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By Hubert Horan, who has 40 years of experience in the management and regulation of transportation companies (primarily airlines). Horan has no financial links with any urban car service industry competitors, investors or regulators, or any firms that work on behalf of industry participants
Uber is Staggeringly Unprofitable, Is the Industry’s High Cost Producer, and Cannot “Grow Into Profitability”
This is the third of a series of articles that will use data on industry competitive economics to address the question of whether the Uber’s aggressive efforts to completely dominate the urban car service industry has (or will) increase overall economic welfare.
The capital markets, which ignored the industry for over a hundred years, have made massive investments in Uber and related companies. Are these markets benefiting society by allocating capital to more productive uses? A judgement that a Uber-dominated industry would enhance overall welfare requires evidence that:
Uber can (or will soon be able to) earn sustainable profits in a competitive market
Uber can operate urban car services significantly more efficiently than the traditional operators they have been driving out of business,
Uber has introduced major product/technological/process breakthroughs that create huge competitive advantages incumbents could not match,
Uber can earn returns on the $13 billion its investors have provided within the normal workings of open, competitive markets, while ensuring that the gains from its efficiency and service breakthroughs are shared with consumers.
The first article presented evidence that Uber is a fundamentally unprofitable enterprise, with negative 140% profit margins and incurring larger operating losses than any previous startup. Uber’s ability to capture customers and drivers from incumbent operators is entirely due to $2 billion in annual subsidies, funded out of the $13 billion its investors have provided. That P&L evidence shows that Uber did not achieve any meaningful margin improvement between 2013 and 2015 while the limited margin improvements achieved in 2016 can be entirely explained by Uber imposed cutbacks to driver compensation.
The second article presented a breakdown of the taxi industry’s cost structure, and demonstrated that Uber was the industry’s high cost producer, with a significant cost disadvantage in every cost category except fuel and fees where no operator could achieve any advantage. It also explained that Uber could not “grow into profitability” because there were no significant scale economies related to any of these cost categories. Both findings were completely consistent with the P&L evidence in the first article showing huge operating losses, and no evidence of the rapid margin improvement shown by past digital startups, whose businesses could exploit major scale economies.
Any Major Business Model “Innovations” Should Have Already Had Major P&L Impacts
This article will focus on the question of whether the Uber business model is based on breakthrough product/technological/process innovations.
It must be emphasized that “competitive advantage,” as used in these articles, refers strictly to advantages powerful enough to transform the industry’s competitive dynamic, allowing one company to profitably grow much faster than its competitors. Consumers might prefer certain product attributes offered by one company, but unless they significantly alter market and profit shares within the industry, they do not constitute “competitive advantages”.
Unlike previous tech startups, Uber has never made any specific, detailed claims about the sources of competitive advantage that might explain its rapid growth. While it has discussed aspects of its business model, Uber has never presented evidence about their efficiency/service impacts that independent outsiders could review. There have been scores of articles in the business press speculating about possible explanations for Uber’s rapid growth, but all ignore the billions in subsidies that have funded growth to date, and none were based on any hard evidence about their impact on industry competition.
Since there are no formal, documented claims about Uber’s competitive advantages that can be confirmed or challenged, this article will review a set of the most common undocumented claims found in media coverage.
If Uber had actually implemented transformative change, evidence of the transformative impact should have already appeared in the financial data presented in the previous two articles.
Uber has been operating since 2010. If Uber had dramatically redefined the product and the market, one would see obvious, tangible evidence of how its service was dramatically different from traditional taxis, and one would see huge demand growth in response to the totally new product offering. If Uber had found ways to produce urban car service significantly more efficiently than incumbents, one would see obvious, tangible evidence of its lower production costs and one would see superior profitability or at least strong, steady margin improvements on a clear path towards sustainable profitability.
In fact, there is no evidence of any of those things. One can observe product and service advantages over traditional operators, but these can been entirely explained by massive subsidies. Uber users pay only 41% of the cost of their service; it has gained share because competitors need to charge users 100% of their costs there is no evidence that taxi customers in a competitive market would pay more than twice as much for the service quality advantages Uber investors have been subsidizing.
