Confession: I Don’t Think Uber is Actually a Great Business (Yet)

Additional Background If You Stumbled on this Post Randomly

Uber is everywhere – especially in the startup/technology world that I follow closely, mostly through podcasts. It is the source of deliciously spirited debate because it is a wonderful blend of ubiquitous consumer product and highly publicized startup juggernaut. And whenever I get in too many debates with people about one topic and get stuck on a plane with no wi-fi, I write out my arguments, which I occasionally publish and commit to the public record. 

I’m not a journalist who spent 200 hours researching the story, a venture capitalist who knows all the secret information discussed behind closed doors, or a billionaire who can say “listen to me, I’m richer and smarter than you” – I just digest a ton of information, try to think about things from first principles, and filter out all the bullshit and think independently if possible. Slightly nervous, but here it goes.

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Uber is an incredible success by any measure of a startup – the company was founded only seven years ago, has raised $10B from world class investors, and is now valued at $62.5B.

It provides all of us with delightfully quick and (usually) cheap rides in nice cars, driven by pleasant people. Uber’s existence makes my life much, much better, and the founders have been able to execute at a level that is simply stunning.

Consequently, Uber has been anointed as the official Silicon Valley Company of the Future That Wins Everything (SVCOTFTWE) by the startup/venture capital/media industrial complex.

However, I believe that the certainty of Uber’s future dominance is vastly overrated. While Uber is indeed an amazing company, it is actually not a fundamentally great business, and its future is even more challenging. The lack of public counter-narrative about the business of Uber makes me feel like I’m either insane, or this is an “emperor has no clothes/is wearing old sweatpants” situation.

Uber Alarm Bells

There are alarm bells that call into question the inevitability that Uber, the business, will actually be the Silicon Valley Company of the Future That Wins Everything. They tell me “don’t believe the hype, look closer” because, as my 8th grade baseball coach used to say, “no one shits ice cream” (not even Uber). 

1) No one with a significant public voice (that I can remember) says anything bad about the business of Uber. They criticize its ethics, social impact, culture, etc, but it is taken as gospel that Uber is basically Standard Oil re-created. Lemming behavior like this, perpetuated by Silicon Valley insiders, makes me suspicious. I’m also legitimately nervous writing something negative about them and publishing it, which is weird in of itself (please don’t cancel my account Uber.)

2) Especially since, according to released financials from the first half of 2015, even though Uber did $3.6B in bookings and made net revenue of $663M (their earnings after paying drivers), after including “Cost of Revenue” Uber only made gross margins of $25m (and GM was actually negative in the second quarter). Although recently the CEO claimed they were profitable in the US, that still means (unless I’m missing something from these leaked financials) they made almost no money on actual rides on the aggregate, even before all their other expenses.

For a business that is highly price elastic (e.g. if you raise prices by 50%, consumers will definitely respond by purchasing much less), that is very concerning because it means they haven’t proven that their core product is fundamentally and sustainably profitable in any way that is consistent with their valuation. They are still selling $10 bills for $10.07. There is a valid argument that they are profitable in markets where they have hit scale, but that still means they are fundamentally reliant on that scale to make money. “We make money with scale and market dominance” is not the same as “every time we deliver our service, we make lots of money”.

3) Growing as quickly as Uber is ridiculously hard and causes issues that are invisible to the public. They seem to have a very aggressive, opportunistic, wall street, us-against-the-world culture that is probably necessary for this kind of growth, but it makes you worry about what skeletons have been buried along the way. How will they react in the face of serious adversity (or declining growth)?

4) No insiders are allowed to sell their shares. Seems like something you would do if you were trying to ruthlessly control the messaging around your company valuation because you’re not sure the business really backs up that valuation.

5) Uber is avoiding going public, and they are getting progressively easier, dumber money, from people who literally aren’t allowed to look at their financials. I understand that operating a public company is pretty heinous compared to running it privately, but it also raises suspicion that the public markets will destroy the story they’ve created about their valuation and the business behind it, and they are really just avoiding that reality check.

