Wednesday, September 28, 2016

What almost everyone gets wrong about Uber and driverless cars

From Rick Newman
Self-driving cars are the company’s holy grail. Morgan Stanley estimates human drivers account for half the cost of a ride-sharing trip, which means Uber may one day be able to dispense with its biggest cost, plus hassles such as lawsuits over whether Uber drivers should be treated as full-time employees. It could also become a logistics company on par with FedEx (FDX) and UPS (UPS), offering package delivery and other transportation services. If you buy this vision, Uber is the next Amazon (AMZN)—a coming goliath so transformative that 10 years of deep losses would be well worth the global domination the company will one day wield. That’s why investors have plowed nearly $12 billion into Uber, valuing it at a whopping $68 billion. Facebook (FB) raised less than $3 billion before going public in 2012.

Coverage of Uber by both business and tech journalists has been weak. Coverage of autonomous vehicles by both business and tech journalists has been weak. When you put the two together, the results are unsurprisingly pretty awful.

The majority of the stories make two fundamental mistakes.

The first involves confusion over self-driving versus driverless cars. Other than a probable improvement in safety, self-driving cars (assuming they required a human present just in case) would have very little impact on Uber's business model. While remarkable progress is being made, achieving the level of autonomy required for reliable driverless vehicles where you can simply tell your car an address and send it on its way with no humans on board remains a daunting technical challenge.

An even more basic mistake is routinely made on the business side. The confusion springs from the difference in absolute and relative impact. If companies operated in a vacuum, any development the reduced cost would be good. In the real world though, you also have to consider the impact of the development on your competitors.

Here's an example. Imagine you own one of two delivery services in a town. Both you and your competitor have roughly the same number of trucks but you have invested a great deal of money upgrading and making sure that your vehicles are as energy-efficient as possible. So far, the cost of the upgrade has been balanced out by your savings on diesel so that you are able to charge roughly the same rate as your competitor. A drop in fuel prices will reduce your operating cost. Normally that would be a good thing, but the cost for your competitor will drop by even more so that he will be able to undercut you on prices.

The Uber business model is based on the fact that there are a huge number of underemployed people who own underutilized cars (virtually all private vehicles are underutilized). Since car and driver are already just more or less sitting there most of the time, Uber is able to offer rides at a rate that would not otherwise be sufficient to cover all the assorted cost.

(Technically Uber doesn't offer the rides, but you get my drift.)

{And, yes, there are people who buy cars just to drive for Uber. There are also people who buy commemorative plates as a hedge against inflation.}

If you take drivers out of the equation, suddenly it becomes unclear what advantage Uber has over taxicab companies, car rental services, car dealerships or any business that maintains a large fleet of cars. Let's consider the Hertz example here in Southern California. Currently you have locations spread around LA and Orange counties, with each lot having to maintain a minimum stock. With truly driverless cars, you can get awfully close to 100% utilization for much of the day. Just have your extra vehicles prowl for fares and make deliveries, then send them to whatever location needs them next. Add to that maintenance facilities, purchasing power, a late model fleet and countless economies of scale.

You can imagine similar scenarios for any number of other businesses and in each of those scenarios, Uber and Lyft get screwed over by large, new, well-positioned competitors.

All of this leads us to the dirty little secret of the ride sharing industry. Though it was made possible by technological innovation (specifically the smart phone), the stability of the business model depends not on sustained disruption and transformation but on things remaining basically the same.

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