Mythbusting Uber’s valuation

Uber, the ride hailing app, is the archetypal billion dollar unicorn.

How it’s managed to convince investors it’s worth $62.5bn, however, is the real mystery, given its model is arguably neither innovative or viable.

Put bluntly, what Uber has really managed to do is persuade the world a smart and efficient urban transport system geared towards mass transit — within which taxis cater to the marginal client that’s prepared to pay a premium for an occasional chauffeur-driven ride — can be transformed into a much less economical one, without any commensurate costs being passed on to anyone, whilst somehow also accommodating investor returns.

The key innovations the company has deployed, meanwhile, to convince investors that’s possible have been anything but technological.

To the contrary, they’ve been based on the good old fashioned exploitation of suppliers, notably the paying of (below-cost) earnings to taxi drivers as well as the transfer of investor money directly to customers in the form of subsidies. Crucially, they’ve also been based on transference of risk from its own corporate balance sheet to those of its suppliers, most of whom lack the economies of scale or expertise to absorb those risks as efficiently.

Investors, for some inexplicable reason, have failed to see this.

If Uber is cheap it is not because it has out innovated the incumbent cab market, which at the end of the day has access to exactly the same ride-hailing technology. To the contrary, it’s because investors have failed to recognise that the source of its greatest innovations is and always has been cheap money.

Indeed, from egregious undercutting tactics based on promotional giveaways to turning a blind eye to exploitative labour practices thanks to the cheap funding of aggressive lobbying campaigns aimed at changing legal frameworks or the reckless flooding of the market with huge amounts of spare capacity, none of it would be possible without access to cheap financing.

In this way, investors preoccupied with FOMO seem to have missed that for a bespoke chauffeur driven service to be readily available to anyone 24/7 at a price that is competitive with public transport, the ratio of spare drivers to potential riders at peak times must be 1:1. Extend that logic to off-peak times and you realise that for every potential user there must be a score of drivers or more sitting idly in standby mode to accommodate that luxury. Unless every single one of those drivers has a secondary job that doesn’t require any real commitment, that’s tantamount to the re-establishment of an upstairs downstairs server-master model, afforded by subsistence wages on labour’s part.

In a conventional taxi model, of course, prices are smoothed throughout the day to ensure off-peak rates pay for peak services at affordable rates — hence why there are never any taxis around when you need them. You could also say, we all pay a little more at off-peak time to ensure desperate users don’t get gouged at peak time and that as a whole we’re all incentivised to make more responsible and efficient travel arrangements for our day-to-day travel.

In Uber’s model, however, it’s the exact opposite. Overcharging at peak time funds idle capacity at off-peak time, ensuring that whilst there’s always a taxi when you need one, there’s also a substantially larger amount of spare capacity when you don’t.

That’s an incentive model which might make sense for wooing unconscious or inanimate spare capacity back into marginal operation, but not necessarily one for the conscious sort, whose long-term security and welfare is supposed to be the actual objective of technological innovation.

So how has this happened?

BCA’s Brian Piccioni and Paul Kantorovich had a stab at some of the causes of the insanity in a report out at the end of August.

As they noted, unlike many other unicorns, Uber’s business model is frighteningly simple and highly replicable. The $62.5bn valuation can’t consequently be a reflection of that. Perhaps then it’s about something altogether different? Regulatory arbitrage perhaps?

That may be the case, but there are consequences to regulatory arbitrage, say Piccioni and Kantorovich. For one thing, regulation affects all players in the long run equally, so even though Uber has done the bulk of the heavy lifting on the legal cost side, the overall effect is still one that has seen the value of a taxi medallion in New York City drop by 50 per cent. There is also absolutely nothing preventing other companies from replicating its model or stealing market share with the use of even more egregious promotional tactics funded by profligate investors.

So perhaps it’s about brand? By using Uber in an unfamiliar city, customers can be sure they know what they’re getting at a price that’s not exploiting their lack of local knowledge.

Piccioni and Kantorovich say that doesn’t really cut it either. Most cab rides are made by local people, and a local version of Uber is sufficient. It would not in their opinion take much for a company to set up shop as a sort of clearing house of taxi apps, a la Expedia.

So perhaps autonomous cars will be the ultimate moat building exercise for Uber?

Again here, there are issues. As Piccioni and Kantorovich note, Uber has literally zero experience managing an asset-heavy business with large capital and maintenance costs, and significant liability exposure. Nor is Uber the one doing the innovation, so they will always have rent someone else’s technology:

We believe it is highly unlikely a non-car company such as Uber will become a leader in AV technology, despite their partnership with Volvo. Even though Uber has been able to raise an unprecedented amount of money for a private company, they do not have the financial resources to directly compete with Google in developing AV technology while losing money on their main business.

So perhaps it’s about the profitability of the underlying sector?

Again no. As Piccioni and Kantorovich say, the provision of taxi services is not an intrinsically profitable undertaking. Most adults have a driver’s license, many own cars, and modern GPS systems mean drivers do not even have to acquire an encyclopedic knowledge of streets, routes and points of interest:

To the extent the taxi business was profitable, it was mainly profitable for wealthy permit holders who leased out their permits to drivers who earned modest incomes. If those permits disappear the artificial barrier to entry disappears and the returns on the business will plummet – as can be expected.

To all extents and purposes Uber’s technology is banal, barriers to entry are negligible and unionisation/legal risk is substantial. Piccioni and Kantorovich conclude the valuations being ascribed by venture capital funds are indeed fantastical, and predicated mostly on what the shares might sell for if the company were sold or taken public. But, as they note, few companies have $69bn to spend and fewer still would spend it on a car service. What’s more, given that the enterprise value of Southwest Airlines, one of the best run airlines in the world, is about $23bn, it seems unlikely to them that Uber is worth any more than a small fraction of that figure in an IPO.

Ultimately Uber’s success comes down to convincing the world that it has made a progressive leap by allocating cheap human resources towards the job of waiting around at the beck and call of an increasingly powerful elite.

From an aggregate economic allocation and welfare point of view that’s an obviously nuts proposition. What it amounts to is a transfer of labour from high productivity sectors to ultra low productivity sectors on the assumption that if this workforce is given autonomy over their non-productive time they can deploy it more efficiently in the market than if it was being allocated by a scaled-up specialist operator.

Since that, by definition, inhibits specialisation or skill acquisition in labour markets, all it really encourages is the purposeful unscaling of the economy and thus the entrenchment of a suppressed, underpaid, servant class with no prospect to ever benefit from a consumer surplus.

Related links:
Why Uber’s capital costs will creep ever higher - FT Alphaville
If and when Uber drivers unionise… - FT Alphaville
‘This house proposes that we nationalise Uber’ – The Long and Short
Leigh Day Legal Action For GMB Uber Drivers To Secure Rights On Pay, Holidays, Health And Safety, Discipline And Grievances – GMB, July 2015

Copyright The Financial Times Limited 2019. All rights reserved. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

Read next:

Read next:

Lookout, there’s a dollar crunch!

FT Alpha Tweets