The Ride Sharing Business: Playing Pundit by Aswath Damodaran, Musings On Markets
This is the third and final post in a series of three on the ride sharing business. In the first, I valued Uber and looked at the evolution of its business over the last 18 months. In the second, I valued Lyft and looked at pricing across ride sharing companies. In this one, I look at the future of the ride sharing business from the perspective of an outsider with no expertise in this business.
In my last two posts, I first valued Uber, with its expansive narrative, and then looked at putting numbers on Lyft’s less ambitious storyline. In my Uber post, I argued that the ride sharing market was proving to be bigger, broader and growing faster than I had estimated it would be in June 2014. In the Lyft post, I examined how VCs were pricing ride sharing companies. In this post, I want to complete the story by looking at the current state of the ride sharing market and for scenarios for the market over time, with consequences for investors, car riders and drivers.
The Ride Sharing Market: The State of the Game
In my posts on ride sharing, I noted that the ride sharing market has grown exponentially in the last two years, drawing in new users and redefining the car service business. That growth can be seen in multiple dimensions:
- Anecdotal & Qualitative evidence: I am usually wary about using anecdotal data but I have been keeping tabs on Uber usage in my travels and I have been amazed at the company’s global reach. This summer, I did seminars in São Paulo, Moscow and Mumbai, and in each venue, a significant proportion of the attendants had taken Uber to the event. In fact, my children talk about Ubering to destinations unknown, rather than taking a cab, just as xeroxing and googling became synonyms for copying and online searching.
- Operating metrics at ride sharing companies: The operating metrics at the ride sharing companies individually, and in the aggregate, back up the proposition that this is a high growth business.
|Company||Revenues in 2014||Revenues (2015)||Growth Rate (2015)|
- Investor expectations: The increases in the values attached to ride sharing companies indicate that investors are also scaling up expectations of future growth in this business. Using Uber’s estimated value of $51 billion in its most recent VC funding to illustrate the process, I estimated imputed revenues of $51.4 billion in 2026, which, if you hold its revenue slice share at 15% (my assumption) yields an imputed gross billing of $342.8 billion in 2026. If I repeat this exercise with the other ride sharing companies, the collective revenues being forecast by investors may exceed attainable revenues, an example of what I termed the big market delusion.
|Company||Estimated Value (Price)||Revenue Share||Operating Margin||Failure Probability||Imputed Revenue(2026)||Imputed Gross Billing (2026)|
The growth in ride sharing has been accompanied with more intense competition and rising costs, as can be seen in the large and growing operating losses reported by the companies in this business. The reasons for these losses are manifold, as I noted in my Uber post. Some of the costs come from intense competition for drivers and customers, with companies following the Field of Dreams model, that Amazon has used to such effect in the last decade. Some costs come from outside, higher insurance costs and employee expenses, as ride sharing companies go from being fringe players to larger businesses. Some costs flow from legal fights with regulators, licensing agencies and other rule-writers, whose desire to control the business clashes with the market-driven imperatives of ride sharing. The optimistic view is that these costs will become smaller as companies scale up, but will they? As revenues scale up, the number of drivers will increase proportionately, and unless the competition disappears, the costs of fighting for drivers and customers will continue. In brief, the existing ride sharing model looks like a long term money loser, unless something fundamental changes.
At the risk of playing market prognosticator in a market where I am a novice, I see four possible scenarios that can unfold in this market, all possible, but perhaps not equally probable.
- Winner-takes-all: The big prize in many technology businesses is that there is a tipping point, where the winner ends up capturing much of the market. That is the template that Microsoft used two decades ago with MS Office to capture the business software business and that Google used to scale the heights of online advertising. The payoff to such a strategy is that you not only control the dominant market share but that you get pricing power (and higher profits). It does seem to be the strategy that Uber is following in the ride sharing business, but there remain three road blocks that may get in the way. First, you have to remove your competitors from the playing field and while Uber had the cash buffer and capital raising upper hand last year, that advantage has narrowed as a result of partnerships and new capital flowing into other ride sharing companies. In a perverse way, Uber’s best chance of succeeding at this strategy is if there is a hitch or stop in the flow of capital to tech companies, though that may work against its objective of going public in the near future. Second, you have to navigate your way through the anti trust and monopoly questions that will inevitably follow, not an easy or an inexpensive task, as Google and Microsoft have discovered over the last decade. Third, while technology remains a focal point for ride sharing companies, the car service or logistics business needs physical infrastructure, making it more difficult to preserve global networking benefits.
- The Losers’ Game: While the winner-take-all is alluring, its logical conclusion, if you have multiple players pursuing it, and none winning, is that you can make the business a loser’s game, one in which the market grows as promised and companies generate high revenues, but make very little in profits. A big business can sometimes be a bad one, as I noted in this post on bad businesses and why companies in these businesses continue to invest and grow in them.
- The Divide and Rule Game: As the old colonial empires discovered a few centuries ago, and the Sicilian crime families realized in the late 1920s in the United States, the most profitable end game, when competition is cut-throat (literally), is to negotiate a truce, where the spoils are divided up and each competitor is given control of a segment. In the ride sharing market, if the business boils down to two or three large players, they may be able carve up the global market and each player will get a free run in their carved up portion . This will be, of course, terrible news for drivers and customers and may attract regulatory or legal scrutiny, but for investors collectively, it will be most value-adding scenario. There are two potential weak links. The first is that this truce, by its very nature, will not be a friendly one and small violations can lead to it unraveling. The second is that it rests on the premise that there is no outside party that is powerful enough to step in and take advantage of the soft spots in the market.
