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By The Economics
Sep 3rd 2016 | SAN FRANCISCO
SEVERAL of America’s great industrialists built empires in Pittsburgh, including Andrew Carnegie, a steel magnate. Now the city is attracting the attention of a new, aspiring robber baron. Last year the ride-hailing firm Uber swooped down on a robotics research centre run by Carnegie Mellon University in search of autonomous-vehicle expertise. It has been testing self-driving cars on Pittsburgh’s roads for months, and will soon begin offering customers the chance to request rides in one.
Since the launch of its first smartphone app, UberCab, in 2010, the startup has attracted $18 billion in equity and debt. Today it carries a valuation of close to $70 billion, making it by far the largest of the startup “unicorns” worth over $1 billion (see chart 1). No technology firm in history has raised more money from private investors before going public. Its deep-pocketed backers include Saudi Arabia’s sovereign-wealth fund, mutual funds, Silicon Valley venture capitalists and a crowd of other firms. They are stalking the next big win in the technology business at a time when returns from other assets are widely disappointing.
Uber operates in more than 425 cities in 72 countries and has around 30m monthly users. In 2016 it will probably have around $4 billion in net revenues, more than double the previous year’s. Originally dedicated to connecting customers with limos and other ritzy rides, since 2012 it has offered a peer-to-peer service called UberX that lets drivers of all sorts of cars offer rides to passengers using its app. This service now accounts for the bulk of the firm’s revenues. The company also offers an UberPool service that allows several passengers travelling in the same direction to share a ride. It does not own its car fleet, but takes a cut of the fare in return for providing the platform that allows the drivers to work—typically 25%, with the rest going to the driver.
A runaway American dream
The company combines great name recognition with huge potential for growth. Like Facebook and Google before it, it has its own verb (“Let’s Uber there”). Speaking to The Economist, Travis Kalanick, the company’s co-founder and boss, says his goal is not simply to disrupt the taxi market but to make ride-sharing so cheap and convenient that using Uber becomes an alternative to owning a car. Meanwhile, he is pushing into new areas, such as delivering food and packages. Last month Uber acquired Otto, a newborn autonomous-lorry company, for around $600m and 20% of Uber’s future profits from trucking.
If Uber can pull all this off, it could be one of the biggest companies in the world—one which plays a critical role in the lives of consumers and the fabric of cities. The potential for profit is enormous. Worldwide spending on internet advertising, the business that sustains internet giants like Google and Facebook, will be $175 billion this year—larger than the taxi market, which is estimated at roughly $100 billion. But the global market for personal mobility is worth as much as $10 trillion, according to Adam Jonas of Morgan Stanley, a bank.
These prospects go some way to explaining a valuation higher than the market value of 87% of firms in the S&P 500 and more than a third higher than that of General Motors, which had a gargantuan $152 billion in sales last year. Unsurprisingly, a valuation of around 17 times the loss-making company’s 2016 revenues spurs a certain amount of scepticism. Such a figure can be justified only by lots of future growth, which will cost yet more money. But when Uber goes public, perhaps as soon as next year, in order to provide an exit for current investors, will its new shareholders be willing to tolerate continuing losses in the name of growth?
There are other questions, too. Are the barriers to entry in Uber’s business high enough to defend it against rivals such as Lyft in America, Ola in India and Grab in South-East Asia, and from future competition from the likes of Alphabet’s Google? Will regulation hamstring its growth? And perhaps most crucially, how will it manage the transition to driverlessness? The firm’s long-term success lies in changing the way people and goods get moved around—exactly the area that autonomous vehicles will disrupt. The company feels a pressing need to navigate this technological change before the carmakers and rival technology companies provide competitive visions of the future of transport, and of who will profit from it.
Two of today’s digital giants provide a useful guide to Uber’s position and plans. Its executives never have Amazon far from their minds as they plot their company’s future, says Bill Gurley, a venture capitalist at Benchmark Capital, who invested in Uber and sits on its board. Amazon has favoured relentless growth over the pursuit of profits for much of its history, keeping prices low to win loyalty and grab market share. Uber is trying a similar tack by subsidising drivers to keep fares down, by rapidly expanding into new cities and by launching new services, such as the delivery of food and other items.
Investors like to see the company in terms of Facebook. When the social network accepted an investment from Microsoft that valued it at $15 billion in 2007, a time when it had not shown any real propensity to make money, this was decried as folly. When it filed to go public at a valuation of around $100 billion in 2012, accusations of madness came back, based on worries about the company’s ability to adapt to the mobile phone. Today Facebook has a market value of more than $360 billion. A fear of missing out on the internet’s next Facebook-sized hit is a big factor in the flood of capital into Uber’s coffers.
Investors’ bullishness is bolstered by Uber’s position at the intersection of three linked disruptive trends. First is the emergence of asset-light business models. The cost of expanding is far lower for a startup that does not own its own cars or consider its drivers employees. Second is the shift to the sharing economy, which underlies the success of peer-to-peer services; a system that lets people do as much or as little as they like attracts workers. The third is that consumers, especially young consumers, are increasingly happy to pay for access to things, rather than own them outright.