It made sense for Facebook to put off going public – Zuckerberg didn’t want a bunch of wall street guys fucking up his business by making him monetize in stupid ways. He was smarter than they were, and he knew he was better off not having to listen to them about something as nuanced and sensitive as monetization. Uber, the business, has much less to risk by going public and dealing with wall street interference (unless it is worried about the business being damaged by the destruction of its SVCOTFTWE myth).

6) Uber essentially sells a commodity product (although I will concede some people have a brand preference for Uber or Lyft – first mover advantage does matter). Commodity products need monopolies or contractual agreements to be substantially profitable – otherwise open competition drives the profit margins towards zero because the only way commodities can compete is on price. At the moment, Uber has neither a monopoly nor contractual agreements to leverage to profitability. Also, people hate monopolies and will only use them as a last resort (see: cable companies; an October 2014 blog post I wrote saying people should use Lyft instead of Uber to keep prices low and slow down an Uber monopoly on ride-sharing.)

7) At some point gas prices will go up again and that will make rides more expensive, affecting the supply/demand equation in some way, scary for a business that sells a price elastic, commodity good that is reliant on a two-sided marketplace.

8) They keep experimenting with other businesses – like UberEATS. Either they are just that aggressive that they can successfully add new dimensions to their business while going a million miles per hour already, or they are secretly concerned about the fundamental profitability of rides/liquidity of the system and need another source of profits from drivers.

9) Uber gets sued for things that fundamentally mess with their business model (independent contractors instead of employees).   

If that wasn’t enough, there is a clear “next evolution” for Uber’s market – autonomous cars. With other companies, you know they will get disrupted somehow, but you aren’t sure. With Uber, we all know that whatever business they are building now will have to be rebuilt under a different paradigm in the next 5-15 years.

And when autonomous cars come, so do the other tech giants who need massive markets to fuel growth  – Apple, Google, Amazon, as well as Tesla and the auto industry. The tech giants don’t have to actually make any money with the rides business (because their core businesses throw off so much cash), but Uber does. Would you want to be a business that had to make money selling a product competing against a business that didn’t?

Let’s quiet the more “instinctive” alarm bells now and take a more analytical, business school approach, using Porter’s Five Forces to assess Uber’s level of power in the business context:

Supplier Power

Uber has low-medium supplier power.

Uber has negative supplier power because suppliers (drivers):

• Have no binding contracts to guarantee supply at a price – Uber has a much different supplier power than a steel company with a 5-year contract with an iron ore mine that has a set price
• Are totally fragmented
• Can easily switch to competitors and sell the same good (you see tons of Uber drivers who also drive for Lyft, and some also work for companies like DoorDash and Postmates)
• Have a degree of pricing power, in that they can easily switch to another low-skill, on-demand job

Uber has positive supplier power because suppliers (drivers):

• Like driving for Uber when they can earn enough – driving people around is pretty chill as far as low-skill jobs go
• The supply of underpaid or underutilized low-skill labor appears to be on a permanently upward trend, which is shitty for the world, but good for Uber

Buying Power

Uber has medium buyer power.

Uber has negative buyer power because buyers (riders):

• Demand is price elastic. Surge pricing affects demand short-term, and permanent price rises will affect demand long-term. When my deodorant raises prices 50% (thanks Old Spice!), I’m still buying it, but if Uber raises prices 50% (short or long-term), I’m trying to take a Lyft or not relying on Uber as my primary ride sharing service. If the price is raised 75% or more, I’m taking a Taxi or finding another mode of transport or not going. 
• Have very low-switching costs (only need to download Lyft or another app and save credit card)

Uber has positive buyer power because buyers (riders):

• Are fragmented and have no power to individually drive down price.

Competitive Rivalry

Uber has high competitive rivalry (for now).

Uber has negative competitive rivalry power because competitive rivalry:

• Comes from Lyft in the US, who has raised $2b (including from General Motors and Andreesen Horowitz) and is still fighting them hard
• Comes from other massive firms like Didi Kuaidi, who are well funded and competing tooth and nail abroad, causing Uber to lose $1b/year in China alone.