- The Game Changer: I believe that the existing ride sharing model is an unstable one. As I argued in my post on Uber, the very strengths of the models (bare bones infrastructure, drivers as independent contracts and no car ownership) makes it unsustainable in the long term, since ride sharing companies have to compete for drivers on a continuous basis, offering them incentives to switch from competitors, and customers, with special deals. It is therefore likely that a new model will emerge, though it remains an open question of whether it will come from one of the players in the game, or from an outsider. Thus, Uber’s hiring of robotics engineers may be a precursor of a different ride sharing game, with driverless cars and infrastructure investments, or it may be Google or Tesla who enter the picture with a different way of operating this business.
If these scenarios remind you a little little of the prisoner’s dilemma, where two rational individuals are given a choice between cooperating and competing, there are parallels. Consider one possible version, where the ride sharing companies globally boil down to two competitors: Uber, as a global ride sharing behemoth, and the Not-Uber, an alliance of national ride ride sharing companies (Ola+Didi Kuaidi + GrabTaxi + Lyft..). The box below captures the possible outcomes of this game, which will get infinitely more complicated if there is an outsider player lurking on the fringes.
Based on my very limited knowledge of the companies in this space, I would give the highest odds to the ride sharing business becoming a loser’s game, attach about equal probabilities to it becoming a winner-take-all or a game changer emerging, and see the least chance that the ride sharing companies will collude to maximize profits and value. There are others, who know more about this business than I do, who see this game evolving differently over time. Mark Shurtleff at Green Wheels Mobility Solutions, the ride sharing expert that I referenced in my last post thinks that I am being too pessimistic on some counts and perhaps too optimistic on others and feels that there are small start ups that are finding a better business model than the big players. There are some who believe that I am underestimating the pull of the familiar and that ride sharing companies, once established, will be difficult to displace.
The Dance of the Disrupted
In a post from a few months ago, I looked at the the dark side of disruption, i.e., the businesses being disrupted, both with the intent of identifying the businesses most at risk and to look at the stages, at least as I see them, of how the disrupted business deal with the chaos of seeing established business models being upended. Using that five stage process, it seems to me that the taxi cab business is now at an advanced stage:
|Stage of disruption||The Taxi Cab Business|
|1. Denial and Delusion||This is long in the past, but in the first year or two of Uber’s existence, there were many in the conventional car service and taxi cab businesses, who were convinced that not only was this a passing phase, but that no customer in his right mind would want to miss the comfort, convenience and safety of a yellow cab experience. (Irony alert!)|
|2. Failure and False Hope||With each misstep by a ride sharing company (and Uber in particular), whether it be an employee with a loose tongue or a assault by an Uber driver, the hope that this misstep will put an end to the ride sharing business rises among taxi operators and regulators. However, only the most delusional among these hold on this hope.|
|3. Imitation and Institutional Inertia||In the mistaken belief that all that separates the ride sharing companies from conventional car service is an app, taxi operators have turned to putting apps in the hands of drivers and customers. At the same time, any attempts to introduce flexibility into the existing car service business are fought by politicians, regulators and some of the operators who benefit from the current structure.|
|4. Regulation, Rule Rigging and Legal Challenges||This seems to be the place where car service companies are making their stand, aided and abetted by regulators, courts and politics. By restricting or even banning ride sharing, they are slowing it’s growth but as I see it, the fight is on its way to being lost, since it is the customers who ultimately will determine the winner in this game, and they are voting with their dollars.|
|5. Acceptance and Adjustment||It may be slow in coming, but a portion of the conventional car service business is adjusting to the new reality, sometimes because they realize that it is a fight that is unwinnable and sometimes because the financial hill is getting steeper to climb. This is especially true for cab operators who have borrowed much or most of the money that they used to buy medallions and are discovering that they cannot pay their debt.|
So what does the future hold? Will there be no taxi cabs left on the streets of New York, London and Tokyo in a few years? I think that the taxi cab business will shrink, but not disappear, and that it will retain a portion of its business in those public spaces where regulators have the most say, airports, train stations and public arenas. If this is the future, it is also clear that there is more pain to come and it will take the form of continuing decline in taxi cab revenues and market capitalization at these companies. As for the private car service business, it will either adapt and share revenues with the ride sharing companies (which still needs cars and drivers) or focus on corporate relationships (offering discounted and on-demand services to companies that do not want their employees using multiple ride sharing services).
Coming soon to a business near you?
As I watch the traditional taxi cab business flailing and ride sharing companies grow at their expense, and am tempted to pass judgment on the inability of those in the business to adapt to the world that they live in, there are two general lessons that come to mind. From the disruptor’s standpoint, I think that the success of Uber and its peer group in changing the car service business is a reminder that existing business models can be disrupted in short order by new technologies, but the collective losses reported by these companies are also a reminder that making money on disruption is much more difficult.
Looking at the same process from the perspective of the disrupted, it is a reminder that the pain inflicted on the car service business could very easily be coming to the business that you are in. If you are in the financial services business, the entertainment business or the health care business, all of which are deserving of disruption, I wonder whether you would react any more rationally than the London cabdrivers who went on strike to stop Uber, and ended up getting many of their customers to try Uber for the very first time. I operate in the education business, a large and extraordinarily inefficient business, and there is no group more resistant to change and more unprepared to adapt than tenured professors at research university. I cannot wait to see this group, convinced of its intellectual superiority and attached to unreal perks (minuscule teaching loads, research assistants and sabbaticals), go through the throes of disruption.
Ride Sharing Series (September 2015)
- On the Uber Rollercoaster: Narrative Tweaks, Twists and Turns
- Dream Big or Stay Focused? The Lyft Answer!
- The Future of Ride Sharing: Playing Pundit