Uber’s Unsustainable Business Model

Is Uber the wave of the future, or another short term bubble that will soon pop?
Is Uber the wave of the future, or another short term bubble that will soon pop?

I love Uber, most of the time.  Probably you do too, and if you have yet to try it, when you do, you will most likely also quickly become an enthusiastic convert to their service.  But the very things we love are the things that will lead to its demise, or, if not demise, its future massive change of service offering.

Having used – or tried to use – Uber four times in the last week, I spent some time, either in the back of Uber cars, or while waiting on the side of the road for a car, to reflect on this modern day phenomenon which has grown in value to now have a valuation recently assessed at $68 billion.  Uber is a private company – said to be the world’s most valuable startup, and so its market value is a bit theoretical, but can be guessed at based on its occasional rounds of capital raising.

Uber’s essentially assetless $68 billion valuation is interesting to compare to other companies.  American Airlines is worth $18 billion, Delta is worth $27 billion, and United is worth $15 billion.  Toss in JetBlue ($6 billion) and these four airlines together, along with their hundreds of airplanes and other assets, are worth less than Uber.  Or compare Hertz, Budget, and Avis, in total worth $7.5 billion.  Even Tesla with its sky-high $34 billion market cap is a mere half of Uber’s.  And so on.

Uber also lacks something that all these other companies claim to have, in varying degrees.  Brand loyalty.  Many (most?) of Uber’s drivers are simultaneously working for Lyft and/or other competing companies.  Many/most of Uber’s passengers also have Lyft and other similar competing apps on their phone.  The first service to provide a ride, and at the best price, wins out for passengers, and the company offering the most work and highest pay gets the drivers.  The lack of brand loyalty also makes the barrier and cost of entry for new competitors to be lower than it otherwise could be, ensuring Uber remains exposed to real or potential commercial pressures to keep their rates low.

This valuation is astonishing for a company that not only owns no vehicles or other substantial assets, but which also loses money at a prodigious rate.  Again, as a private company, little is known about its financial position, but as the linked article shows, it is thought to have lost $987 million in the first half of 2015 alone, more than its entire 2014 loss of $671 million.  Most recently, after losing perhaps $2 billion, maybe more, trying to break into the Chinese market and unsurprisingly failing in the attempt, it sold its Chinese operations to its competitor in China, Didi.  The good news – Uber received about $1 billion as part of the deal.  The bad news, the rapprochement with Didi lasted less than a week, and now Didi is turning to attack Uber in other Asian markets.

In other words, those investors who see Uber as redolent with profitable growth opportunities as part of global expansion should now be doing a double-think – Uber has either lost or now has at great risk much of the entirety of the huge Asian markets.

So Uber’s value seems unrelated to its assets, its goodwill, or its future growth potential.

But I’d like to focus not on Uber’s global strategy and the billions of dollars in play/at risk, because all of this is layered on the assumption that Uber’s core business model has the potential to become profitable.  Its core business model is simple – a ride-hailing service where people wanting rides are efficiently connected with people offering rides, in a manner that is win-win-win for the passengers, the drivers, and Uber as intermediary.  Is this indeed a viable model?

Which brings our focus to those wonderfully inexpensive rides we enjoy in nice clean cars with friendly Uber drivers.  Usually, an Uber car can be summoned within 5 minutes or so in most major cities that Uber is active in, although the unpredictable ‘surge pricing’ that Uber adopts when there are too many people wanting rides and too few drivers can see the usual low rate double or triple and massively exceed what a traditional taxi would cost.  I had experience of that last week when first there was an abundance of Uber cars available, then 15 minutes later, the app reported no cars available, then shortly thereafter, it advised that surge pricing was in effect with a minimum ‘flag fall’ hire fee now exceeding what a regular taxi would charge for the entire ride.  (Uber is now trying to obscure its surge pricing by just quoting a price and not telling the potential rider that the rate is potentially three or more times higher than it normally is.)  For Uber to say it has no cars available in Bordeaux, the fifth largest city in France with an urban population of 750,000, is astonishing.  At least with a regular taxi service, you are told that there might be a wait for a taxi, but apparently with Uber, you either get a car quickly, or not at all.

