Wednesday, January 11, 2017

They lose money on every ride but they make it up in volume

On one level, ride sharing is a good idea -- using smartphones to connect passengers with underutilized drivers has potential to provide significant benefits on both sides of the transaction -- but, as mentioned before (see here and here for a couple of recent examples), the bullshit narratives and mystical thinking of both investors and journalists have taken something that could have been an innovative business model and turned it into something damned close to a Ponzi scheme

As you would expect from a Gawker remnant, Jalopnik has been the go-to site for Uber coverage, both firsthand and through useful links to and summaries of essential reporting and analysis elsewhere.

Here, Ryan Felton directs us to an important piece of analysis by Hubert Horan,

Uber is currently the most highly valued private company in the world. Its primarily Silicon Valley-based investors have a achieved a venture capital valuation of $69 billion based on direct investment of over $13 billion. Uber hopes to earn billions in returns for those investors out of an urban car service industry that historically had razor-thin margins producing a commodity product. Although the industry has been competitively fragmented and structurally stable for over a century, Uber has been aggressively pursuing global industry dominance, in the belief that the industry has been radically transformed into a “winner-take-all” market.


For Uber (or any other radical industry restructuring) to be welfare enhancing, it would have to clearly demonstrate:

    The ability to earn sustainable profits in competitive markets large enough to provide attractive returns on its invested capital

    The ability to provide service at significantly lower cost, or the ability to produce much higher quality service at similar costs

    That it has created new sources of sustainable competitive advantages through major product redesigns and technology/process innovations that incumbent producers could not readily match, and

    Evidence that the newly-dominant company will have strong incentive to pass on a significant share of those efficiency gains to consumers.

Unlike most startups, Uber did not enter the industry in pursuit of a significant market share, but was explicitly working to drive incumbents out of business and achieve global industry dominance. Uber’s huge valuation was always predicated on the dramatic growth towards global dominance. Thus if Uber’s valuation and industry dominance were to be welfare enhancing, Uber’s efficiency and competitive advantages would need to be overwhelming, and there would need to be clear evidence of Uber’s ability to generate large profits and consumer welfare benefits out of these advantages.


As shown in Exhibit 2, for the year ending September 2015, Uber had GAAP losses of $2 billion on revenue of $1.4 billion, a negative 143% profit margin. Thus Uber’s current operations depend on $2 billion in subsidies, funded out of the $13 billion in cash its investors have provided.

Uber passengers were paying only 41% of the actual cost of their trips; Uber was using these massive subsidies to undercut the fares and provide more capacity than the competitors who had to cover 100% of their costs out of passenger fares.

Many other tech startups lost money as they pursued growth and market share, but losses of this magnitude are unprecedented; in its worst-ever four quarters, in 2000, Amazon had a negative 50% margin, losing $1.4 billion on $2.8 billion in revenue, and the company responded by firing more than 15 percent of its workforce.[4] 2015 was Uber’s fifth year of operations; at that point in its history Facebook was achieving 25% profit margins.[5]


There is no evidence that Uber’s rapid growth is driving the rapid margin improvements achieved by other prominent tech startups as they “grew into profitability.”

Assuming that the unusual spike in EBITAR margin in the first half of 2014 (157%) was due to one-time events or accounting anomalies, Uber has been steadily producing EBITAR margins worse than negative 100% since 2012, and the absolute magnitude of losses has been increasing.

Uber corporate revenue for the year ending June 2015 was over 500% higher than the year ending June 2014, but the EBITAR margin barely changed, moving from negative 115% to negative 108%. Uber had a negative $1.2 billion EBITAR contribution in the first half of 2016, suggesting full year GAAP losses approaching $3 billion. Uber’s EBITAR contribution margin improved from negative 108% in the first half of 2015 to negative 62% in the first half of 2016, but this margin improvement is entirely explained by Uber imposed cuts in driver compensation. As shown in Exhibit 3, Uber only allowed drivers to retain 77% of each passenger dollar in 2016, down from 83% in 2014-15[6]. If drivers had retained 83% of 2016 passenger payments, Uber’s EBITAR contribution would have been negative $1.8 billion, and its EBITAR margin would have fallen to negative 122%. Uber’s EBITAR margin did not improve because its productive efficiency or market performance was improving; capital was simply claiming a higher share of each revenue dollar and giving less to labor.

