Monday, September 26, 2016

“Transformative” remains a word better suited to Hogwarts than to the Harvard Business School

The thinking of business writers has become so muddled and, in places, so overtly mystical that the important fundamental drivers are completely lost in the discussion. Words like "disruptor" or "transformative" have such tremendous emotional resonance for the writers (and investors) that they blind them to the underlying business forces.

Case in point from Rick Newman (with the important caveat that Newman may be more describing than endorsing the common wisdom here)
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.

Putting aside for the moment the question of whether Amazon or Facebook are themselves overvalued, there is a simple business reason why first mover advantage was so important for these companies.

Amazon took advantage of that early lead and all of the tremendous capital that went with it to establish a monumental distribution system. This presents a huge brick-and-mortar barrier to entry for any potential competitor. As for Facebook (or for that matter LinkedIn), the single most important factor when you are thinking about joining a social network is "are the people I want to connect with on this network?" Once again, unless the company screws up big time, early dominance can present an almost insurmountable obstacle for potential compeetitors.

Then there's the question of scale. Amazon and Facebook have business models that only makes sense on a national or better yet international level. There is no plausible scenario where local or regional players can significantly eat away at their market share let alone grow to the extent that they become real threats.

Barring a massive and truly unprecedented piece of regulatory capture, Uber will always be vulnerable to new players as long as we're talking about its current business model. All that is required is a big enough marketing and recruiting budget to establish brand and to line up a sufficient number of drivers for a given area. That's not a cheap or trivial task but it is most certainly doable. Perhaps more to the point, if this sector ever becomes profitable enough to justify the proposed value of Uber, then there will be enough money flowing to guarantee plenty of competitors.

As mentioned before, a locally based Amazon or Facebook does not make a great deal of sense. By comparison, you can make a very good case for a locally based ridesharing service. The start up costs are a small fraction of a national launch. You can prioritize highly lucrative markets. Business models can be tweaked. Specific demographics can be targeted. Special deals can be cut with local institutions and organizations. Regulatory issues can be dealt with much more easily.

Consider Austin, Texas. When Uber and Lyft pulled out in protest last May, a non-profit created an alternative ride sharing service and had it up and running in about a month. Keep in mind, we're talking about an independent with little capital starting from scratch. A well financed company that's gone through this a couple of times could certainly match or even beat that turnaround time.

If I were one of the investors who had poured nearly $12 billion into the company, that would make me nervous, even if it is a transformative disruptor.

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