If “innovations” are not powerful enough to transform product or operating economics, then they are not relevant to a discussion of how industry competition has been transformed, or whether that transformation will actually improve economic welfare. This article will consider many of the innovations that Uber supporters have suggested as possible sources of Uber’s transformative, disruptive competitive power. The question is why any of these might drive dramatic profit improvement in the future, when they have had no apparent impact in the past six years.
Unlike Uber, Amazon Proactively Publicized Its Many Legitimate Competitive Advantages
It is useful to compare the public claims and perceptions about Uber’s growth with the case of Amazon, which like Uber, was seeking to drive a massive set of incumbent competitors out of business in order to achieve long-term industry dominance.
Amazon’s business model was focused on “disrupting” a book retailing industry that had high prices, high margins and high costs. By contrast, Uber cannot explain how it will realize billions in profit from an industry selling a commodity product with razor-thin margins that had already cut costs to the bone. Unlike Uber, Amazon proactively provided outsiders with compelling, verifiable evidence of the sources of its (potential) efficiency and scale advantages. These included the huge savings from eliminating “brick-and-mortar” retail locations, enormous scale economies in warehousing and distribution, sophisticated software that not only processed customer orders but dramatically simplified product search and identified customer-tailored buying suggestions, increased leverage with publishers and other suppliers, and huge scale economies that allowed it to expand geographically and into new markets at negligible marginal cost once its basic selling and warehousing/distribution infrastructure was in place.
The huge scale economies meant it could rapidly drive down unit costs as it grew, building strong loyalty through rock-bottom prices, and making it virtually impossible for existing (or new) entrants to ever match its efficiency levels. Amazon’s efficiency claims could be readily verified by objective outsiders who were expert in the relevant retailing, warehousing and ecommerce fields.
Amazon’s digital platform meant it could expand into other lower-margin businesses but did not invest heavily in these new businesses until it had secured a sustainable position in its core business. Unlike Uber, Amazon encouraged an active public discussion of its business model in order to build credibility and support in the financial community. While many observers were uncertain about Amazon’s long term profit potential, and questioned specific practices, there was universal agreement that its ability to rapidly capture share from industry incumbents was based on legitimate competitive advantages.
Uber Has Not Been Exploiting Powerful “Sharing” or “On-Demand Economy” Efficiencies
Two of the primary narratives constructed to “explain” Uber’s growth were that it was pioneering the development of the “sharing economy” and the “on-demand economy.” Both narratives extrapolated wildly from claims that had no real-world economic basis, and that have never been successful exploited in any other setting.
The alleged basis of the “sharing economy” was that cars were only used 56 minutes a day on average, and that “ridesharing” companies like Uber were creating huge value by exploiting the 97% of the time when cars were idle.
This ignored the fact that the overwhelming majority of personal items had much lower utilization, and that “sharing” businesses had existed for decades but because personal ownership and control had huge value almost never expanded beyond tiny, obscure niches (tuxedos, bowling shoes), and in the rare cases with broader demand (car rentals) prices were always substantially greater than the comparable cost of direct ownership.
“Sharing economy” claims misrepresented a rare, marginal opportunity (borrowing otherwise idle garden tools from a neighbor) as something that could drive the economics of a global-scale industry. Yes, an isolated individual with a truck and a few hours of free time might be able to deliver a few packages at lower cost than the average UPS delivery van, but it is ludicrous to argue that independent truck drivers responding to delivery requests from a cellphone app in their spare time could drive UPS out of business and serve its entire national market at lower cost.
An individual with nothing else to do could decide to use his car to serve Uber passengers for a few hours on Saturday night, but Uber could never replace all existing taxi capacity nationwide with guys driving their personal cars for a few hours when it happened to fit their schedules. Serving the global car service market requires massive fleets of full time drivers and dedicated vehicles. Uber is no more a “ridesharing” company than United Airlines is a “planesharing” company.