The average cost per mile of UberX is probably around $1.50 (€0.84/km). It already costs more than that to own a car in some places. In New York City, car ownership works out at around $3 a mile. All told, about 14% of people in the urban centres of America’s top 20 metropolitan statistical areas (MSAs) may find it cheaper to use UberX at current rates than to own a car, according to Rod Lache of Deutsche Bank. The more Uber can bring costs down, the more widely it will compete with car ownership. Mr Lache reckons that autonomous cars might bring the price per mile down to 89 cents or less—below the average cost per mile for car ownership across all 20 top American MSAs.
From the fire roads to the interstate
Cost is not the only reason someone would give up a car; convenience and time matter, too. Like Amazon, though, Uber understands that low prices hook customers and is trying to push them down more. In San Francisco the price of an UberX ride is half what it was two years ago. An UberPool costs around half of an UberX ride.
Even without an interest in forming habits, though, Uber would have little choice about low prices—because it has competition. The switching costs for both passengers and drivers are relatively low, which means new entrants can buy market share by subsidising trips and earnings. The same exuberance that has driven up Uber’s valuation has also given its rivals the resources with which to attack it.
Lyft, with 20% of the American market to Uber’s 80%, is spending an estimated $50m a month to increase its share, and in many places it has been succeeding (see chart 2). Uber has had to pay out to avoid losing passengers and drivers in key markets. New companies, hearing of gold in the ride-hailing hills, have rushed in; two startups, Juno and Via, have toeholds in New York. Being the biggest company in a market helps a lot, because customers want short waiting times and drivers want frequent fares. But fighting off competitors still costs money. After claiming earlier this year that its developed-market business had become profitable, Uber lost an estimated $100m in America in the second quarter.
Competition at home and abroad will affect Uber’s profit margins in the medium term. Thibaud Simphal, the boss of Uber’s French operations, admits that ride-hailing could be “a high-volume, low-margin business. It’s transportation. It’s like retail.” For the time being, investors are willing to accept these low margins as Uber pursues growth above all else. But their patience may wear thin if the intense competition drags on. Amazon built up its business at a time when few competitors shared its vision of the size of the e-commerce opportunity. Uber does not operate in a world of low expectations.
One wild card is whether Lyft remains an independent company. There have been reports it has been seeking a buyer. In 2014 Uber might have been that buyer, something that has not been previously reported; negotiations fell apart over price. Mr Kalanick insists he does not regret the outcome: “It’s a really powerful thing for a company to compete. It makes you fierce about serving your customer.” Having a rival also helps deflect regulators’ scrutiny. Yet many of Uber’s investors wish the two had gone forward with a deal, so that Uber would not have to keep battling for share.
If the competition can be won with money and determination, Uber has to be well-positioned. It was not the first firm to recognise the potential of peer-to-peer ride-sharing: Sidecar, a now-defunct startup in San Francisco, got the ball rolling. Lyft came next. But Mr Kalanick used the momentum achieved by raising a lot of capital and expanding rapidly to great effect. Uber’s huge cash pile now acts as an “almost unassailable barrier” to new entrants, says Sunil Paul, the founder of Sidecar. And even with $9 billion, Mr Kalanick does not rule out the possibility of asking investors for more: “If the money is there, that means my competitors will raise it, and that means I need to as well.”
However dominant Uber’s position may be, Mr Kalanick will not let up. “[He] always sees himself as an underdog,” says Thuan Pham, Uber’s chief technology officer. Uber is not Mr Kalanick’s first startup; that was Scour, a file-sharing firm which filed for bankruptcy in 2000 after being sued by media companies for $250 billion for copyright infringement. He sold his second startup to Akamai, an internet firm, for a modest $15m. Those experiences left him obsessed with details and intensely focused on improvement. He enforces a feedback system called T3B3 (top-three, bottom-three skills), requiring his deputies to give him brutally honest feedback. “He changes himself faster than we can change our algorithms,” says Mr Pham. In the T3B3 process he shared his observation that Mr Kalanick should thank people more; now, apparently, he does.
Uber has also shown a capacity for change. It launched UberX when many employees at the company thought it should not risk disrupting its black-car service by offering a cheaper option. And this August, after years spent ploughing huge amounts of money into its business in China, it announced that it was merging its Chinese business with that of a local rival, Didi Chuxing, in return for a fifth of the new firm, worth around $7 billion today.
Investors were thrilled. They had worried that Uber would continue to lose billions of dollars chasing its Chinese dream. Mr Kalanick is extremely secretive about Uber’s financial data, but in the first two quarters of 2016, with $2.1 billion in revenue, the company lost at least $1.3 billion, according to reports, and there are good reasons to think that a lot of that was lost in China. Now Uber can share in the growth of the Chinese market without spending another dime.
