Uber: The Road Not Taken

Uber: The Road Not Taken

Why Uber’s business model keeps bleeding money—and how it might yet right itself as a useful but less grandiose venture

January 30, 2017

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Uber, the wildly popular ride-sharing company, now hopes to pioneer both self-driving and self-flying vehicles. But long before Uber gets to that futuristic strategy, the company’s core business model appears to be in serious trouble.  

There are other roads that Uber might take, ones that could combine the company’s innovative ride-hailing technology with practical solutions to urban congestion and decent driver pay. But Uber and its grandiose CEO Travis Kalanick seem more interested in pursuing mega-profits and mega-gambles.

Over the past year, even as its valuation has soared to $69 billion—now greater than Ford, GM, or Tesla—Uber has been losing money at a rate that some tech analysts say is faster than any technology company ever. The company lost “significantly more” than $2.2 billion in the first nine months of 2016, and more than $800 million in the third quarter alone, according to Bloomberg’s Eric Newcomer.

The primary reason is that Uber is charging too little for passenger rides. In its price war with traditional taxi companies and its chief ride-sharing competitor Lyft, Uber is heavily subsidizing each ride with its own venture capital funders’ money.

Transportation industry expert Hubert Horan analyzed what he called “Uber’s bleak operating expenses,” finding that Uber passengers have been “paying only 41 percent of the actual cost of their trips.” So an Uber passenger isn’t paying even half the cost of that ride. “That’s a subsidy greater than what public transit systems receive,” according to transportation reporter Ryan Felton. Bloomberg reports that these passenger subsidies comprise the majority of Uber’s losses.

Can this company eventually become profitable? Nobody really knows, but already some of the boosters and experts in autonomous vehicles are starting to walk back their previously optimistic timelines, saying that self-driving vehicles will not appear in widespread circulation for decades. So if investors are hoping Uber will improve its bottom line by deleting drivers from its expense sheet, they likely will have a long wait indeed.  

Pivoting for Uber’s life

To understand why Uber is in trouble, you have to understand something about how Silicon Valley operates. Frequently one hears the word “pivot” tossed around the valley; that’s a sugarcoated way to say that a company’s business model is struggling to earn enough revenue to reach profitability, and is burning through the venture capital funding that gives it life.

If the VCs get spooked and start pulling back on their investment, that company is toast. That forces the CEO to pivot—change strategy to reassure the VC investors and keep their subsidies flowing. In the back of everyone’s mind is the whispered secret that three out of four Silicon Valley startups fail, and nine out of 10 never earn a profit.

Dllu/Creative Commons

Uber self-driving car testing in San Francisco. 

Over the last few years, one can see numerous examples of Uber pivots that have led to one dead end after another. “Many other tech startups lost money as they pursued growth and market share, but losses of this magnitude are unprecedented,” according to Horan. In its worst-ever four quarters, Amazon lost money at just a third of the rate of Uber; and at this point in Facebook’s trajectory, six years following its launch, it was achieving over 25 percent profit margins.

Pivot #1: On-demand delivery of food and packages. Since subsidizing its passengers’ rides has turned out to be such a financial sinkhole, Kalanick has sought ways to squeeze more revenue out of each driver’s car. Uber has created two services, UberEats and UberRush, to deliver food and packages in between passenger pickups.

The problem is that this is a very competitive market with low profit margins. Established players like FedEx and UPS, and newcomers like Postmates, GrubHub, Deliveroo, and Instacart, crowd the field. Moreover, Uber drivers avoid these services because they earn peanuts for a lot of hassle and long (mostly unpaid) wait times when picking up the food or package. Many customers have found the quality of service to be lacking. Uber of course says the reaction has been “overwhelmingly positive.” But the bottom line is that there’s not a lot of profit to wring out of delivering an $8 burrito.

Pivot #2: Packing in more passengers via UberPool. Uber has also tried to figure out how to stuff more passengers into the same vehicle. The company’s latest strategy is UberPool, as in carpool, which allows its drivers to pick up multiple passengers who share part of the same ride in serial fashion for a lower fare (much like a commercial airport shuttle).  

