Since it began operations in 2010, Uber has grown to the point where it now collects over $45 billion in gross passenger revenue, and it has seized a major share of the urban car service market. But the widespread belief that it is a highly innovative and successful company has no basis in economic reality. An examination of Uber’s economics suggests that it has no hope of ever earning sustainable urban car service profits in competitive markets. Its costs are simply much higher than the market is willing to pay, as its nine years of massive losses indicate. Uber not only lacks powerful competitive advantages, but it is actually less efficient than the competitors it has been driving out of business.
Uber’s investors, however, never expected that their returns would come from superior efficiency in competitive markets. Uber pursued a “growth at all costs” strategy financed by a staggering $20 billion in investor funding. This funding subsidized fares and service levels that could not be matched by incumbents who had to cover costs out of actual passenger fares. Uber’s massive subsidies were explicitly anticompetitive—and are ultimately unsustainable—but they made the company enormously popular with passengers who enjoyed not having to pay the full cost of their service.
The resulting rapid growth was also intended to make Uber highly attractive to those segments of the investment world that believed explosive top-line growth was the only important determinant of how start-up companies should be valued. Investors focused narrow*ly on Uber’s revenue growth and only rarely considered whether the company could ever produce the profits that might someday repay the multibillion dollar subsidies.
Most public criticisms of Uber have focused on narrow behavioral and cultural issues, including deceptive advertising and pricing, algorithmic manipulation, driver exploitation, deep-seated misogyny among executives, and disregard of laws and business norms. Such criticisms are valid, but these problems are not fixable aberrations. They were the inevitable result of pursuing “growth at all costs” without having any ability to fund that growth out of positive cash flow. And while Uber has taken steps to reduce negative publicity, it has not done—and cannot do—anything that could suddenly pro*duce a sustainable, profitable business model.
Uber’s longer-term goal was to eliminate all meaningful competition and then profit from this quasi-monopoly power. While it has already begun using some of this artificial power to suppress driver wages, it has not achieved the Facebook- or Amazon-type “plat*form” power it hoped to exploit. Given that both sustainable profits and true industry dominance seemed unachievable, Uber’s investors de*cided to take the company public, based on the hope that enough gullible investors still believe that the compa*ny’s rapid growth and popularity are the result of powerfully effi*cient inno*vations and do not care about its inability to generate profits.
These beliefs about Uber’s corporate value were created entirely out of thin air. This is not a case of a company with a reasonably sound operating business that has managed to inflate stock market expectations a bit. This is a case of a massive valuation that has no relationship to any economic fundamentals. Uber has no competitive efficiency advantages, operates in an industry with few barriers to entry, and has lost more than $14 billion in the previous four years. But its narratives convinced most people in the media, invest*ment, and tech worlds that it is the most valuable transportation company on the planet and the second most valuable start-up IPO in U.S. history (after Facebook).
Uber is the breakthrough case where the public perception of a large new company was entirely created using the types of manufactured narratives typically employed in partisan political campaigns. Narrative construction is perhaps Uber’s greatest competitive strength. The company used these techniques to completely divert attention away from the massive subsidies that were the actual drivers of its popularity and growth. It successfully framed the entire public discussion around an emotive, “us-versus-them” battle between heroic innovators and corrupt regulators who were falsely blamed for all of the industry’s historic service problems. Uber’s desired framing—that it was fighting a moral battle on behalf of technological progress and economic freedom—was uncritically ac*cepted by the mainstream business and tech industry press, who then never bothered to analyze the firm’s actual economics or its anticompetitive behavior.
In reality, Uber’s platform does not include any technological breakthroughs, and Uber has done nothing to “disrupt” the eco*nomics of providing urban car services. What Uber has disrupted is the idea that competitive consumer and capital markets will maximize overall economic welfare by rewarding companies with superior efficiency. Its multibillion dollar subsidies completely distorted marketplace price and service signals, leading to a massive misallocation of resources. Uber’s most important innovation has been to produce staggering levels of private wealth without creating any sustainable benefits for consumers, workers, the cities they serve, or anyone else.
