With Uber and Lyft both announcing large quarterly losses last week, it’s clear they have a long way to go to reach profitability, and analysts are increasingly focused on the long-term viability of the industry.
One potential pathway is the advent and utilization of autonomous vehicles (AVs), which could reduce the single largest expense incurred by the ride-hailing networks: compensation to human drivers. However, just adding AVs to lower costs won’t be a silver bullet.
While margins are difficult to pin down, some data has shown city-level gross margins to be approximately 10%, meaning that a ride that costs a customer $2 would cost Uber UBER, -6.66% or Lyft LYFT, -5.45% $1.80 to provide, leaving them with a 20-cent gross profit.
Under widely held assumptions in the AV space, the cost of providing that same ride could drop from $1.80 to $1 and eventually lower. So, a $2 ride would then earn Uber or Lyft $1 in gross profit—five times the profit as a human-driven ride. Multiply that improved profit per ride across millions of rides and it’s easy to see why Uber and Lyft are eager to bring autonomous vehicles into their networks.
But how realistic is this scenario? Unfortunately, AVs will not dramatically improve profitability to the ride-hailing firms.
Ride-hailing is fundamentally a commodity, meaning a ride from Uber is effectively no different than a ride from Lyft. With commodity products, the profit margins almost always migrate to levels just barely above the marginal cost to provide the product. So. In fact, the ride-hailing industry shares some unflattering characteristics with another industry selling commodity products—airlines.
Like air travelers, ride-hailing customers are very price sensitive, routinely checking prices across apps before booking a ride. This is another similarity with the airline industry — it’s incredibly easy for customers to discover the lowest price.
Given the price sensitivity of customers, small changes in price can directly lead to changes in market share. This is a well-known aspect of competition among airlines. If one airline wants to quickly load up a flight on a route on which it competes with another airline, it only needs to lower its price so that its flight appears at the top of search listings.
Likewise, if Uber wants to temporarily take market share in a city, it can undercut Lyft’s pricing and take an outsized chunk of market volume. And, given the ease and speed with which prices can be changed, the temptation to do so is virtually irresistible. Competitors don’t stand still in the face of price cuts and naturally retaliate by matching or undercutting their rival’s new price. In part, it’s these kinds of price wars that have made profitability so elusive for Uber and Lyft.
All of these factors combine to produce an industry in which prices will inevitably march lower and lower until they barely exceed costs, resulting in subsistence profits. In the example where an autonomous ride costs $1 to provide, we would expect the price of that ride to drift down to around $1.10, earning the ride-hailing company a similar 10% margin.
Though a boon for penny-pinching riders, the emergence of autonomous vehicles will have a relatively muted impact on the profitability of ride-hailing companies themselves. AVs are unlikely to solve the dynamics that lead to aggressive price-cutting that eats away at margins.
To improve their profitability, Uber and Lyft will need to look elsewhere, although the challenging economics of running a commodity business will be difficult to fully escape.