But it turns out driving passenger after passenger is a real grind for drivers. Christian Perea, a longtime Uber and Lyft driver says, “Drivers end up doing a lot more work for the money.” As people get added into your ride or cancel along the way, he says, “it becomes frustrating having to change direction every few minutes while constantly checking your phone while in traffic. It’s honestly kind of a safety hazard.” Drivers say they burn more fuel hauling more weight, which adds more wear and tear on their vehicles and increases their costs, as well as their insurance risk if there is an accident. Driver-support websites like UberPeople.net and various Facebook groups have lit up with drivers’ complaints saying that UberPool is not worth the hassle and stress, and a recent survey found that only 13 percent of drivers are satisfied with their UberPool experience. Passengers get frustrated too, especially when the first passenger picked up ends up being dropped off third or fourth. The service is failing to win over either passengers or drivers, or significantly improve Uber’s bottom line.

Pivot #3. China Syndrome and other foreign misadventures. Uber lost an additional $2 billion during its short two-year stint in the land of capitalist-communism. In both March and June 2016, Kalanick launched media publicity blitzes, proclaiming his company’s success in China, spinning out his upbeat assessment. The Financial Times published an article with the bubbly subtitle “Ride-hailing app expands aggressively in China, now its biggest market.”

Less than two months later, Uber pulled out of China. It was losing money and market share so fast to its Chinese competitor Didi Chuxing that it had no choice.

But China isn’t the only place where Uber has been picking losing battles. In Europe, Kalanick thought he could get away with using unlicensed drivers, and generally mow over regulators and trample the transportation laws and cultural values in Germany and other member states. It didn’t go over well. Most Europeans now regard Uber as the latest example of cowboy capitalism, and never bought Uber’s story that it is a “technology company” and so shouldn’t be subject to traditional taxi laws. Many countries have outright banned Uber, which has appealed to the European Court of Justice where it’s hoping for regulatory relief. But even if that happens, unlike in the taxi-poor U.S., taxi service has been good enough in most European cities to leave Uber with fewer opportunities.

Uber also has invested at least a billion dollars into India, but with mixed success as its main competitor, the Indian ridesharing company Ola, has much greater market share and is available in three times as many cities

Pivot #4. Settling Uber drivers’ lawsuits. Uber has always insisted that its drivers are independent contractors and not employees, and that it would vigorously contest any lawsuits by drivers, or rulings by regulators, making any claims to the contrary. Yet last April Uber abruptly agreed to pay $80-100 million to settle a class-action lawsuit by 300,000 drivers in California and Massachusetts who claimed that they are Uber employees and thus entitled to reimbursement for driving expenses.

It was surprising that Uber suddenly backed down from its original aggressive posture, but if it had lost the lawsuit, that would have completely overturned its business model, pushing its expenses into the stratosphere because Uber would become responsible for its drivers’ safety-net costs as well as driving expenses. That in turn would have sent the VC investors running for the escape hatches. A couple of previous rulings on the “contractor vs. employee question” already had gone the wrong way for Uber.

So to put off that day of reckoning, Uber abruptly settled. Yet the relief was short-lived because a few months later federal Judge Edward Chen tossed out the settlement as being “not fair, adequate, and reasonable” for the drivers. The attorneys on both sides are still trying to negotiate a settlement that might satisfy the judge.

Imaginechina via AP Images

Despite the media fanfare that accompanied its launch in China in 2016, Uber was forced to pull out after just two months. Here, a pedestrian walks past an Uber service station in Wuhan, Hubei province. 

Meanwhile Uber recently lost similar cases in the U.K., which is one of its top overseas markets and Switzerland. The U.K. judge harshly criticized Uber’s defense of its labor practices for its “fictions and twisted language," and dismissed its core arguments as “faintly ridiculous.” Uber is appealing both cases, and if it loses the company’s labor costs will rise significantly. The company is fighting more than 70 federal lawsuits in U.S. courts, all of which are expensive and a permanent drain on its bottom line.

Four pivots, four wrong directions … none of them bringing Uber to profitability. But here’s the final dagger in Uber’s future. It’s not just that CEO Kalanick has made some terrible strategic decisions. As Horan astutely points out, Uber’s biggest problem is the very nature of the business it has chosen to “revolutionize”—being a taxi company.

Unfortunately for Uber, built into that industry are certain physical realities and costs that ensure that the profit margins will always remain fairly low. Previous digital success stories like Amazon, EBay, Google, and Facebook could scale rapidly and eventually achieve profitability because the marginal cost of expanding their operations over the internet was relatively small. Amazon saved a ton of money by using its website to get rid of expensive brick-and-mortal retail stores and sales clerks, and then leveraging those savings for market advantage.

