This is the second of a four-part series on Uber’s past and future. Today’s article assesses the effectiveness of quick fixes to improve Uber’s profitability. 

  1. Why Uber May Never Be Profitable — June 2, 2019
  2. Are There Quick Fixes To Improve Uber’s Profitability? – June 3, 2019
  3. What Can Uber Do In The Short-Term To Reverse Its Steep Losses? – June 4, 2019
  4. Can Uber Ever Deliver The Transformative, Profitable Future That Its CEO Has Promised? – June 5, 2019

In January 2018, CEO Dara Khosrowshahi told Uber executives that he wanted the company to nearly break even by the end of the year and to be profitable in 2019, as a public company. As it turned out, Khosrowshahi’s expectations were off by a tad, which in Uber terms meant a few billion dollars. Uber’s operating losses accelerated throughout 2018, culminating in $1.05 billion of red ink in the fourth quarter. And Q1 2019 got off to an equally discouraging start, with losses of $1.03 billion. Why has the company been unable to find quick fixes to its profitability problem?

The most obvious quick fixes are for Uber to raise prices, shrink driver pay, or acquire competitors to consolidate market power. But none of these initiatives address the root causes of Uber’s flawed business model, and thus they cannot and will not be effective.

1. Raise prices

Many observers have suggested that the time has come for Uber to raise prices, since millions of customers have come to rely on its services, and competitors are also under pressure to shrink chronic losses.

But there are good reasons why rideshare companies have been engaged in intense price competition, and Uber and Lyft’s move to public financing doesn’t change their underlying market dynamics. As long as consumers (and drivers) view competing services as substitutable commodities − just an app-click away − rideshare companies will be forced to compete aggressively for each and every fare.

In addition, since rideshare barriers to entry are relatively low and access to capital (at least historically) relatively abundant, even incumbents with strong market positions have to be mindful of the threat of new entrants if prices (and profits) begin to rise. This proved to be the case in China, where even after Uber discontinued operations in 2016, the dominant remaining competitor, Didi Chuxing, has been unable to achieve profitability, as entrants flush with new capital, have attacked major metropolitan areas in the largest ridesharing market in the world.

There is an extensive body of theoretical evidence to demonstrate that in duopoly markets with largely undifferentiated services and equivalent cost structures, incumbents inexorably will engage in a race to the bottom to match prices at zero-profit marginal cost. The ridesharing sector has proven to be a textbook example of this market dynamic in major markets around the world.

Given Uber’s alarming recent declines in ridesharing growth- the centerpiece of its valuation pitch to investors for years - the company is likely to be especially reluctant to  “solve” its profit problem by unilaterally raising prices in the foreseeable future.

2. Squeeze driver pay

Uber operates in a two-sided market, and just as raising consumer prices is problematic, attempts to squeeze driver pay could severely threaten Uber’s supply of drivers. In the months leading up to its IPO, Uber cut mileage-based pay rates in selected US metro markets by 25%, infuriating drivers already struggling to make ends meet in a company averaging net pay of only $9.21 per hour. An ad hoc network of rideshare drivers across the US organized a 24-hour strike two days before Uber’s IPO to draw attention to inadequate pay.

Uber is already facing driver supply challenges in its home market, where low unemployment, rising wages, and growing competition for gig workers is constraining the company’s ability to attract and retain new drivers. Cutting driver pay to improve corporate profits is simply not a viable option.

3. Acquire Lyft or other competitors across Uber’s global enterprise to achieve greater market power

Uber could use its formidable cash reserves to buy its way to market dominance in major markets, giving it greater pricing power.

But acquisition-driven consolidation is problematic on several grounds. First, mergers for the expressed purpose of lowering competition and raising consumer prices would likely run afoul of antitrust laws, particularly in markets like the US and India where the top-two players command a market share of over 90%.

Second, smaller potential acquisition candidates are already partly or fully owned by deep-pocketed strong competitors (for example Bolt in Europe, owned by Daimler and Didi; and 99 in Brazil owned by Didi), making buyout opportunities unlikely.

Finally, it is difficult to justify pricey acquisitions to gain market power in an industry with limited economies of scale and low barriers to entry. Granted, Uber did recently acquire Careem in the Middle East, but this appears to be an isolated opportunity and immaterial to Uber’s overall economics. Given mounting financial pressures, Uber is more likely to divest more country operations than to seek additional acquisitions in the years ahead.

Uber is facing perhaps even greater deep-pocketed competition in its food delivery business, where new capital at skyrocketing valuations is flooding the market. For example, Amazon recently announced a $575 million investment in London-based Deliveroo, Doordash just raised an additional $600 million at a valuation of $12.6 billion (nearly double Doordash’ market value in its $400 million funding round just three months ago!). And Postmates has already filed confidential paperwork with the SEC for an IPO, after announcing the addition of another 1,000 cities to its US-based restaurant delivery network. Uber Eats is thus likely to be mired in a fierce and unprofitable market share battle in the restaurant delivery sector for years to come.

As long as Uber’s services are viewed as undifferentiated and its business model exhibits low economies of scale, weak network effects, low switching costs and barriers to entry, quick fixes will not be effective.

So where can Uber look to improve its financial performance? The answer lies in finding new ways to gain strategic leverage from Uber’s superior global scale and scope, as covered in my next column to be posted on June 4, 2019.

~source