If rapid growth could not drive major margin improvements between 2012 and 2016, there is no reason to believe that Uber will suddenly find billions in scale economies going forward. Fundamentally digital companies like Amazon, EBay, Google and Facebook had massive operating scale economies because the marginal cost of expanded operations was close to zero. Aggressive pricing fueled the growth that drove major margin improvements and also created major consumer welfare benefits.

By contrast, in the hundred years since the first motorized taxi, there has been no evidence of significant scale economies in the urban car service industry. That explains why successful operators never expanded to other cities and why there was no natural tendency towards concentration in individual markets. Drivers, vehicles and fuel account for 85% of urban car service costs. None of these costs decline significantly as companies grow. As the P&L data above demonstrates, Uber has not discovered a magical new way to drive down unit costs.

Uber’s refusal to consider an IPO may best be explained by the recognition that publishing detailed, audited financial data confirming these massive losses and the complete lack of progress towards profitability could undermine public confidence about its inevitable march to industry dominance.

There have been hundreds of articles claiming that Uber has produced wonderful benefits, but none of these benefits increase consumer welfare because they depended on billions in subsidies. Uber is currently a staggeringly unprofitable company. Aside from the imposition of unilateral cuts in driver compensation, there is no evidence of any progress towards breakeven, and no one can provide a credible explanation of how Uber could achieve the billions in P&L improvements needed to achieve sustainable profits and investor returns.


  1. Mark:

    Setting aside the question of Uber's profitability, doesn't Uber offer big consumer welfare benefits in the suburbs where you no longer have to wait an hour for a cab?

    Let me put it another way:

    Right now Uber rides are cheap, and I'm guessing you're right that the low fares are being subsidized by somebody, and if there's any expectation that this subsidy will last, it's from an expectation of government subsidy. (The argument is obvious: mass transit is expensive so take the money that was being spent on transit and use it to subsidize Uber etc.) And, sure, this falls under the general category of "grift," and I'm glad people are blowing the whistle on it. There's something annoying about ride-sharing services being described as paradigms of free enterprise while expanding based on the hope of government subsidy.

    But forget about all that. Suppose Uber etc. were not being subsidized by the stock market, and suppose they did not have a good chance of getting massive future subsidies from the taxpayer. Without subsidy, maybe Uber rides would cost 4 times as much. But even at 4 times the price, Uber still adds consumer welfare for suburbanites, no?

    1. Just to be clear, ridesharing services are potentially a very good idea, offering what can be a sound business model and a real benefit to the consumers. There are, however, some disturbing elements to the way the Uber story has developed.

      First, a deep-pocketed company running at a loss to drive out competition is never good for consumers in the long run. Growing up in Arkansas, I saw this particular chapter of the Walmart playbook all too often. If Uber goes under but manages to kill Lyft and devastate the taxi industry first, the consumers are big losers. (By the way, when I took a cab a few months ago, they were there in 10 minutes, took a credit card, and sent me a text when they arrived at my door.) I'd actually like to see more local and regional rideshare companies spring up to provide even more competition.

      Second, I think Uber has passed what I call the Ponzi threshold. The hype has grown so overheated and the expectations have become so unreasonable that the actual business, no matter how worthwhile cannot possibly live up to them. Though it started with a sound concept, there is no way it can deliver the growth investors are demanding. The result is that management has to make impossible promises and push a bullshit narrative. Among other things, this distorts markets and drains resources away from promising developments. It also encourages more hype and bullshit companies to follow their lead.

    2. Mark:

      Yes. Also there's the problem that there will be a way to deliver some of the expected growth, and that is government subsidy. It's the obvious next step.

    3. Of course, Uber (and Lyft and AirBnB) already have a substantial indirect government subsidy by not having to face the same fees and regulations as its competitors, but direct subsidies are certainly possible.

      If this does happen, experience has taught us that getting billions in taxpayer dollars will not stop the C-level executives from seeing themselves as heroes in an Ayn Rand novel.

  2. I think of it as a tax on venture capitalists. In a more socialist world, we might have just raised taxes on the the top 0.001% by 0.1% and used some of the tax revenue to pay for subsidized drivers to offer rides in areas under-served by transit and car services. We pay for paratransit for people with medical problems. Why not open it for everyone, make it better and pay for it out of societal surplus?

    Of course, with no realistic IPO plan, Uber is probably counting on a taxpayer bailout.