In contrast, Uber is toiling in the steel and cement world of the taxi industry. Horan writes that “in the hundred years since the first motorized taxi, there has been no evidence of significant scale economies in the urban car service industry.” Drivers, vehicles, and fuel comprise 85 percent of livery service costs, none of which decline significantly as companies grow. So there isn’t much room for Uber to find some new kind of efficiencies that would allow it to drive down unit costs and outcompete its rivals, leaving shaky strategies like paying drivers less and subsidizing rides with VC money to offer lower fares.

Uber’s chief ridesharing competitor Lyft has not figured out the magic formula either. Lyft was tagged with a staggering $600 million loss in 2016 because it has matched Uber’s fare cuts and also subsidized passenger fares. So the massive losses for both Uber and Lyft appear to be endemic to the ride-sharing industry, and not likely fixable unless the companies drastically raise their fares.

Making Uber’s situation even more precarious, Kalanick’s drive to cut costs has alienated one of his most important assets—his drivers. By regularly slashing wages, including three years in a row, Uber is burning through its drivers as fast as its venture capital subsidies. Uber’s own internal numbers, as revealed in a report coauthored by Princeton economist Alan Krueger, show that about half of its drivers last only a year on the platform, clearly an unsustainable burn rate.

Thus Travis Kalanick’s core problem: He picked the wrong industry to disrupt. This explains Kalanick’s most grandiose pivot and biggest gamble to date—his attempt to cut his driver costs by deleting the drivers themselves, via self-driving vehicles. But this may be another massive gamble that he cannot win, at least not in time to save Uber.

A gamble bigger than China: self-driving cars

The crash last May in Florida of a Tesla self-driving vehicle killing its driver, and another Tesla self-driving crash in China earlier in the year, spotlighted doubts about the autonomous driving technology, a concern already raised by transportation experts.

Uber launched its own self-driving experiment in Pittsburgh last September, as a carefully orchestrated publicity stunt to maximize national media impact. But more than anything, it showed that autonomous vehicles are still pretty clunky contraptions that are nowhere near ready for prime time.

An Uber employee had to remain behind the steering wheel at all times, loosely gripping the wheel, as alert as an actual driver and ready to intervene. And as journalists riding in the vehicles from The New York Times, USA Today, and others reported, often the drivers had to take back control from the algorithms. One rider reported that the human had to commandeer control at least 30 percent of the time.

Heisenberg Media/Creative Commons

Uber CEO Travis Kalanick in Paris. 

The self-driving cars couldn’t pass on the left, even to move around a truck blocking the right lane. They couldn’t make right turns at red lights, since the algorithms can’t edge forward and scan for traffic (which frustrated the heck out of waiting human drivers). The cars also drove sluggishly, but despite crawling along some of the vehicles still got into various scrapes and fender benders, and one drove the wrong way down a one-way street (Uber disputes whether the algorithms or human drivers caused the mishaps).

In a brief San Francisco experiment with self-driving cars in December, a number of other problems emerged. Besides cutting off bicyclists in bike lanes and clogging up traffic with their slow pace, at least two cars ran red lights. One of these was captured infamously by a dashboard video camera on a taxi, which went viral on the internet. The other red light runner accelerated into an intersection and nearly caused a collision.

Certainly, it is a technological marvel that self-driving vehicles perform as well as they do. But the current state-of-the-art is woefully inadequate, as many experts increasingly acknowledge. Imagine what could potentially happen if Uber unleashed millions of these sorts of cars all over the streets, as Travis Kalanick has proposed?

There are simply too many thousands of decisions that drivers have to make, every minute of every single day, that are devilishly difficult to program into the algorithms. Beyond the actual technology, daunting questions remain about liability and responsibility when something goes wrong. Who is liable—the algorithm, the programmer of the algorithm, the regulator that approved the algorithm, the insurer that insured the algorithm, the owner of the vehicle—or all of the above? The ensuing legal mess will be a full employment act for lawyers.

For all of these reasons, other companies working on self-driving vehicles, and which are not so invested in media stunts as a way to reassure venture capital funders, offer a drastically more cautious take on the future pace of development.

Bradley Stertz, a manager for Audi, says a fully automated vehicle with no driver is still 20 or 30 years away. “To have the car understand every single possibility is a massive challenge,” he says. Gill Pratt, CEO of the Toyota Research Institute, told an audience at the Consumer Electronics Show in early January 2017 that, “None of us in the automobile or IT industries are close to achieving true Level 5 autonomy. We are not even close.” Level 5 is an industry term for cars that are fully autonomous and do not require human supervision. The technology needs to be foolproof before thousands of vehicles can be allowed on the streets, but this technology is nowhere near that standard.