Uber has always claimed it designed so that people could just “push a button and get a ride” and hundreds of other startups have pursued this “on-demand” model in other fields such as food delivery or office supplies. But the operational costs and challenges of taxi service (and delivery/logistical services) have been known for decades, including huge demand peaks, unplannable volatility (demand spikes when it rains), and empty backhauls.
Mitigating these costs requires advance knowledge of customer demand, and integrated, centralized operations planning. Package delivery companies can arrange trips to minimize unproductive backhaul mileage, and can shift lower priority deliveries to off-peak times. The instant gratification that “on-demand” services are supposed to provide make all these costs and challenges worse. Resource utilization plummets because more drivers and vehicles must stand by to serve the Saturday night peak, but driver assignments can’t be optimized because people who wanted to just “push a button and get a ride” wouldn’t book their trips in advance, and Uber’s business model eliminates the possibility of centralized operations planning.
For these reasons, none of Uber’s many attempts to expand into other “on-demand” services, such as UberEats, UberRush, UberFresh or UberEssentials have demonstrated any ability to expand outside of narrow niches, and none of the many other startups focused on “on-demand” services have become profitable, growing businesses. The basic economics of “on-demand” services—designed for a narrow set of customers willing to pay a premium for immediate service whenever they feel like it—are fundamentally incompatible with Uber’s goal of providing a major portion of urban transport infrastructure.
Uber Has Not Expanded the Market for Urban Car Services
Although nothing in Uber’s business model or actual financial results suggests either near-term profitability or the existence of major scale economies, Uber and its supporters regularly argue that its valuation is justified by its nearly unlimited growth potential. Bill Gurley, one of Uber’s original investors argued that using Uber would soon become cheaper than driving your own car—its market potential should not be based on the size of historic taxi demand but the size of the entire urban ground transportation market. But Gurley failed to disclose the magnitude of current losses and did not explain how Uber could ever produce taxi service as efficiently as current operators, much less how it cut costs to the point where its prices would be fully competitive with car ownership and transit services.
Uber’s Use of “Independent” Drivers Is Not an Innovation and Does Not Increase Efficiency
As discussed in the second installment of this series, the use of independent contractor drivers is not an Uber innovation, although Uber takes the longstanding practice a step further by shifting vehicle costs and capital risks onto its drivers.
Independent contracting transfers wealth from labor to capital but does not improve efficiency or service; when introduced in New York in the late 70s/early 80s fleet owner income increased on a per shift basis by 72%, while hourly driver take-home pay fell 23%. Independent contracting makes the integrated network revenue and capital asset management that is central to every other transport mode impossible. Independent contracting would destroy all airline, freight and transit networks since no one would show up to operate trips that were critical to network efficiency but had poor trip revenue.
Uber’s App Is Not a Powerful Technological Breakthrough
Many consumers seem to like Uber’s ordering/dispatching smartphone app, but it has not had any material impact on cost efficiency, and has not done nothing to help Uber’s huge corporate cost disadvantage. It offers some useful functionality, but since this software can be (and has been) easily replicated, it could not create a long-term advantage.
Hundreds of other consumer industries have migrated from telephone ordering to smartphone and internet ordering (pizza delivery, airline booking), but there is not a single case where this had any material impact on industry competition, much less created tens of billions of dollars in corporate value. The major emphasis on the app in pro-Uber articles appears to be symbolic; the app implies the existence of magically new “on-demand” efficiencies (just push a button and your car appears).
Highlighting the app also implies that Uber is a “technology company” that has completely “disrupted” industry economics, and is not simply a traditional company like Domino’s Pizza that is utilizing smartphone ordering. Needless to say, none of these articles are written by anyone with actual expertise in ecommerce or urban transportation, and none provide any evidence supporting the claim that the app represents breakthrough technology that gives Uber a powerful competitive advantage.
