Where technology and economics collide
Uber’s next CEO will face several urgent problems, from a sexist workplace culture to a high-profile lawsuit against Google’s self-driving car company. But the biggest problem will be something more basic: The company loses billions of dollars every year.
Under Travis Kalanick, who stepped down as CEO on Tuesday, Uber pursued a “scorched earth” strategy, says Evan Rawley, a professor of business at Columbia University. In the United States, Uber has spent lavishly to prevent rival Lyft from gaining market share.
That spending was never sustainable. Last year, Uber lost $2.8 billion, financed by venture capitalists who are convinced that Uber will eventually become a hugely profitable behemoth akin to Google or Facebook.
But if investors start to doubt that Uber is on a path to profitability, they’ll shut their checkbooks. And the events of the past few weeks — a string of scandals culminating in Kalanick’s resignation — are exactly the kind of thing that’s likely to spook investors.
That means Uber’s next CEO is going to need to wean Uber from its dependence on venture capital money and reach profitability sooner than Kalanick envisioned.
And the first step to doing that will be to admit that Kalanick’s lofty vision for the company wasn’t realistic. Uber isn’t going to become a global taxi monopoly, and it’s probably not worth $68 billion, as investors thought when Uber last raised money in 2015.
Admitting that Uber is worth less than investors thought will be a big blow — especially because the promise of stock option-driven wealth has been one of Uber’s best recruitment tools. But it’s also essential for getting Uber on a sustainable path for the future.
Uber probably isn’t worth $68 billion
When a startup raises money, it negotiates on an estimate of the company’s value known as a valuation. This figure determines how much of the company investors get for each share they buy. In 2014 and 2015, investors poured money into Uber at higher and higher valuations: $18 billion in June 2014, $40 billion December 2014, $51 billion July 2015, and finally $68 billion in December 2015. In contrast, Lyft, which operates only in North America, was valued at just $7.5 billion in April 2017.
This means that Uber needs to wind up several times as large as Lyft to justify its huge market valuation. If Lyft becomes Pepsi to Uber’s Coke, that counts as a win for Lyft’s investors. But it would be a big blow for everyone who participated in the company’s last three fundraising rounds on the assumption that Uber was worth $40 billion or more.
And the problem goes beyond investors. Stock options have been a powerful tool to help Uber attract and retain the best employees. But options aren’t so attractive when a company’s stock price starts to fall. If employees start to doubt they’ll ever get a big payout, the most talented ones are more likely to leave for a rival company.
Uber has also been able to attract employees based on the idea that the company is inventing the future of transportation. Beyond ride-hailing, Uber is also working on self-driving cars and even flying cars. But stopping Uber’s losses may require companies to cut back spending on these projects. And that, in turn, will make Uber a less exciting place to work.
The danger for Uber, then, isn’t likely to be that it can’t turn a profit. The danger is that getting to profitability may require Uber to dramatically scale back its ambitions, which will hamper the company’s ability to raise new funds or recruit the best employees.
There’s a simple way for Uber to become profitable: raise prices
Once Uber does scale its ambitions back, however, reaching profitability should be fairly straightforward: The company just has to raise prices.
Uber connects drivers with passengers and takes a cut of around 20 percent. Drivers provide their own cars, so it actually costs Uber very little to provide rides to customers.
So then why is Uber losing so much money? The most important reason is that Uber is offering generous subsidies and incentives to both drivers and passengers. Drivers get bonuses for signing up and working longer hours, as well as being guaranteed minimum earnings at certain times. Uber has also offered passengers deeply discounted fares to encourage them to use the service more and to try out new offerings like UberPool.
Lyft, Uber’s main American rival, has been just as aggressive. Indeed, in some cases Lyft has announced fare cuts and prompted Uber to follow suit with fare cuts of its own. Because Uber has a lot more customers than Lyft in most American cities, these price wars have been a lot more expensive for Uber than for Lyft.
Uber has been using similar strategies internationally, using generous subsidies to gain market share against overseas rivals. In India, for example, Uber is the underdog in a competition with the homegrown ride-hailing service Ola.
So far, Uber and Lyft have been locked in a fierce price war that’s bad for both companies (though good for consumers). But Rawley believes that could change quickly.
Uber and Lyft, he says, offer “a premium service relative to taxicabs,” yet they often charge less than the taxicab would. “The only thing really keeping Uber and Lyft from charging a premium is that they’re afraid the other guy will beat them.” He believes that “Lyft would be very eager to raise prices” if Uber did it first.
The danger for Uber is that Lyft might instead keeps prices low and gain market share as a result. But it’s not obvious that this would be such a disaster for Uber. After all, as long as the companies are locked in a price war, a larger market share just means steeper losses. If Lyft is determined to make the ride-hailing market unprofitable, maybe Uber should just let Lyft have more of it.