Prior to its IPO, Uber publicly released limited P&L results. These showed GAAP net losses of $2.6 billion in 2015, $3.8 billion in 2016, $4.5 billion in 2017, and $3.9 billion in 2018.1
In its April IPO S-1 prospectus, Uber recast all its historical P&L results, allegedly to isolate the terrible results in three major markets (China, Russia, and Southeast Asia) that Uber has abandoned from the results of its ongoing operations (which are the primary concern of potential investors).2 But Uber’s S-1 included $5 billion—roughly $3 billion in divestiture gains and $2 billion representing Uber’s valuation of its untradeable equity/debt positions in the companies that took over its failed operations—as part of net income from its ongoing operations. This deliberate misstatement was designed to give potential investors the impression that the profitability of Uber’s current marketplace services had improved by $5 billion, and that Uber actually made a billion dollar net profit in 2018. If one correctly segregates ongoing and discontinued results, however, Uber’s actual 2018 profit improvement was zero. Its ongoing operations lost $3.5 billion in 2017, and lost $3.5 billion again in 2018. The company’s losses over the last four years from still ongoing operations were roughly $14 billion.3
Previously, Uber had been the only “ridesharing” company with sufficient public data to allow a detailed analysis of business model competitiveness versus incumbent operators. But the March release of Lyft’s IPO prospectus revealed that it has the same terrible economics as Uber,4 and there is no public evidence that any other “ridesharing” company (such as Didi, Grab, Ola, and other large Asian operators) has a path to sustainable profitability.
Like Uber, other well-known start-ups lost money at first, but—unlike Uber—they quickly generated the strong positive cash flow needed to fund growth. The gross fares paid by Uber passengers increased from $9 billion in 2015 to $45 billion in 2018. If Uber had the powerful scale/network economies that allowed start-ups like Amazon and Google to rapidly “grow into profitability,” the results would have shown up in Uber’s financial performance years ago. In fact, Uber’s operating and investing activities burned $2.2 billion in cash in 2018, its ninth year of operation.
Uber’s GAAP profit margin was –135 percent in 2015. It appeared to improve to –51 percent in 2017 and (adjusting for the divestiture and noncash equity gains discussed above) –35 percent in 2018. Yet these subsequent “improvements” were not driven by efficiency gains, but by the ability to force driver take-home pay down to minimum wage levels. If Uber drivers still received their 2015 share of each passenger dollar, Uber’s negative margins would still be in the triple digits.
Primarily digital companies benefit from very strong economies of scale because the marginal cost of expansion becomes negligible once basic corporate infrastructure is in place. Uber, by contrast, provides a transportation service with a very small percentage of fixed costs; costs increase with each additional vehicle and driver, and Uber incurs huge start-up costs with each new city and country it enters.
Uber (and taxi services in general) realize none of the network economies that some other transport companies enjoy (e.g., airline hub networks). They also have none of the Facebook-type network effects (following what is known as “Metcalfe’s Law”), by which each new user makes the network more valuable to all other users, which makes it nearly impossible for smaller competitors to survive.
If Uber’s growth had actually resulted from superior efficiency, there would be ample evidence that it could provide taxi service at significantly lower costs than traditional operators. The opposite is true; Uber has higher costs than traditional operators in every cate*gory other than fuel.
The cost structure of any urban car service company has four components: vehicle costs (typically 18 percent of total, including acquisition, financing, maintenance, and licensing), corporate costs (15 percent, including dispatching, advertising, overhead functions such as IT and legal, and returns to shareholders), fuel (9 percent), and driver compensation (58 percent, including benefits).5
Uber’s business model shifts the vehicle costs (ownership, maintenance, insurance) that traditional companies used to incur to its “independent contractor” drivers. Passenger fares need to cover total (Uber plus driver) costs. But shifting the burden of vehicle costs and financing onto drivers makes those costs higher, since hundreds of thousands of drivers with limited capital and business experience cannot possibly manage these costs as well as even a typi*cal traditional cab company. Traditional cab companies also have much lower corporate costs, as they avoid Uber’s huge expenditures in areas like political lobbying, global branding, IT development, big corporate headquarters, etc.
Uber should also have higher driver costs than traditional opera*tors, because the huge increase in the demand for drivers should have improved wages, benefits, and working conditions. As will be discussed below, however, Uber initially offered incentives that in*creased its driver costs, but since 2015 has suppressed take-home pay to minimum wage levels. This exercise of artificial market power cannot be considered an Uber efficiency or productivity advantage.
While Uber has not achieved the global industry dominance its investors were originally seeking, its ability to reduce driver pay illustrates how it always intended to use market power as a major source of returns.