Uber’s Surge Pricing Does Not Increase Efficiency
Some Uber supporters have falsely claimed that its use of surge pricing is a major breakthrough comparable to variable pricing systems in airlines, hotels and other travel industries. From his 30 years in aviation, the author has extensive experience with how modern pricing tools can actually improve industry efficiency and consumer welfare. Uber’s Surge Pricing lacks most of the market information critical to the benefits these systems create, used extremely crude (if not arbitrary) decision rules, and cannot achieve comparable efficiency impacts because urban car service market dynamics are totally different.
A comprehensive discussion is not possible here, but because people buy airplane tickets and hotel rooms well in advance, and have complete information about all of the price/schedule options in the marketplace these systems allow demand from both highly price sensitive and highly service/schedule sensitive customers to be satisfied while dramatically reducing capacity and operating costs. Airlines avoid buying planes for everyone whose first inclination is to fly on Friday evenings, and can offer huge discounts to people with schedule flexibility.
But research has long demonstrated that the timing of taxi demand is highly inelastic, (people want a cab at a very specific time) so variable fares will not change demand patterns, improve taxi utilization or increase total revenue. All forms of urban transport have similarly inelastic demand; the Long Island Rail Road has had peak/off-peak pricing for a hundred years but rush hour is still rush hour. No level of taxi discount will get anyone to shift their Saturday night plans to midday Tuesday. Uber’s surge pricing simply raises fares (up to eight times normal levels) without prior warning. Given the short notice this does nothing to increase total taxi supply, but merely redistributes drivers to higher fare areas.
More importantly, Uber’s surge pricing reduces overall economic welfare because the sociological distribution of urban taxi demand is bipolar; 43% is from people earning less than $20,000 (and 55% from people earning less than $40,000), most of whom do not have cars while 35% is from people with incomes greater than $100,000. Studies show most of the lower-income demand is driven by jobs and services that cannot easily be reached by public transit, or trips at hours when public transit does not operate. Surge pricing reduces wait times for wealthier people returning home from restaurants and nightclubs by eliminating all service for lower income people working late night shifts that have no transit options. A pro-Uber paper by a major libertarian think tank simply dismissed these as “people who do not really need a ride.”
Uber Has Not Solved the Problems of Serving Peak Demand or Low-Density Neighborhoods
The market perception that Uber’s offers superior service quality is entirely explained by unsustainable subsidies that boosted driver compensation and car capacity far above the levels that could be justified by passenger fares. By offering compensation substantially above previous market levels, Uber could obviously offer more professional drivers and newer, cleaner vehicles. However, passengers were only paying 41% of the actual costs to provide this level of quality, and there is no evidence that taxi customers in a competitive market would pay more than twice as much for the service quality advantages Uber investors have been subsidizing.
No one can explain how this quality advantage can be sustained as Uber cuts wages, and more drivers figure out their true take home pay, after accounting for vehicle costs and capital risks.
The industry’s biggest service problems—limited and unreliable car availability when demand is highest (you can’t get a cab after dinner on Saturday night, or after your late evening arrival at LaGuardia, or when it is raining), and poor service to lower-density neighborhoods (including but not limited to low income neighborhoods) exist because the true cost of providing peak period and low-density neighborhood service is substantially higher than the fares taxi riders expect (or are willing) to pay and nothing in Uber’s business model reduces the cost of these services.
Every form of urban transport faces the problem of extreme demand peaks that are very expensive to serve; the taxi demand peak occurs in the evening, with especially extreme peaks on Friday and Saturday night. This is largely driven by (largely lower income) people working evening and night shifts when transit service is unavailable and people travelling to dining and entertainment venues.
The profitability of individual taxi trips varies widely depending on the associated empty backhaul costs, but taxi operators (including Uber) have no way to know the exact backhaul cost associated with each trip in advance, and no way to adjust fares in line with true incremental cost of each trip.
The true cost of an early morning airport trip (which will have an empty backhaul because no flights have arrived) is nearly double the cost of a later afternoon trip, when return fares are ready and waiting, but both trips are priced identically. The economic cost of trips to neighborhoods with low demand density (where backhauls are rare) will be much higher than trips within a city’s high demand core (downtown, shopping/entertainment districts, wealthier residential areas).