Uber is at best a fickle service provider.  But most people seem willing to forgive Uber its occasional extravagant surcharges in return for its more common very low fares.  After all, when Uber goes too high, we can change to Lyft, or to using a regular taxi service.  In addition, ridiculous controls and restrictions on Uber by city governments restrict and interfere with its ability to provide service to and from all locations (airports and train stations often have restrictions on Uber – ‘for our protection’ but in truth, the only protection is to established taxi companies, not to us).

We as passengers can sometimes benefit from Uber, but we can’t always rely on it.  It is worth considering, while enjoying an Uber ride – what would happen if Uber effectively put regular taxi services out of business?  What would happen if we got a ‘no cars available’ message and had no other alternatives to turn to?  In my case, the alternative ended up as being a three mile walk, with luggage, in the searing heat of the mid-afternoon summer sun.

Maybe Uber will grow to ‘meet the market’.  But if it is losing money at present, is more growth going to cause it to lose money faster or to stop losing money and turn profitable?  More to the point, is there an unlimited supply of potential drivers that Uber can add to its driver base?

The answer to the question about driver supply is key.  That very low fare you just paid to an Uber driver may or may not be sufficient for the driver to stay in business.  Remember that Uber takes 20% – 30% of the fare you pay for its role in the middle, and all of a sudden, a $10 Uber fare means a net of perhaps $7.50 for the driver, who then has to pay all his own costs and also self-employment taxes on whatever slim ‘profit’ may remain.

The IRS allows people to claim 54c a mile for operating a vehicle as a reasonable approximation to the overall costs incurred – a mix of amortized fixed costs (depreciation, financing and licensing and insurance), semi-variable costs (repairs) and truly variable costs (gas and other consumables/wear items).  If we accept that number at face value, then what to make of Uber’s mileage rates in the US when it is charging passengers as little as 65c a mile in Orlando, 75c a mile in Atlanta, $1 in Denver, and $1.15 in San Francisco, $1.35 in Seattle, and $1.75 in Manhattan?

If one reduces these rates by only 20% (assuming the low end of commission shares taken by Uber), that means the unfortunate driver in Orlando is netting only 52c a mile – he or she is losing 2c every mile driven (although there is also a time based fee of 11c a minute that helps bring the driver back to better-than-break-even).  Say the driver is averaging one mile a minute during the hire, and so they are netting (11 cents less 20%) minus 2c = 6.8 cents, which translates to $4.08/hr – appreciably less than the minimum hourly wage.  If we then adjust for the fact the driver probably had to wait a while between fares, and had to drive some distance from where they were when the ride was requested to pick up the passenger, the situation becomes even worse.  The driver in Manhattan or Seattle is probably doing okay, but the driver in Orlando or Atlanta, not nearly so well.

Uber claims its drivers make about $20/hr, but this is before expenses.  If one simply says ‘to make $20, the driver needs to drive 20 miles or more’ then deducting 20 x 54c for the cost of those 20 miles reduces the driver’s earnings down to $9.20, and then taking self-employment taxes off the $9.20 reduces it down to about $8/hr.  All of a sudden, that $20/hr doesn’t look quite so great, does it.  The various studies, often commissioned by Uber, which purport to show that Uber drivers make more than limousine and taxi drivers seldom compare apples with apples – they incorrectly compare an Uber driver’s gross rate with the other drivers’ net rates.

This disparity between gross rates of earnings and net rate of profit is not something all drivers appreciate when they first start working for Uber, but quickly becomes apparent, causing many drivers to leave, and making Uber’s core pool of drivers part-timer who are using Uber earnings as a top-up above the money they earn elsewhere, and using a car they already own so that their fixed costs of ownership don’t apply so much.

But the bottom line is clear – few if any Uber drivers are making much money, and their future earnings are totally dependent on how Uber chooses to set its rates and commissions.  Uber is apparently edging up its share of each fare, while also dropping the fares charged to passengers.

Its entire business model centers around being the cheapest.  This is not proving consistently successful in all markets, and is leading to its large operating losses.  Even in this new economy, being the cheapest is seldom a profitable way to build a business.

