As 2017 drew to a close, Uber secured another round of investment to shore up its dwindling balance sheet. Softbank’s tender offer injected $1.25 billion of fresh capital into the company, while giving seed investors who chose to cash out a whopping 360,000% return on their investment. Softbank’s CEO, Masayoshi Son has made a fortune from his prior big bets on Yahoo, Vodafone, Alibaba, Sprint, Nvidia and others. What is Son seeing in Uber (or, for that matter in other ride sharing companies Didi Chuxing, Ola, Grab and 99, in which Softbank has also heavily invested) that overlooks the company’s dismal financial performance to date?
My Forbes article last month, “Why Can’t Uber Make Money?,” identified fundamental weaknesses in Uber’s business model that has led the company to lose more money, faster than any startup enterprise in history. In the year just ended—Uber’s seventh—the company’s projected loss of $5 billion is unprecedented and clearly unsustainable. And there is little reason to believe that on its current course, Uber can stop the bleeding any time soon for one simple reason: a fundamentally broken business model.
The taxi industry that Uber is seeking to disrupt was never particularly profitable when allowed to expand in unregulated markets, reflecting the industry’s low barriers to entry, high variable costs, low economies of scale and intense price competition—and Uber’s current business model doesn’t fundamentally change these structural industry characteristics.
While Uber’s business model has created enormous value for consumers, propelling the company’s rapid growth, its extremely aggressive pricing simply doesn’t generate enough revenue to deliver attractive compensation to drivers and sizable profits to shareholders. By pricing its services roughly 30% below comparable taxi fares and then retaining 25% or more of gross bookings for itself, Uber has squeezed the revenues available to compensate drivers, who are ultimately responsible for providing the labor, equipment, maintenance, insurance and fuel to serve consumers. There is little in Uber’s current business model that promises to reduce the factor costs of its ridesharing service, nor are there inherent economies of scale that would lower unit operating costs with continued growth. Thus, in attempting to disrupt the taxi industry, Uber has shifted, but not significantly reduced the costs of delivering an inherently low profit service.
The same value trap–low consumer willingness to pay, high unit costs and low economies of scale—also saps the profit potential from “last-mile” delivery services like uberEATS and uber RUSH who compete against a host of money-losing competitors like Postmates, Doordash and Instacart. Investors poured more than $9 billion into 125 on-demand delivery companies over the past decade in search of the next “Uber for X” unicorn, but new capital is drying up, as many venture capitalists are losing money and faith in a sector with bankruptcies and fire sales piling up. For example, within the last two years, Doordash was forced to accept a 16% valuation down round (with harsh terms to boot) while other urban delivery players like SpoonRocket, Sprig and Maple shuttered operations.
Contrast these challenging economics with other startup enterprises that are creating and capturing value by disrupting industries with historically high margins andhigh costs. In such cases—eyewear, fashion apparel, mattresses and enterprise business systems—companies like Warby Parker, Rent The Runway, Casper and Amazon AWS have developed innovative business models delivering better service at considerably lower cost across the value chain, which fundamentally alters industry economics. For example, Warby Parker and Casper disintermediated inefficient industry value chains with as high as a 10-fold markup from manufacturing cost to retail price in their respective industries, to deliver superior customer experiences at vastly lower prices than traditional competitors, while still leaving room for sustainable operating margins.
Such is not the case with Uber. Since the dawn of the internet, we’ve witnessed many sobering cases of companies with intriguing value propositions but unproven business models who flamed out in their mad dash to scale fast, profit later. Kozmo and Urbanfetch were early casualties in the urban last-mile delivery business, burning through more than $300 million of venture capital before declaring bankruptcy in 2001.
That same year also claimed another epic business model meltdown–Webvan, the company that pioneered the online grocery delivery category. Flush with $800 million in venture and IPO capital raised during the height of the eCommerce bubble, Webvan raced to establish first mover advantage, building highly automated pick-and-pack warehouses in 26 cities across the US. But Webvan never got a chance to master the executional discipline required to operate profitably in the low-margin grocery category, and each new launch city merely deepened their negative cash flow. As a result, Webvan went from IPO to bankruptcy in only 18 months, one of the fastest public company flameouts in history.
The Webvan saga presents a cautionary tale for any company engaged in a mad dash to scale fast and profit later, particularly in categories with challenging underlying economics. To be sure, Uber has several benefits that its predecessors lacked at the turn of the new Millennium, including low cost computing, bandwidth, GPS, mapping and software tools, widespread consumer acceptance of mobile and online transactions, and deeper (albeit dwindling) capital reserves. Nonetheless, like Webvan, Uber has yet to prove it can consistently operate profitably in major metro markets, despite seven years of effort, yielding more than $9 billion of negative cash flow.
Against this backdrop, what does Masayoshi Son see in Uber that warrants its recently completed $7.7 billion investment for a 15% stake in the company? The answer likely lies in Son’s expectation for improved financial performance over two distinct time horizons.
