The sharing economy: Ridesharing business model

The sharing economy: Ridesharing business model

Phuah Eng Chye (14 October 2017)

Sharing is not new. It is a form of barter and social cooperation prevalent in ancient and agricultural communities. More recent equivalents are time barter and cooperatives and the definition could also be extended to cover unlicensed part time operators (informal taxis, bed and breakfast). But sharing activities in the past was manual, small and slow. Improvements in information capabilities has massively expanded the organisational scale of sharing.

Juliet Schor highlights the uniqueness of information-driven sharing in mobilising “technology, markets, and the wisdom of crowds to bring strangers together” to “reduce transactions costs, create opportunities in real time, and crowdsource information.” The marvel is that “stranger sharing entails higher degrees of risk, and many of today’s exchanges are quite intimate – sharing one’s home or car, going into strangers’ homes to do work, or eating food prepared by unknown cooks.”

To understanding why sharing spread so quickly, it is useful to analyse the exponential growth of ridesharing services. The insights below are sourced from Bill Gurley.

  • Visibility and pick-up times. Ridesharing companies provide customers visibility on the location of their taxies and predict pick-up times. Reducing pick-up times increases reliability and expands potential use. There is a virtuous cycle between faster pick-up times and service expansion.
  • Utilization. Ridesharing increases utilization or the amount of time a driver has a paying ride per hour. Due to the high price elasticity, rising utilisation allow drivers to lower their rates which leads to an even larger increase in demand.
  • Coverage density. Ridesharing can enlarge the coverage area which increases the number of potential customers and expands market size even in areas where consumers rarely order taxis.
  • Payment. Ridesharing introduced the convenience of payment through the smartphone.
  • Civility. The dual-rating system (with customers and drivers rating each other) leads to a much more civil rider/driver experience.
  • Trust and safety. Most customers believe they are safer in a ridesharing taxi than in a traditional taxi. This is because there is a record of every ride, customer and driver; making the system much more accountable than the traditional taxi. Drivers with poor ratings are struck off.

Bill Gurley highlights ridesharing expands an existing market beyond its traditional uses. The ordering system and the ability to efficiently organize drivers allow companies such as Uber to “operate effectively in markets where it simply didn’t make sense to have a dense supply of taxis.” Hence, the quality of service availability, convenience, relative costs and high levels of trust provide the basis for potential market-creating growth because of the defection of users from other transportation alternatives such as car rentals, car ownership and mass transit.

Detractors argue the business case for ridesharing is over-hyped. Hubert Horan attributes the success of ridesharing platforms to the massive subsidies (financed by investors) to undercut fares and expand capacity at the expense of competitors. Based on his analysis, “Uber passengers were paying only 41% of the actual cost of their trips…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…In addition to the massive subsidies for uneconomical fare and service levels needed to shift passengers away from traditional operators, Uber needed to subsidize uneconomical driver compensation premiums large enough to get hundreds of thousands of drivers to abandon other operators and sign up with Uber.”

Hubert Horan further argues “Uber’s above-market drive pay premiums created a competitive Catch-22; they fuelled the rapid growth that was critical to its unprecedented valuation and established the perception that Uber had better drivers and vehicles. However, that also meant Uber would have a hopelessly large cost disadvantage in the biggest and most important cost category. Cutting driver compensation back to previous market levels would also halt growth and undermine Uber’s perceived quality advantage.”

Hubert Horan thinks “Uber’s costs (dispatch costs, corporate overhead and profits) are much, much higher; even though they provide less than half the service of traditional companies…Unlike traditional cab companies, Uber fees need to cover the cost of global marketing, software development programs, branding and lobbying programs, the huge market development costs of Uber’s expansion into hundreds of new cities and must also fund a return on the $13 billion its owners have invested.”

He attributes the lack of scale efficiencies to the characteristics of the taxi business – where “85% of costs related to direct operations; each shift involves one vehicle and one car regardless of the size of the company. This is why there has never been any natural tendency towards significant concentration in individual taxi markets, and why taxi companies rarely expanded beyond their original markets.”