So, for now, enjoy Uber, and appreciate it all the more with the realization that your ride is being subsidized by a driver who is barely earning minimum wage and investors who are at risk of seeing Uber’s mounting losses result in a collapse of its current astonishingly high market valuation.

6 thoughts on “Uber’s Unsustainable Business Model”

  1. I too was left standing by the roadside outside my apartment in NYC when the Uber driver said he was waiting for more than two minutes and cancelled and I was charged $5. It was just before a thunderstorm and a bad time of day(4 p.m.) when the taxi shifts change. It took my doorman 10 minutes to hail me a cab (luckily we’re in NYC!) but I (with difficulty) got the $5 charge refunded as a ‘credit’ on my next ride. Doing some research on the web revealed that when Uber announces ‘surge pricing’, all the drivers cancel their accepted rides when they have not yet picked up their passengers as otherwise they have to honor the pre-surge price. It certainly left a bad taste in my mouth and made me very suspicious of using them going forward and I am actively looking at other call a ride services.

  2. Uber’s business model is clearly not sustainable. Not only are their prices too low to make sense, they also make a special effort to tick off their drivers. Most drivers use Uber and Lyft, but they prefer Lyft. This includes immigrants who have only basic English and MBAs between jobs seeing if driving for such a service could cover their car ownership expenses.

    The obvious Uber strategy is to drive out all competition and then raise prices. Amazon has done this to some extent. For a while they had amazing prices and Prime shipping was insane, e.g. an extra $4 got me a gas powered lawnmower delivered overnight. Now they have good prices, good enough so that another web site would have to offer an insane price and/or free shipping to get me to buy from them rather than Amazon.

    The problem Uber has is that their dispatch model is too easy to copy. It isn’t just Lyft. Even a number of traditional taxi companies have copied Uber, and Apple has been helping them. If they register their service, Apple directions shows users their price for the ride as an alternate to walking, driving or taking transit. In contrast, Amazon isn’t just about prices, it’s about having an extremely broad selection of products and incredible logistics.

    The reason I tend to use Lyft or Uber is not about the price, though I am probably unusual. The problem is that traditional taxi companies outside of NYC and a few other cities have long been a pain to use. In SF, for example, street hails were only available in a few places and the phone dispatch system meant long waits on hold, long waits for rides and unreliable pickups. Seattle was no better. It was simply impossible to get a taxi in Ballard, and despite GPS technology, one had no clue as to when or if one’s ride was coming. You can bitch about Uber or Lyft, but it is amazingly better than the old taxi model.

  3. One correction. You miscalculated how much money an Uber driver makes in a typical $10 ride.
    This is important for riders know so it’s a big deal that you missed this part.

    If a ride in Atlanta costs $10 Uber takes $1.75 off the top in the form of a safe rider fee. That leaves $8.25. Of the $8.25 Uber takes 25% or $2.06. So for a typical UberX ride of $10 Uber takes $3.81. Very close to 40% of the ride goes to the Uber. On shorter rides Uber takes even more. On a minimum UberX ride of 2-3 miles Uber takes 45% of the $6.75 cost.

    The driver is not making much. That is why drivers quit in droves. And that is why Uber subsidizes driver pay so much. Uber sets fares at artificially low levels in an attempt to kill taxis and Lyft. This artificially low fare is why driver pay is artificially low. I write artificial because the fare is not being set by conditions related to the execution of the business.

    Investment money and high unemployment levels are allowing Uber to charge far less than what would be required to sustainably run the business. Eventually the investment money will dry up. In the meantime the drivers are losing big time.

    1. Hi, Robert

      That’s a good point you raise (about the ‘safe rider fee’). My sense is that the 25% slice of the rest varies – in some cases it might be closer to 15%, but I’ll definitely concede that Uber gets even more (and the drivers even less) than I’d earlier calculated.

      I’d hate to buy a new(ish) car specifically to become an Uber driver, because one has so little control over one’s earnings capacity, and of course, there’s the scariest specter of all coming ever closer – driverless cars.

  4. Pingback: Is There a Road Ahead for Uber? - The Travel Insider

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