Taxi drivers struggling to make a living often refuse trips to these low-density neighborhoods, a problem that can be exacerbated by fear of crime and racial prejudice. If taxi companies set fares in line with true service costs, prices to low density neighborhoods would likely increase 50-100% and peak period prices would be 3-5 times normal levels. As noted, Uber’s surge pricing does not increase efficiency; it simply prices taxis out of the reach of many current users, reducing both total taxi demand and overall economic welfare.
Uber’s $69 Billion Valuation Has Not Been Driven by the Potential to Expand Into Other Markets
Claims that Uber’s huge valuation is justified by growth opportunities beyond the urban car service such as delivery services, carpooling, transit services and “driverless cars” ignore the massive subsidies current operations depend.
Without sustainable car service profitability, Uber cannot expand into other businesses with even lower margins and earn an adequate return on capital. As discussed earlier, many of these claims assume non-existent “on-demand” industry economies. Amazon could easily enter new markets because the digital and warehousing/distribution systems they had built for bookselling could be adapted to other retail markets at very low cost, but it did not move into them until the financial viability of its core business had been firmly established.
Uber has made “driverless cars” a top strategic priority in 2016, but there is no evidence that this drove its rapid valuation growth in prior years, and it is unclear why investors would wager billions on the prospect that it will eventually be able to design and build highly sophisticated vehicles more efficiently than competitors such as Google, Tesla, Toyota, Mercedes-Benz, Ford and General Motors. Additionally, all of these competitors can realize returns from investment in new software and manufacturing processes at each stage of development, while Uber gets no benefit until the (highly uncertain) point when maximum level of automation is achieved,  and the cost of drivers can be eliminated. Uber’s sudden, huge emphasis on the financial potential of cars without cars at some unspecified future date suggests it may want to distract attention from its inability to operate cars with drivers profitably.
Uber Has No Material Sources of Competitive Advantage That Would Allow It To Earn Sustainable Profits in a Competitive Market
Will the growth of Uber increase or decrease overall economic welfare?
The first post in this series laid out the P&L evidence of Uber’s staggering losses. Uber has grown because consumers have been choosing the company that only makes them pay 41% of the cost of their trip. There is no evidence that taxi customers in a competitive market would pay more than twice as much for the service quality advantages Uber investors have been subsidizing. Incumbent operators have been losing share and filing bankruptcy because they cannot compete with Silicon Valley billionaire owners willing to finance years of massive subsidies as they pursue industry dominance.
The second post laid out evidence of the cost structure of the urban car service industry in order to demonstrate that Uber was the industry’s high cost producer, with structurally uncompetitive costs, and none of the scale economies needed to grow into profitability.
This post reviewed a wide range of claims about potential sources of competitive advantage, and found that none were based on actual evidence of industry economics, and none of the claimed sources had ever had major competitive impacts in any other industry, or ever created tens of billions in corporate value. The findings from the three posts are entirely consistent with one another, and consistent with the conclusion that Uber could never generate sustainable profits in a competitive market.
The critical caveat here is “in a competitive market”. Uber’s investors did not put $13 billion into the company because they thought they could produce urban car service more efficiently that incumbents, and use those efficiencies to earn outsized profits under “level playing field” competitive conditions. Since Uber’s entry in 2010, the urban car service market has had the polar opposite of “level playing field” competitive conditions, with small scale incumbents with no access to capital struggling to cover their bare bone costs facing a behemoth company funded by Silicon Valley billionaires willing to subsidize years of multi-billion dollar loses.
Needless to say, Uber’s managers and investors are very smart people and have always been aware of Uber’s losses, structural cost disadvantage, and their lack of product/efficiency based competitive advantages. The next article in this series will discuss that Uber’s strategy for earning returns on its $13 billion investment was always based on eliminating both competition, and any regulatory/legal obstacles to the exploitation of anti-competitive market power.