In the short- to medium-term, while Uber can no longer realistically expect to become the “last man standing” in major metro markets around the world, it can still hope that a reduced set of large ridesharing competitors will become more disciplined in avoiding financially ruinous fare wars, much as US airlines did in reversing thirty years of shareholder value destruction by undertaking industry-consolidating acquisitions over the past decade. If and when competition in the ridesharing and last-mile delivery sectors does thin out (despite relatively low barriers to entry), remaining players could enjoy somewhat greater pricing power and decreased driver recruiting costs. Softbank also has invested heavily in other major ridesharing companies, which should promote more favorable coopetition between Uber and Didi Chuxing, Ola, Grab and 99 in global markets. Nonetheless, the ridesharing industry has dug itself into a deep hole, and underlying business model weaknesses are unlikely to radically improve the industry’s profit outlook.
Over the longer term, Uber has always pinned its potential for improved financial performance on autonomous vehicles (cars and air taxi drones), taking expensive and unreliable drivers out of the equation. In theory, driverless vehicles should allow ridesharing providers to increase productivity and service quality while sharply reducing operating cost -- subject to three critical caveats.
First, the economics of autonomous vehicle technology have yet to be proven, and we don’t yet fully understand the tradeoffs associated with substituting capital for labor in transforming the industry. Under any circumstances, widespread adoption of autonomous vehicles will eventually require billions of dollars of new investment, which Uber may not be in a position to fund.
Second, Uber is far from alone in the race to perfect driverless vehicles, and it is yet unclear whether Google (Waymo), the car industry or rideshare companies will be best positioned to extract value from deploying driverless vehicles to ridesharing services. If the key to sustainable profitability in the urban transport sector is driven primarily by access to superior autonomous vehicle technology (with high barriers to entry), and not in operating a metro-by-metro ridesharing platforms (with relatively low barriers to entry), driverless vehicles may not prove to be the salvation to Uber’s elusive quest for profitability.
Finally, under the best of circumstances, the time framefor widespread deployment of “Level 5” autonomous vehicles in dense urban areas is likely to be measured in decades, not years. This is not a bet that any investor looking for a quick return on investment is likely to make. And this reality may ultimately explain Masayoshi Son’s big bet on Uber et al, to become the kingmaker of the ridesharing industry.
Son has consistently proven himself to be an exceptionally patient visionary, willing to make large investments in nascent technologies that have yielded outsized returns over time. Son has been an early and big player and ultimate winner in the explosive growth of Internet 1.0 (Yahoo), eCommerce (Alibaba), telecommunications (Vodafone, Sprint), microprocessing (ARM, Nvidia), robotics (iRobot, Boston Dynamics), the sharing economy (WeWork), and solar energy (SBG Cleantech). Time will tell if Son’s bet on ridesharing will also pay off.
But in order to survive until the hoped for transition to a more profitable driverless vehicle future, Uber will need to take aggressive near-term actions to improve operating performance. Two imperatives should be high on Uber CEO Dara Khosrowshahi’s priority list:
1. Fix driver relations. In Uber’s two-sided market, it is critical to effectively balance the economics and participant experience of both riders and drivers. Uber has consistently put rider satisfaction ahead of its treatment and compensation of drivers. This bias has led to low driver satisfaction and growing turnover, both in absolute terms and relative to its main US competitor, Lyft. Recent corrective efforts have been a step in the right direction, but still gallingly inadequate, as exemplified by the (deliberately?) poor execution of long-overdue in-app tipping, and the company’s strategically sound, but poorly communicated upfront pricing initiative. Trying to run a service business with competitively disadvantaged satisfaction of mission critical de facto employees is an expensive and losing hand. Khosrowshahi would be well advised to add an additional item to his recently promulgated statement of Uber Cultural Norms that commits the company to ensuring and delivering the most rewarding and supportive driver experience in the industry. This will undoubtedly be a costly transition, which only reaffirms the strategic imperative of focusing on selected markets where Uber can sustain competitively advantaged pricing power and operational efficiency.
2. Shrink to grow. From its inception, Uber made a calculated bet that it could achieve global domination, wiping out both incumbent taxi companies and competing shared ride providers, to enable the company to exercise monopoly pricing power. But it is now apparent that Uber has lost this bet in its headlong rush into an industry with historically low profit potential and low barriers to entry. There are undoubtedly defensible geographic markets and user segments in the global ridesharing market that can currently sustain profitable operations. Khosrowshahi will need some serious soul-searching to rethink Uber’s soaring ambition and penchant to win-at-all-costs in all markets. This will require abandoning current operations showing little potential for near-term profitability, while continuing to explore opportunities to exploit industry-leading scale in selected markets that promote competitively advantaged operations (e.g. uberPOOL and Express POOL which can yield lower costs, higher asset productivity and greater returns, particularly for market share leaders).
There are numerous inspiring case studies of overextended companies that retrenched to a defensible core, only to reemerge down the road, stronger than ever. Given Uber’s current burn rate, Uber clearly needs to zero base budget its sprawling current operations to decide where to defend the core at all costs, and where the company should temporarily retreat to live to fight another day.
Softbank has given Uber additional runway to get its operations and finances under control. But the company will have to make some hard choices to ensure that unlike Webvan, its soaring ambitions don’t result in a mad dash to oblivion.
After 40 years in management consulting and venture capital, I joined the faculty of Columbia Business School, teaching courses in business strategy and corporate entrepreneurship
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