In addition, he suggests “it is inconceivable that (with) hundreds of thousands of independent, poorly financed Uber drivers, Uber could ever achieve lower vehicle ownership, financing and maintenance costs than professional fleet managers at a reasonably managed traditional operator, or do a better job balancing long-term asset costs against local market revenue potential. Shifting operating costs and capital risk from Uber’s investors onto its drivers does not eliminate them from the overall business model, and actually makes them higher.”

Hubert Horan concludes “Uber’s decentralized business model precludes the efficiencies integrated operators can achieve such as volume purchasing of vehicles and insurance and the use of sophisticated systems to optimize asset acquisition and utilization against volatile demand patterns.”

Aswath Damodaran expressed concern that “a significant portion of their (Uber) expenses are associating with maintaining revenues rather than growing them (ridesharing discounts, driver deals and customer deals)”. He notes “the business model that has brought these companies as far as they have in such a short time period are flawed, because what allowed these companies to grow incredibly fast is getting in the way of converting revenues to profits, since there are no moats to defend.” He suggests ridesharing companies are already investing in self-driving cars, robots and other infrastructure as part of a strategy of building up “business moats” to shore up their current lack of a sustainable competitive advantage.

Hubert Horan also points out it is a fallacy there was huge value from tapping the 97% of the time when cars were idle. He says this ignores “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”.

In relation to ridesharing, he argues “problems include (1) people don’t like sharing vehicles (2) people really don’t like it when their trip takes twice a long because of the other people; because of (1) and (2) nobody with access to a car ever uses the service (3) the normal time wasted in single-trip taxi service (taxi takes 20 minutes to arrive instead of the promised 10, passenger isn’t ready when they said they would be) gets hugely magnified here (4) software can’t solve very much of the trip inefficiency problems because it doesn’t have accurate info in advance, and the demand density isn’t big enough to create a lot of opportunities for more efficient trips. (5) in a big dense city, where there’d be enough people going in the same general direction at any given time the efficient solution has already been found. It is called public transportation”.

The initial euphoria on sharing platforms have faded and recent articles have become critical. Yet the criticism can be overdone. Sharing is not likely to completely replace purchases and ownership. At the same time, it is not just a fad. It is underpinned by genuine customer popularity and is already having a substantial impact. It is important to analyse ridesharing beyond the business issues and to understand the challenges it pose and the opportunities it offers. My next article will analyse the disruptive effects of ridesharing on the taxi industry.

References

Aswath Damodaran (9 June 2014) “A disruptive cab ride to riches: the Uber payoff”. Musings on markets. http://aswathdamodaran.blogspot.my/2014/06/a-disruptive-cab-ride-to-riches-uber.html

Aswath Damodaran (17 August 2016) “The ride sharing business: Is a Bar Mitzvah moment approaching?” Musings on markets. http://aswathdamodaran.blogspot.my/2016/08/the-ride-sharing-business-is-bar.html

Bill Gurley (11 July 2014) “How to miss by a mile: An alternative look at Uber’s potential market size”. Abovethecrowd.com. http://abovethecrowd.com/2014/07/11/how-to-miss-by-a-mile-an-alternative-look-at-ubers-potential-market-size/

Hubert Horan (Nov-Dec 2016) “Can Uber ever deliver? Parts One to Five”. Nakedcapitalism.com

http://www.nakedcapitalism.com/2016/11/can-uber-ever-deliver-part-one-understanding-ubers-bleak-operating-economics.html

http://www.nakedcapitalism.com/2016/12/can-uber-ever-deliver-part-two-understanding-ubers-uncompetitive-costs.html

http://www.nakedcapitalism.com/2016/12/can-uber-ever-deliver-part-three-understanding-false-claims-about-ubers-innovation-and-competitive-advantages.html

http://www.nakedcapitalism.com/2016/12/can-uber-ever-deliver-part-four-understanding-that-unregulated-monopoly-was-always-ubers-central-objective.html

http://www.nakedcapitalism.com/2016/12/can-uber-ever-deliver-part-five-addressing-reader-comments-and-questions.html

Juliet Schor (October 2014) “Debating the sharing economy”. Great Transition Initiative. http://www.greattransition.org/publication/debating-the-sharing-economy.

 

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