Tuesday, August 5, 2014

Does Uber Possess Viable Business and Social Models?

Uber is a company that provides a platform whereby people in need of a vehicle to take them somewhere can be matched up with people who have a car and are willing to drive someone to a location for a fee.  Uber’s drivers are considered independent contractors rather than employees and generally provide the vehicle, car insurance, gasoline, and toll fees; they pay their own payroll taxes and receive no benefits.  Uber’s current model uses a pricing system that increases rates when demand is high; it splits the cash flow with its drivers, taking 20 percent for itself.

Uber provides direct competition for taxi services in the cities in which it operating.  Supporters argue that Uber can provide more efficient service than the highly regulated taxi model.  Critics point out that Uber’s business model may not be sustainable, and its impact on society may not be beneficial.

It is appropriate for a city’s taxi service to be considered a form of public transportation.  History has clearly demonstrated that there is a need for such a service.  The fact that taxi operators have been so highly regulated for so many years suggests that the service is critical to the life of the municipality.  It also suggests that considerations other than supply and demand have been important to city planners.

An ideal taxi service would provide drivers with enough income to live a decent life.  It would provide enough vehicles to meet the demand, and it would charge fares that are affordable to a significant fraction of the population.  If too many vehicles are available, unoccupied cars would be clogging the streets and an individual driver would earn less.  If there are too few cars, wait times for service become intolerable and customers unhappy.  Fares have to be consistent with supply of vehicles and demand for their service if everything is to remain in balance.  This system has been in place for the better part of a century in our cities and has produced a stable transportation model.

The issue is whether or not Uber makes our urban areas better places to live.  That is far from obvious.

The competition from Uber will drive down the income of taxi drivers and could eliminate some of those jobs.  Uber would, in effect, be replacing permanent, full-time workers with a living wage by a herd of day laborers whose income will be erratic and most likely driven down over time.  If Uber is successful it will attract competitors—and markets will do what markets do.

Jeff Bercovoci has provided an excellent discussion of Uber’s future prospects in an article for Forbes: The Bear Case For Uber (Yes, There Is One.  He does not claim to know what the future holds, but he allows as how it could be considerably less rosy than the Uber leaders now expect.

One of the problems with Uber’s business model is that the price for entering into competition with it is so very low.

“The same innovations that made it possible — GPS-enabled mobile devices, smart utilization algorithms, frictionless digital payment and social authentication — make it possible for anyone who wants to build a platform that would do much the same thing, without taking 20% of the proceeds.”

Uber is already beset by competitors trying to undercut it.

“The price war that Uber’s locked into now shows what happens when the marginal cost of providing a service shrinks to insignificance, says Jeremy Rifkin, an economics lecturer and author of “The Third Industrial Revolution.” ‘As you move toward zero marginal cost, the margins aren’t there for the profits,’ says Rifkin. ‘You’re going to have cooperatives coming in, and you’re going to see governments coming in like they are with bike sharing’.”

Bercovici provides an overview of the current competition.

“Even in the let’s-disrupt-transportation church, Uber has no shortage of competitors pecking away at it from every angle. The biggest, Lyft, competes primarily in the arena of low-cost service, but in May it added a premium tier, Lyft Plus, challenging for the market where Uber makes its biggest profits. There are services that specialize in traditional taxis (Hailo, Flywheel), services for riders willing to share the backseat with strangers (Hitch), services for those who just want a cheap car for a few hours but no driver (Getaround, Relayrides) or a driver but no car (Redcap). And of course there are the traditional taxi and car-service companies and rental providers.”

Price competition is already a serious concern.

“Lyft president John Zimmer says his company is committed to being the cheapest option for riders; in order to keep drivers happy as well, it has had to forego taking any cut of fares, subsisting on the $333 million in venture funding it’s raised. To undercut Lyft in its home market, Uber recently dropped fares on UberX by 25% while promising to keep drivers’ take-home intact. Not only does Uber make nothing on those rides; it pays the drivers a bonus on top of the fare. Both companies say any sacrifice on their part is temporary, but in this environment, it’s hard to imagine Uber will be able to impose its 20% cut of fares consistently, especially with low-cost UberX growing at five times the rate of the premium tiers and new entrants popping up all the time.”

Perhaps the greatest concern is that governments will step in and insist that Uber and its competitors live under the same rules as taxi operators.

“Across North America and Europe, taxi and limo drivers’ unions have been lobbying legislators to regulate or outlaw peer-to-peer services, and occasionally succeeding. “What they’re trying to do is get all their competitors to have to incur the same costs they do,” says Samuel Staley, who teaches economics and urban planning as director of Florida State University’s DeVoe Moore Center. One industry group, the Taxi, Limousine and Paratransit Association, claims that 30% to 40% of a traditional taxi’s operating expenses consist of regulatory costs Uber is now avoiding, especially primary commercial liability insurance. (Uber requires drivers to have their own insurance, although it does provide secondary coverage for certain situations.)”

Some cities have withheld permission for Uber to operate; others have banned it.  The threat of regulatory controls will likely increase if Uber becomes more of a city presence.

Uber has labor problems to contend with as well.  It seems to prefer drivers who are willing to work full-time and who consider driving to be a career.  If that is its goal then it will have to recognize its drivers as actual employees who will have demands.

“….in a handful of cities, including San Francisco, Los Angeles, Seattle and Atlanta, drivers are attempting to organize. “The company is somewhat structured not to take any input from drivers,” says Daniel Ajema, a co-founder of Seattle’s App-Based Drivers Association, which claims more than 150 members. At the top of his group’s list of demands is an appeals process for drivers who’ve been kicked off the platform for low ratings. Bargaining down that 20% commission rate is another priority. ‘We buy the car, we maintain the car, we pay for gas,’ Ajema says. ‘At this point in time, it’s becoming unreasonable to maintain the business.’

“As long as it has the most passengers to dole out, Uber will have the upper hand. But the drivers might have some leverage of their own: While they’re classified independent contractors, allowing Uber to avoid social security taxes and health insurance, it skirts a line when it requires them to drive full-time hours or tells them where to troll for fares. Those are the sorts of criteria the Department of Labor use to determine whether a worker is truly independent.” 

The leaders of Uber seem to be confident that they will not only survive, but will thrive in this environment.

“Uber recently raised $1.2 billion at a valuation of $18 billion, making it, on paper, one of the world’s biggest transportation companies, more valuable than such venerable competitors as Hertz, Avis and United Airlines.”

Some think this just the beginning.

“Benchmark Capital’s Bill Gurley, who sits on its board, argues that the company could easily attain a $150 billion valuation, and his fellow director Bill Maris has tossed out $200 billion.”

And why is Gurley so confident?

“Because, he says, so many of his peers agree with him. That $1.2 billion raise was the result of ‘the most structured financing process I’ve seen for a private company. The collective wisdom of the best investors who had access to a lot of data had one conclusion, and at the end of the day, that’s the best way we know to judge valuation’.”

To which Bercovici provided this apt retort:

“Making ever-bigger bets on the premise that so many other investors can’t be wrong — that’s a pretty good definition of a bubble, whatever Uber’s future holds.”

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