Having sorted China out, Uber is able to concentrate on promising pickings in other developing markets where governments may not be quite as determined as China’s was to see a local firm win out. In India, South-East Asia and Latin America rates of car ownership are low. Just as consumers in emerging markets leapfrogged the desktop internet and went straight to mobile devices, they could choose to bypass buying a car and move around via ride-hailing instead. Mr Jonas of Morgan Stanley reckons that by 2030 around 25% of miles travelled in India will be on ride-hailing and ride-sharing services. Fares in these markets will be lower—in Mumbai a commuter’s hour-and-a-half Uber costs 500 rupees ($7.50)—but the size of the population means there will be a lot of transactions.
At the moment Uber is the underdog in India, lagging Ola, its local rival. Its huge cash resources mean that it is still a competitor, though. In Mexico and Brazil, it is the leader. And as a global brand it will be best placed to serve the small but disproportionately lucrative global business clientele. To distinguish itself from its competitors, Uber is investing heavily in developing its own mapping capabilities by buying assets, including the mapping startup deCarta, and hoovering up talent from Google. (Uber dreams “big” but “not as broad” as Google, says Brian McClendon, a high-profile hire from Google who now runs Uber’s mapping team.)
Developing its own maps enables Uber to offer more precise estimates for pickups and drop-offs to users and better routes for drivers—improvements which are particularly important for carpooling and for autonomous vehicles. These are capabilities that rivals in emerging markets would be very hard put to match.
In addition to competitors, Uber also needs to contend with regulators and policymakers. Most of Uber’s bookings are generated in just 20 cities. Many dense, potentially lucrative urban areas in countries including Germany, Italy and Spain are out of reach for the time being because of regulatory problems. It is unclear how soon and how favourably these will be resolved, if at all.
Steppin’ out over the line
How Uber fares with regulators will depend to some extent on how it manages its relationship with the public. If it succeeds in its vision of becoming a major provider of transport services for both passengers and goods all over the planet, it will have a larger presence in the physical world than any technology company in history. The public will have an opinion about it. Today competition authorities see Uber in a positive light, because it brings more transport options to city-dwellers. But when it puts many taxi companies out of business and becomes an essential part of a city’s infrastructure, there will be calls to regulate it more strongly. Those calls will get louder if, or when, Uber starts to swap growth for profits.
Uber’s relationship with its drivers could hit its image and its pockets. Drivers in California, Massachusetts and New York have sued the company, claiming that they are employees, not freelancers, and are thus entitled to benefits. A judge in California recently allowed one of these cases to proceed, bringing fresh uncertainty over Uber’s financial obligations. Some drivers say that once they cover expenses, they make less than the minimum wage. “I feel betrayed by Uber,” says Omer Abdelnur, who has driven for Uber for three years in San Francisco; he has watched his earnings decline by around 70%, according to his estimates. (Uber says fares have dropped, but wages have stayed level because the volume of trips is up.)
According to one insider, the public-relations nightmare of drivers’ low wages and lack of benefits (compared with techies’ high salaries) has helped to keep Apple and Google out of ride-hailing so far. But this does not necessarily apply to all business models: later this year Waze, a mapping app owned by Alphabet, will reportedly launch a service designed to let San Francisco commuters share rides. And it certainly won’t apply when the cars become driverless.
Mr Kalanick acknowledges that autonomy poses an “existential” risk to Uber. If other companies produce safe software solutions earlier, they could launch ride-hailing or ride-sharing services that undercut and possibly destroy his company. In an autonomous world, the competition may expand to include carmakers like GM, Ford and Tesla as well as tech companies like Google and Apple—which have mountains of cash to spend on fleets, if they want to. If the fleet model proves the way to go, Uber would have to give up its asset-light approach and join in.
There are reasons to be optimistic about Uber’s prospects in navigating this technological change. Because transport is its whole business, it will work harder to ensure it is in the lead. Alphabet, Google’s parent company, has more wonky projects than there are letters. Just as the shift to mobile concentrated Facebook’s attention and required a great deal of discipline, the shift to autonomy has created an urgency and focus at Uber. At the same time, it should be able to incorporate autonomy piecemeal as it is phased in at different paces, and with different rules, in different jurisdictions. Such a transition will be hard for an all-autonomous approach.
That said, Uber has a reputation for pushing into new markets before regulations are in place and working out rules later; there are “lots of places where there aren’t regulations at all, so you can just roll out”, says Mr Kalanick. That may not be such a good approach when it comes to autonomy. Governments that have not thought through laws to govern autonomous vehicles as quickly as they might are unlikely to take kindly to self-driving cars barrelling down roads in the interregnum.
The shift to autonomous vehicles may improve riders’ lives, but it could also spark a backlash against new technologies that put chauffeurs and truck drivers out of work. “We have a lot of attention as it is. I don’t even know how we could get more,” says Mr Kalanick. But if there is a lesson to be taken from Mr Carnegie’s experience of empire-building in Pittsburgh, it is that the public rarely looks kindly on those who amass big fortunes if they do not contribute some of their winnings in return. Offering cheap rides is not going to be enough to count on the public’s good graces.
The Economics
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