale or network effects, despite its massive size. With respect to scale economies, in Uber’s asset-light business model, the vast majority (78%) of gross bookings must be paid out to drivers, whether it delivers one trip, or 10 billion. Moreover, Uber’s next two largest expense categories – Cost of Revenue and Marketing – are also highly related to the number of rides delivered, limiting scale efficiencies.
Network effects are much weaker than Uber envisioned, because of extremely low switching costs and dual-apping between competing rideshare services. A large number of riders and drivers toggle between multiple rideshare companies. As a result, Uber and Lyft are served by roughly the same number of US drivers, despite Uber’s US revenue being roughly 2.5 times greater. So much for Uber’s supposed network effects that assumed it could attract more drivers because it has more riders, which in turn would attract more drivers, in a winner-take-all virtuous cycle. Given ridesharing industry characteristics, smaller competitors are able to vigorously compete against Uber in every market it serves.
As a result, Uber has been deeply unprofitable in the US, its biggest and most mature market, while also struggling in international markets. Uber has already withdrawn from China, Russia and Southeast Asia. In Brazil, despite its 80% market share, Uber remains unprofitable, as fierce competition from Cabify and 99 (now owned by Didi) has kept prices low and marketing expenses high.
And Uber is not alone. For the similar reasons, none of the other major rideshare providers around the world are profitable either, including Lyft in North America, Didi Chuxing in China, Ola in India, or Grab in Southeast Asia.
Many of the structural weaknesses undermining ridesharing profitability apply to Uber’s adjacent businesses as well, including local package delivery (UberRush, which the company recently discontinued), its Xchange auto leasing program (which the company sold off last year) and its UberEats restaurant delivery business, which is currently engaged in a fierce food fight amongst unprofitable but well-capitalized competitors around the world.
Indicative of the growing severity of Uber’s market and competitive challenges, the company’s growth and profitability weakened considerably over the last twelve months, contributing to its broken IPO. Investors have also been dismayed by Uber’s lack of transparency on key operating metrics (e.g. driver churn, unit economics, financials by geography and business segment), and to its frustrating lack of detail on profit improvement strategies (beyond vague references to leveraging its superior scale or becoming the “Amazon of transportation”).
Until and unless Uber can find ways to overcome the numerous weaknesses in its business model, the company will never be profitable. The second article in this series will explore whether there are any quick fixes to improve Uber’s financial performance (spoiler alert: no).