29 July, 2015

Uber (Part 1) - The prize is likely not worth the chase, but the future is coming anyway


This is the first of several posts regarding my somewhat idiosyncratic views on the strategic issues facing Uber circa July, 2015*.

It springs from a discussion I had with several students towards the end of the "Strategic Analysis of Business" class I taught at Sunstone** this summer.  The original question was whether Uber's generic strategy was better classified as "regulatory disruption/arbitrage" or "the sharing economy" or both.

Our discussion quickly evolved into a broader examination of the competitive issues facing Uber including the growth imperatives implied by a bond offering term sheet described in a recent Bloomberg article.  This is an especially interesting topic given increasing rumors of Uber's impending IPO.

While I'm not an expert on any particular aspect of Uber's business, our class discussion identified a handful of strategic elements that will be critical to its success (or failure) over the next few years.  I decided to use that discussion as a launch point for this blog.

Uber's prize may not be worth the chase

My own view is that Uber's prize is not worth the chase - it is overvalued in a way that any win will be a pyrrhic victory for most who are involved.  But the future will happen anyway.

Uber's current valuation of $50 billion implies some combination of unlikely events:
  • Uber will win an unlikely share of the global on-demand transportation market, including the huge "latent demand" growth enabled by providing safe rides priced below taxis
  • Uber will successfully defend against the likely substantial further erosion of its 20% driver/passenger matching platform cut (or even reverse the erosion)
  • Uber's urgent external cash flow needs must shift from dilutive sources rapidly enough to reduce the increasing pressure on their already sky-high valuation

Uber's future will disrupt the world regardless of whether Uber benefits from it

I'm certainly not the first to question Uber's valuation, though I hope to explore the topic in a new way and offer some interesting implications.  These implications vary by perspective and are common business dynamics:  New investors will likely require increasing protection at the expense of existing investors.  Existing investors are likely to experience tension between doubling down and cashing out, exacerbating the information asymmetry between new/existing investors and increasing any principle/agent tensions with Uber's workforce.  Etc.

Much of Uber's investment funds raised to date have likely been used for one-time legal and marketing expenses which serve only to lower the barriers of entry to a wave of follow-on competitors.  This negative cash flow is likely to continue to require additional investments until Uber's operations in "mature" cities are able to fund their expansion into "new" cities.  At the same time, a new wave of competitors is likely to contest both new and existing cities and result in the commodification of the marketplace app.  This competition has both revenue and margin implications which feed back into my valuation concerns.

Any lead that Uber builds in each city will be difficult to defend over the long run unless Uber is able to use the size and scope of their commoditized marketplace to venture into related businesses which reinforce their marketplace - much like Amazon used the base elements of their e-tailing business to expand beyond the storefront and fulfillment businesses into on-demand computing and now entertainment.  Uber's adjacent options could include things like self-driving cars and selling the "data exhaust" from ride data.

More broadly, regardless of whether Uber "wins", elements of its business model will clearly shape the future of local transportation markets in ways that have yet to be widely noted.  Interests ranging from auto manufacturers to public transit to local and national governments should be aware of how the growth of the on-demand transportation market will undermine critical elements of their own business models.

People who work at Uber, or are considering investments in Uber, may want to consider the dynamics outlined in these posts.


Note: this has been cross-posted at Sunstone here

Planned follow-on posts on Uber [updated 10/08]:
Part 2a - Intuition-building for "multi-sided markets" and "network effects"
Part 2b - A framework for analysis/discussion of Uber
Part 3a - A primer on valuation of software companies
Part 3b - Does fundraising through subsidiaries raise a Yahoo/Alibaba question?
Part 4a - The consensus view of on-demand ride economics and their implications
Part 4b - The limits of cost savings from electric vehicles
Part 4c - The asymptotic limits of shared vehicle costs
Part 5 - Unit economics of food delivery
Part 6 - Transit network cross-subsidies make it easier to cherry-pick profitable routes

Re-regulation possibilities for Uber
Ten ideas for Uber moving forward
Competitive responses in anticipation of Uber's moves
Broader SaaS implications demonstrated by Uber: Capital intensity of sales, growth imperatives


*To the best of my knowledge, I have no financial interest or conflict in examining Uber.  I do live several blocks from Carnegie Mellon's NREC, from where Uber recently hired 40 robotics engineers.  I use Uber periodically, and enjoy using it, for several reasons.  Uber has not contacted me (nor me them, and I have no current plans to).  All facts introduced in this discussion are sourced from public information, mostly recent articles in reputable newspapers.  None of this discussion should be considered investment advice

**"India's largest management program for tech professionals."  Disclaimer: One of the Sunstone founders was a colleague of mine at McKinsey.  I've taught several classes there since their founding, including for compensation

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