In my analysis of the Uber UX I claimed that Uber can retain users as long as prices are competitive because they provide a superior product to the taxi service. I stand by this assertion and if replacing taxis is all that Uber intends to do they would keep prices stable but what makes Uber interesting is that it has much greater potential than simply a taxi replacement.
##The Kalanick Doctrine and Why Uber exists
You get an insight into Uber’s doctrine from this Kalanick quote:
“If Uber is lower-priced, then more people will want it,” he explains. “And if more people want it and can afford it, then you have more cars on the road. And if you have more cars on the road, then your pickup times are lower, your reliability is better. The lower-cost product ends up being more luxurious than the high-end one.”
Bill Gurley a general partner at VC firm Benchmark one of the investors in Uber provides more detail:
When Uber launched its low-cost UberX offering in the summer of 2012, the company quickly realized that the demand for its transportation services is HIGHLY elastic. As the company achieved lower and lower per-ride price points, the demand for rides increased dramatically. A lower price point delivered a much better value proposition to the consumer, yet still remained a great business decision due to the remarkable increase in demand.
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The “math d”partment” and management realized that if they could increase driver utilization (the number of rides per hour for a driver), then they could lower the price for the end user while maintaining earnings quality for the driver. Higher efficiencies through higher volumes and better algorithms could help deliver the desired lower price points and better cash flows. Interestingly, these lower price points would lead to more demand, even more liquidity, an even higher utilization, and then another incremental price decrease. Pretty quickly UberX passed UberBlack to become the highest volume service on the Uber platform.
The claims made here are in stark contrast to the outcome produced by unlimited supply from past experiences of deregulation as presented here by transport scholar Paul Dempsey’s, Taxi Industry Regulation, Deregulation, and Reregulation: the Paradox of Market Failure (pg. 102) via Justin Singer:
[W]e need not rely on the theoretical assumptions of what unlimited entry will produce. We have empirical results which we can assess to determine what deregulation of the taxicab industry has produced.
Before 1983, some twenty-one cities deregulated taxicabs in whole or part. The experiences of these cities reveal that taxicab deregulation resulted in:
- A significant increase in new entry;
- A decline in operational efficiency and productivity;
- An increase in highway congestion, energy consumption and environmental pollution;
- An increase in rates;
- A decline in driver income;
- A deterioration in service; and
- Little or no improvement in administrative costs.
This is analogous to the tragedy of the commons where unlimited entry of taxi operators compete for a finite number of riders which decreases driver utilisation across the board. Because the costs are still the same the consequence of lower utilisation is a fall in income unless you increase fares. As a consequence drivers charge higher fares in order to compensate for lower utilisation rates.
How do we reconcile the contradiction in outcomes that is the product of deregulation and Uber (effectively non-sanctioned deregulation)?
I think the difference between the outcome produced by deregulation in the past and Uber now is that before the advent of smartphones and GPS providing real-time data of location-specific demand there was no way to efficiently communicate changes in demand to taxicabs and for taxicabs to respond to those changes in demand. Locations would fluctuate between undersupply and oversupply like a yoyo with taxis driving around like headless chooks looking for fares instead of carrying passengers. The result was to introduce regulation of supply (which didn’t actually solve the problem but ameliorated it somewhat by having less number of empty taxis driving around unproductively) to compensate for the inability to efficiently match supply with demand.
GPS has been around for a while, the difference now is that every single person has GPS on them everywhere all the time through the form of the smartphone, both riders and drivers. Knowing the location of every single driver and real-time location-based demand data combined with the ability to match riders to the nearest driver almost instantaneously changes the premise behind regulation.
Uber can now match supply to demand at a granular level that only a few years ago would be unfathomable. This allows them to increase driver utilisation (as oppose to decreasing utilisation under old deregulation) thereby increasing incomes while reducing fares at the same time which stimulates even more rider demand and in turn driver utilisation and supply and so it goes on.
This is why Uber exists now and not before.
##Beyond the Taxi Market and Economies of Scope
The discovery by Uber of the virtuous cycle between increased driver utilisation, fare reduction, increased rider demand and corresponding driver supply combined with the potential infinite-like supply of underutilised cars and drivers means that Uber can expand the market for for-hire vehicles (FHV) from the existing user base of taxis to potentially car ownership, public transport replacements and delivery services.
Bill Gurley provides a great summary of this potential. In his introduction to UberPool (which awfully sounds like a bus replacement), Bill alludes to Uber being more than a transport for people:
UberPool is a platform for the future. Many people like to speculate as to whether or not Uber will eventually move beyond transporting people and into broader logistics. The technology and algorithms behind UberPool will lay the groundwork for the capability to do multiple stops with multiple cargos, increasing the future optionality for the Uber platform. So UberPool is a fundamental enabling technology for Uber in addition to providing lower price points and increased efficiency.
Ben Thompson describes the implication of Uber moving into delivery services:
Uber transports not just people – Uber has already done all kinds of experiments with delivering things other than people, including Christmas trees, lunch, a courier service, even drugstore items. However, any real delivery service would need to have some sort of service-level agreement when it comes to things like speed and price. Both of those rely on driver liquidity, which is why an Uber logistics service is ultimately waiting for the taxi business to tip as described above.
However, once such a delivery service is launched, its effect would be far-reaching. First, driver utilization would increase even further, particularly when it comes to serving non centrally located areas. This would further accentuate Uber’s advantage vis-à-vis potential competitors: Uber service would be nearly instant, and drivers – again, even if they nominally work for multiple services – would be constantly utilized.
Moreover, there is a very good chance that Uber could come to dominate same-day e-commerce and errands like grocery shopping: most entrants in this space have had a top-down approach where they set up a retail operation and then figure out how to get it delivered; the problem, though, is that delivery is the bottleneck. Uber, meanwhile, is busy building up the most flexible and far-reaching delivery-system, making it far easier to move up the stack if they so choose. More likely, Uber will become the delivery network of choice for an ecosystem of same-day delivery retailers. Needless to say, that will be a lucrative position to be in, and it will only do good things for Uber’s liquidity.
##Barriers to Expansion, Opportunity Cost of Drivers and Autonomous Cars
Because the marginal cost of adding an additional Uber driver is almost zero i.e. cost of recruitment and on boarding are minimal, the limit to supply is driven by the opportunity cost of the drivers themselves. Drivers will only join the Uber network if the income they generate is greater than the income they get elsewhere with the time spent on Uber plus the expenses of running an Uber service i.e. petrol, maintenance etc.
As discussed earlier the ability for Uber to expand beyond the taxi market is a function of their ability to reduce fares. At the moment that hard limit is driven by the opportunity cost of drivers.
With advances in autonomous cars this hard constraint may eventually fall away with time and ultimately the limit on fare reduction be driven by the operational cost of operating a fleet of autonomous cars (not unlike the cost structure of the taxi service that Uber is trying to replace but at a much larger scale and without the driver-labour costs).
This is the motivation for Uber investing in autonomous cars research. See Uber 2.0: Human Self-Driving Cars by Ben Thompson for an excellent discussion of Uber and autonomous cars.
If autonomous cars ever come to fruition and Uber adopts them will change the cost structure of their business model from an operating expenditure driven model to a capital expenditure heavy one. The ability to fund this expenditure shouldn’t pose a problem if they’re able to secure a stable revenue stream from current growth efforts and ability to secure critical mass in each of their local networks as the large stable income flow can be used to secure capital investment not unlike how infrastructure is currently funded in utility sectors.
In the next part I will explain the structure of Uber’s revenue and costs and how this influences their strategy as well as provide a reading list of material on Uber’s business model.