Self-driving vehicles potentially have a future in those transportation situations where the travel path is clear and simple, and there are few quick decisions to be made—autopilot in airplanes is already in widespread use, for example, since the skies are uncluttered and split-second decisions are not a normal occurrence. Even so, planes have two human pilots who can take back control on a moment’s notice.

Long-distance truck driving is another situation with potential, since driving on an interstate is much simpler and less congested, requiring fewer quick decisions. Recently Uber purchased Otto, a company that specializes in self-driving tractor-trailer trucks.

But for Kalanick, self-driving vehicles are just a step toward the ultimate goal. He is betting his VCs’ money on another colossal gamble—a self-driving, autonomous transportation grid of the future. That grid would be composed of a massive (and expensive) infrastructure in which we would all ditch our own private vehicles and transportation will be powered by fleets of driverless vehicles. The streets of the future would teem with lines of cars humming along in assembly-line sync, three to four feet apart, and on highways zipping along at 60 to 70 mph like private train cars. The scale of the change being proposed is so enormous that it is extremely unlikely that one company could ever pull it off alone.

To realize this dream, significant involvement and investment from the government would be necessary, which turns it into a political issue based on what society needs and values. Let’s not forget that, while the Big Three auto companies mass produced millions of automobiles in the 1950s and created an enormous industry, it was the government that paid for and built the interstate highways and local roadways. Without that infrastructure, there would have been no auto industry.

Given the right conditions, certain self-driving vehicles might have a future. But on the mayhem of city streets? That doesn’t seem realistic anytime soon. Uber’s chief competitor Lyft already has tried to bail from this chess game, recently offering itself to the likes of Apple, GM, Google, and even Uber. But no one would cough up the $9 billion asking price. So Lyft soldiers on, cranking up its own hype machine with a sudden recent pronouncement that algorithms will pilot its cars within five years (if Lyft is still in business).

Kalanick himself portrays the stakes in stark terms. “If we don’t get the [autonomous car] software thing nailed, we’re not going to be around much longer,” he told USA Today. Kalanick’s roll of the dice on automated cars is starting to look like another big gamble he can’t possibly win, and certainly not any time soon. Realistically, we are looking at decades of development. In the meantime, with this company bleeding money, Uber’s own survival is in question.

How Uber could be part of the solution

With the right kind of management and smaller ambitions, Uber might find it could survive as a livery service for the digital age. Running “only” a taxi company may not seem as sexy as raising up a transportation revolution, but it is an honorable business that many people depend upon. It has the potential to be a decent business for customers, drivers, and investors. In that vein, here are several suggestions for Uber:

1) While various transportation experts in San Francisco, London, New York City, and elsewhere maintain that Uber’s flooding of cities with tens of thousands of vehicles has contributed greatly to increased traffic congestion, its tracking technology could be used as part of the solution.

Our streets are a public utility that must be shared among all the different sectors. So the Uber technology could be deployed to track the many different types of vehicles on the road today, and to create congestion zones like in London and Stockholm that reduce traffic in downtown cores. But Uber would likely have to be willing to accept a limit on the number of its cars on the road at any one time, especially during rush hour.

2) Also, Uber has said that it wants to be the “last mile” option for riders, transporting them from the end of the public transit line to their homes. But that goal is antithetical to the interests of its drivers, who don’t earn much money on short rides and prefer longer fares. Why not take the time to figure this out with his “driver-partners,” as Kalanick likes to call them, and find a win-win scenario? Uber might find that its driver-partners actually have a lot of great tips about how to improve the service.

3) Why not embrace the creation of a “portable safety net” for Uber drivers, so that they don’t have to trade the employment flexibility that they desire for the health care and social security that they need?

The sooner Kalanick recognizes the real potential of the business he has in hand, and quits chasing quixotic chimeras to charm venture capitalists, the greater his company’s chance of survival. To reach modest profitability, Uber would have to stop subsidizing its passengers and allow its fares to rise, finding that sweet spot in the price point between true supply and demand.

There’s no question that this app-driven service is impressively clever and convenient. Passengers might be willing to pay more to use it. With the right kind of management and less grandiose aspirations, Uber could find a lot of opportunity within these limitations.

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