Uber has positive competitive rivalry power because competitive rivalry:

• Only comes from companies with super deep pockets because they have to compete on price for a long, long time
• Only comes from companies that can execute at the extremely high level that Uber has demonstrated

Threat of Substitution

Uber has high threat of substitution.

Uber has negative power from threat of substitution because threat of substitution:

• Comes from the fact that people have been getting from point A to point B, locally, for all of human history. Uber did not invent something that people cannot live without, and people are used to weighing alternative ways to accomplish local transport. As a substitute to Uber, people can walk, bike, get a ride, take a bus, drive, take a taxi, or just not go.
• Arises because some of these options (public transportation and taxis) provide veritable price ceilings on how much Uber can charge (for now, while they still exist).

Uber has positive power from threat of substitution because threat of substitution:

• Decreases as habits are built and solidified. People are already relying on Uber and ignoring other options.

Threat of New Entry

Uber has medium threat of new entry now, and a high threat of new entry in the near (5-10 year) future.

Uber has negative power from the threat of new entry because:

• Uber cannot contractually lock down their early mover advantage. The main problem Uber has had to solve is how to get a driver to be able to pick up a passenger in less than five minutes. To do this, Uber has done the hard work of selling to both sides of this marketplace, but they cannot lock them up with contracts, leaving them vulnerable to later entrants who operate more efficiently.
• Rides are a price elastic commodity, so many drivers and passengers will use another service for a better deal. Uber has taken all the arrows in the chest “charging the hill” and building this marketplace, but it is possible that someone could come in and get all the benefits of their hard work (or continue to drive their margins negative).
• Uber will eventually need to make money from rides to be an ongoing business, future competitors won’t.
  • Amazon – needs to improve their ability to deliver packages quickly to areas with people (could be same drivers as the ones who take people), needs more things to sell to make Amazon Prime compelling (could be near term threat)
  • Google/Apple/Tesla/Big Auto – has data, developing driverless cars (massive long-term threat)
• Even if they win the near term, driverless cars will require Uber to entirely change what they do, and any competitive advantage and moat achieved erodes rapidly.
• Uber has very little value if it doesn’t create a monopoly – it is a two-sided marketplace. If you lose either supply or demand, you’re screwed.

Uber has positive power from the threat of new entry because:

• Uber is a force of nature. It has deep pockets, moves fast, has bottomless ambition, and isn’t afraid to fight. This deters future competitors and increases its chances of winning these future battles.
• Uber knows these competitors exist. They aren’t flying blind thinking nothing can go wrong, and paranoia goes a long way to fighting off new entrants.

In summary, Uber has low-medium buyer power, medium supplier power, high competitive rivalry, high threat of substitution, and a long-term high threat of new entrants. That does not scream to me the same level of dominance as Microsoft in the 90s, Google in the 00s, and Facebook in the 2010s. They are not an ATM-machine, printing money in a virtual monopoly – they may very well get there, but they are not there yet, and the path ahead is rocky.

Conclusion

Uber has created an amazing product and grown at an astounding rate with incredible execution. It may very well thread the needle and validate being anointed the Silicon Valley Company of the Future That Wins Everything, but it is far from the certainty we are led to believe, and we should not take everything we hear on blind faith.

It seems like the Silicon Valley industrial complex promotes hero-companies like Uber as a reaction to the generally cynical and risk averse perspective outside the startup world. It needs to have a SVCOTFTWE like Uber to show the rest of the world that their optimistic investing and hopeful belief in the power of technology is the correct approach. To challenge the supremacy of the SVCOTFTWE means you’re just an outsider and just don’t get it (which, for the record, was totally true in the case of Google and Facebook.)

And on the aggregate, Silicon Valley optimism is totally validated – wonderful products and services are created that we need and on the whole, it makes the world a better place. The people who work there are really, really smart – but sometimes it is worth double checking to make sure is it actually ice cream being spoon fed into your mouth, not something else that tastes a little funny, could actually be shit, or become ice cream after 5-10 more years of grueling execution. 

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