Uber Economics
Photo Credit: The New Statesman
By Henry Hing Lee Chan

Uber Economics

Apr. 26, 2017  |     |  0 comments

Although Uber is not a publicly-listed company and is not obliged to disclose its financial conditions, in an unprecedented move, it confirmed its 2016 audited gross booking of USD 20 billion, net revenue of USD 6.5 billion, and losses of USD 2.8 billion on April 15. In previous quarters, Uber’s financials have been closely watched by investors and were often leaked to the press. However, the company neither confirmed nor denied the latest leaked financials. The unusual confirmation was done to calm the market on worries over the increasing regulatory challenges that it faces in many parts of the world, and how these challenges will affect Uber’s sharing economic model. The USD 2.8 billion annual loss in 2016 puts the company as the most heavily losing private company in the history of Silicon Valley.

Having already raised more than USD 11 billion in seven rounds of private equity fund raising, Uber is the most valuable private technology company in the world. The company has collected more money than any tech start-up in history. In the series-E fundraising round in December 2014, the disclosed company valuation was USD 40 billion, and the market now estimates that in the latest series-G round of fund raising in mid-2016, the company was valued at USD 62.5 billion. Uber has raised eyebrows over how quickly it has burnt through cash with its expansion to more than 70 countries (close to 600 cities) at the end of 2016, especially with the company rapidly building up its fleet by pumping incentive payments for drivers and free coupons for riders.

Figure 1. Uber’s Fund Raising Rounds

The disclosed financial revenue and losses were both higher than market expectations. Although the losses expanded every quarter, the rate of revenue growth exceeded that of the growth of losses. Fourth-quarter net revenue was USD 2.9 billion, more than three times as much as in the first-quarter. The company is not in need of any immediate fundraising anytime soon. After its fundraising last year, Uber had USD 7 billion in cash on hand, with an additional USD 2.3 billion in untapped lines of credit. That means the company will be able to operate for at least three more years at its current burn rate, even if it does not raise any additional funds. Uber’s ability to sustain its expansion is now being closely watched by the market, a sharp reversal of sentiment from one year ago in which investors handed over billions of dollars to the company at ever increasing valuations and asked few questions about the company’s business model. The market is monitoring closely whether Uber can maintain the momentum of cutting the cash burn in the coming quarters amidst keeping up its fleet expansion.

Figure 2. Uber’s Revenue and Losses in Recent Quarters

Uber’s story demonstrates the controversial business model of transportation sharing and the business logic behind this innovation. There are arguments over whether the Uber model symbolizes an innovative sharing economy or whether it is just an exercise in regulatory arbitrage camouflaged under innovation.

Innovative Sharing Economy?

Uber’s sharing transportation model is based on a mobile app that connects the driver and user of the service. In most cities, Uber offers “upfront pricing” where the rider is quoted the fare that he or she will pay before requesting the ride. In some cities, Uber does not offer upfront pricing, and instead calculates the price of a ride based on its time and distance, akin to a taxi meter.

Uber fares are based on a dynamic pricing model, meaning to say that the same route may be charged differently at different times based on demand and supply changes. When rides are in high demand in a certain area and there are insufficient drivers, the fares will increase to entice more drivers into the area while cutting demand for rides. Though dynamic pricing is economically sound and represents maximization of resources, it has generated the most cases of user complaints. Many people have complained that in times of calamity, the heavy demand drove prices to astronomical levels.

Most Uber drivers use their own cars, and a minority rent their cars from Uber or its partners. Private cars hence are converted into cars-for-rent through the mobile app based platform provided by Uber. This setup raises the supply of cars-for-rent at times of high demand.

Regulatory Arbitrage?

Many taxi drivers have contended that Uber drivers have an unfair advantage over them, as Uber drivers are not subject to the same kinds of regulations and fees placed on taxi drivers. The use of driver-owned existing cars also means that the car is already a sunk cost, allowing Uber drivers to charge lower fares when demand is low. The same is true of the drivers’ time. Uber drivers can provide their service only at their leisure time, so their time value is not of concern, unlike taxi drivers. In many cities where Uber is active, taxi drivers’ incomes have been severely hit as existing taxi passengers shifted to Uber. The free ride discount coupon provided by Uber further promoted the appeal of ride sharing.

There are many court cases brought by taxi drivers against Uber on issues of regulatory arbitrage, ranging from insurance on riding customers, employer-employee relations between Uber and its drivers, professional standards of drivers, and so on. In many cities, Uber had to modify its original business model of acting merely as a booking platform provider for its drivers and provide employment benefits similar to taxi companies in the locality.

Issues Arising from Uber Cars

The rise of Uber and the challenges it now faces illustrate the pitfall of innovation. While one cannot argue against the sharing economy aspect of Uber, one cannot also ignore the regulatory arbitrage issues raised by the taxi drivers. In cities where taxi drivers are heavily regulated and there are sufficient supplies of taxis, the issues of how to regulate Uber and similar app-based services, and how to lessen regulations on existing taxi drivers so that competition between Uber and taxis are placed at an equal footing, are challenges for regulators. In cities where taxi drivers are lightly regulated and there are shortages of taxis, the focus should be on providing an equal operating environment to existing taxi drivers and the entering Uber drivers, and the aggregate supply of vehicles should be encouraged to increase.

The authorities should also note the financial muscle of the “innovative start-up” company. While a vibrant private equity space is laudable, the downside of a monstrous start-up with ample publicly raised funding that can afford to subsidize losses and wipe out competitors should not be underestimated. Embracing innovation should not come at the expense of eliminating competition through monopolistic means. While the app-based platform provides a convenient link between the riding public and drivers which should be encouraged, the use of subsidized coupons to encourage customer shifting is unfair to competitors and should not be encouraged.

More innovation will come with the explosion of new technologies under the 4th Industrial Revolution that has just started. The social choice that the community must make in the Uber case is likely to be repeated soon in other areas. The regulatory issues and lessons learnt in the case of Uber should be scrutinized and improved to meet future innovation challenges.

Leave a Reply

Your email address will not be published. Required fields are marked *