 Stone, Brad, The Everything Store, Bay Back Books (2014)
 Griswold, Alison, It’s Time For Uber To Show It’s More Than Just A Glorified Taxi Company, Quartz, 4 Aug 2016. Lacy, Sara, The only Uber of anything is Uber, Pando Daily, 28 Jul 2015. Griffith, Erin, The problem with ‘Uber for X’, Fortune, Aug 2015
 “the introduction of Uber and Uber-style apps greatly increases the size of the world taxi market” Yglesias, Matthew, Why Uber just might be worth it at $18 billion, Vox , 7 Jun 2014. [since Uber and Lyft are in a] “vicious match for dominance across the globe, ride-sharing prices over all are sure to plummet” Manjoo, Farhad, With Uber, Less Reason to Own a Car, New York Times, 11 Jun 2014.
 Gurley, Bill, How to Miss By a Mile: An Alternative Look at Uber’s Potential Market Size, Above The Crowd, 11 Jul 2014.
 Schaller, Bruce, & Gilbert, Gorman, Villain or Bogeyman? New York’s Taxi Medallion System. Transportation Quarterly, 50(1) (1996).
 For basic descriptions of Surge Pricing by an Uber Board member and by an independent outsider see Gurley, Bill, A Deeper Look at Uber’s Dynamic Pricing Model. Above the Crowd, 11 Mar 2014. Chen, L., Mislove, A. & Wilson, C., Peeking Beneath the Hood of Uber, Proceedings of the 2015 ACM Conference on Internet Measurement Conference, 496 (Oct 2015).
 “the surge algorithm was made of crude heuristics” Efrati, Amir, Surge-Price Builder Leaves Uber, The Information, 17 Oct 2016
 In particular, the timing of demand is highly inelastic (people want a cab now, not later) and near-term demand is price inelastic within reasonable ranges. Fravel, F. D. & Gilbert, G., Fare Elasticities For Exclusive-Ride Taxi Services, report prepared for the Urban Mass Transit Administration, U.S. Department of Transportation, (1978); Shreiber, C., The Economic Reasons for Price and Entry Regulation of Taxicabs, Journal of Transport Economics and Policy, 268 (1975). Frankena, M.& Pautler, P., An Economic Analysis of Taxicab Regulation, Staff Report of the Bureau of Economics, Federal Trade Commission, 162-164 (1984); Schaller, Bruce, Elasticities for Taxicab Fares And Service Availability, Transportation, 26(3), 283-297 (1999).
 Diakopoulos, N., How Uber Surge Pricing Really Works, Washington Post Wonkblog, 17 Apr 2015.
 Schaller, Bruce, Taxi, Sedan and Limousine Industries and Regulations, prepared for the Committee for Review of Innovative Urban Mobility Services, Transportation Research Board, 3-5 (2015) at 8-11; Pucher, J., & Renne, J. L., Socioeconomics of Urban Travel: Evidence From the 2001 NHTS, Transportation Quarterly, 57(3), 49 (2003).
 Meyer, Jared, The Manhattan Institute, Uber-Positive: Why Americans Love the Sharing Economy, Encounter Books. Kindle Edition, 21 (2016)
 As with driver salaries, Uber has publicized “independent” analysis that claims that it provides better service in low-income neighborhoods than traditional taxis, but failed to explain how Uber could economically provide better service, and concealed the existence of the subsidies that did explain it. Alba, D., Uber Cheaper, Faster Than Taxis In Low-Income Neighborhoods, Wired 20 Jul 2015. http://www.wired.com/2015/07/uber-cheaper-faster-taxis-low-income-neighborhoods/
 If taxi companies provided drivers and fleets of vehicles that only operated during these 20-30 peak hours, peak fares would need to be high enough so that the vehicles could earn the same revenue as other vehicles operating 75-100 hours per week
 The National Highway Traffic Safety Administration established five stages of car automation, based on categories originally defined by the Society of Automotive Engineers. Taxis would require drivers in each stage prior to category five (“full automation”). Levels Of Driving Automation Are Defined In New SAE International Standard J3016