Prior to Uber’s market entry, the take-home pay of big city taxi drivers was only $12–17 per hour, and drivers needed to work 60–75 hours a week to earn that much. Despite extensively promoting how it would improve life for its “driver-partners,” Uber actually re*duced take-home pay to $9–11 per hour, below minimum wage levels in many cases.6 There have been multiple reports about drivers needing to sleep in their cars to make ends meet.7 A recent study of drivers for app-based companies in New York City showed that 90 percent were recent immigrants (largely from Haiti, the Dominican Republic, Pakistan, India, and Bangladesh), and 20 percent required public income supplements such as food stamps.8
Uber’s entry substantially increased the demand for drivers. If labor markets worked as predicted by economic theory, this should have significantly increased driver take-home pay and improved working conditions. Instead, Uber exploited artificial market power to subvert normal market dynamics. Its extensive driver recruitment programs used gross dishonesty to deceive drivers, including ongo*ing misrepresentations of gross pay (prior to deducting vehicle costs) as net pay, and at one point the company claimed that Uber drivers in New York averaged $90,000 in annual earnings. Uber’s shift of the full vehicle burden onto drivers created additional artificial power. Traditional cab drivers could easily move to other jobs if they were unhappy, but Uber’s drivers were locked into vehicle fi*nancial obligations that made it much more difficult to leave once they discovered how poor actual pay and conditions were.
Starting in 2015, Uber eliminated most of the incentives it had used to attract drivers and unilaterally raised its share of passenger fares from 20 percent to 25–30 percent. Almost all of Uber’s margin improvement since 2015 is explained by this reduction of driver compensation down to minimum wage levels, not by improved efficiency. These unilateral compensation cuts resulted in a direct wealth transfer from labor to capital of over $3 billion. Comparable cuts at Lyft resulted in a labor-capital wealth transfer of $1 billion.9
Traditional taxi service was widely disliked. In a perfect world, customers want clean, sparkling cabs, and don’t want to pay higher prices for the increased availability and reliability required to get cars to instantly appear whenever they want. Four major structural issues explain why traditional cab companies couldn’t improve pro*ductivity and couldn’t economically provide the level of service customers would have liked. These problems have long been under*stood and are inherent to every form of urban transport. Solving these structural barriers would require significantly reducing operat*ing costs and significantly increasing the productivity of vehicles and drivers. Uber, however, has failed to reduce car service costs, and it hasn’t meaningfully improved productivity. Far from revolutionizing the future of transportation, Uber has not solved any of the in*dustry’s long-standing structural problems.
Most taxi demand is low-income; higher fares would shrink traf*fic and reduce utilization. Taxi demand is sociologically bipolar: 55 percent of demand comes from people earning less than $40,000 per year while 35 percent comes from people earning more than $100,000.10 Demand from lower-income people is driven by access to jobs in areas (or at times of day) when transit service is poor or non*existent. Given the current income distribution of riders, any at*tempt to balance supply and de*mand will either drive lower-in*come passengers out of the market or result in wealthy customers being charged less than they might be willing to pay. Uber does not have the lower cost structure needed to improve service while keep*ing fares low, and apparently realizes that only a small portion of the market is willing to pay fares that would cover the true cost of its service. Higher prices would also reduce vehicle utilization and de*stroy any notion that Uber’s busi*ness has exceptional growth poten*tial.
Uneven geo*graphic demand creates unavoidable empty backhaul costs. Taxi demand, as with demand for every other form of urban transport, has extreme temporal and geographic peaks. Most cities have a dense core area where taxi demand is highest, and taxis operating within that zone can maintain reasonably high daily utili*zation. But the true cost of trips to neighborhoods outside that zone can be as much as twice normal trip costs since they will have an empty backhaul. Low-income neighborhoods receive poor taxi ser*vice because drivers rationally avoid trips where they won’t find a return fare. Uber does nothing to create new demand that can fill those empty seats, and has no way to vary fares based on backhaul utilization. People expect that the fare to the airport should be roughly the same at 6 a.m. (when the cab will return empty) as at 4 p.m. (when return fares are queued up).
Extremely high cost of peak capacity. Peak taxi demand occurs during the late evening, especially on Friday and Saturday nights. As with rush-hour transit and expressway peaks, the cost of the capaci*ty needed to serve peak demand is four to five times the cost of serving demand on Tuesday morning. Cab companies cannot afford to provide all the expensive capacity demanded, creating conflict as wealthier people headed to restaurants and clubs fight over the limited supply of cabs with late-shift workers at hospitals and ware*houses. Uber has done nothing to reduce the high cost of peak service or find paying passengers anxious to travel at off hours. Uber’s core business proposition (“push a button, get a car!”) by definition requires far more capacity and much lower utilization rates than traditional operators.
Overcapacity risk. Taxi businesses in unregulated markets have no natural barriers to entry, and thus face the risk of ruinous over*capacity that reduces utilization and precludes a workable balance of supply and demand. As both Uber and past cases of unlimited mar*ket entry have demonstrated, new entrants don’t charge fares high enough to cover full operating costs, ensuring major losses for everyone.
Uber did not suddenly discover ways to dramatically improve productivity and service quality that everyone else in the industry had been too stupid to recognize for the past hundred years.11 In fact, nothing in Uber’s business model solves any of the major problems that have long frustrated users.
Customers correctly perceived that Uber offered greater availability and reliability than traditional cab companies used to, but failed to recognize that all of these improvements required billions of dollars in unsustainable subsidies. If a new entrant in any other established industry suddenly offered much more service at much lower prices than incumbents ever had, the normal response would be to demand evidence about the productivity breakthroughs making this possible.
Uber could not withstand this scrutiny, as it has no competitive efficiency advantages, and no plausible way to explain how it might ever provide these services and prices profitably. To divert attention from the subsidies that actually drove its popularity, Uber and its supporters put forward a variety of vague, unsubstantiated, and con*stantly changing PR claims designed to mislead the public into thinking its popularity actually had something to do with powerful efficiency breakthroughs.
Uber claimed that its business model was based on cutting-edge technological innovations, which would overwhelm incumbents in any market anywhere. In reality, Uber’s “technology” is less sophis*ticated than what airlines and other industries have been using for decades. Although Uber may have been an early adopter of smart-phone-app-based cab hailing, this service has been easily repli*cated by other companies, including traditional cab operators, and Uber has no significant advantage here. More importantly, there is no evidence that any of it creates meaningful efficiency gains, or that similar technologies led to major competitive upheavals in any other industry. Uber’s business model hasn’t worked anywhere, and it has failed disastrously in many markets that the company once claimed were strategically critical, including China, Russia, and Southeast Asia.
Uber also claimed huge efficiency gains by offering flexible work*ing conditions to people who “want to be their own boss.” And while Uber was able to take advantage of abysmal labor market conditions after the 2008 financial crisis, the claim that many of its drivers were entrepreneurial millennials with a preference for “gig” work has always been totally inconsistent with how its business actually operates. Some drivers may have been initially attracted by Uber’s false claims about driver pay, but near-minimum-wage work is not a lifestyle choice. Uber’s driver rules and incentives ensure that most drivers work full-time, and no large-scale transport service can survive if capacity only shows up when workers happen to feel like it.
Above all, Uber argued that its business model and technology were so innovative that it had created an entirely new industry (“ridesharing”) based on entirely new business concepts (the “sharing economy”). It insisted that it was a “tech company” selling sophisticated software, and could not possibly be compared to taxi companies. In fact, however, Uber carries people from point A to point B, just like taxis have for a hundred years. The “tech company” claim was really an attempt to get people to ignore its huge losses, since tech companies like Facebook had quickly grown into profitability. The “software” claim was designed to justify preventing its drivers from getting the labor law protections employees are entitled to, based on the argument that they were totally independent entrepreneurs who had freely chosen to purchase Uber’s superi*or software products. Furthermore, nothing in Uber’s business mod*el is actually being shared. The only meaningful economic dis*tinction between “taxis” and “ridesharing” is that the latter avoids regulations that traditional taxis must still obey and depends on billions in predatory investor subsidies.
Uber’s claim that its growth resulted from customers freely choosing its superior service in competitive markets is fundamentally false. Competitive markets use price and profit signals to help allocate resources to more efficient uses. Uber grew because its years of billion-dollar subsidies totally distorted those signals, and allowed it to drive more efficient producers out of business.
More at: https://americanaffairsjournal.org/2...f-destruction/
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Originally Posted by Torchbearer
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