As a private company, Uber was one of the biggest success stories of recent years. But as a public company, the story is pretty much the opposite. Uber’s 2019 IPO was the worst ever in US IPO history, as the stock plunged 11% wiping out $655 million of investor wealth in its trading debut. In this article, I’m going to explain why Uber’s business model is unsustainable in the mid to long-term and why I avoid the stock.
Losses are not The Only Problem
Losses only scare me when they don’t come down over time.
As I’ve said in the Investment Guide losses are not bad on their own. When a company grows fast, expenses are going to be higher than sales for some time. The most important thing is for the losses to come down over time.
Unfortunately, that’s not the case for Uber. The company posts record losses quarter after quarter, but not only that, as you can see in the chart below, losses go down only when revenues also go down, a sign of a fundamentally flawed business model.
Is there actually any path to profitability?🤔Let’s see…
Your Ride is Very Cheap
You’d pay much higher for each Uber ride if the company didn’t subsidize the cost of your trip. This is one way for Uber to gain market share but also the main reason for its huge losses.
In 2017, Reuters published that Uber passengers pay only 41% of the actual cost of their trips, with the biggest part of the cost being subsidized by the company. Of course, this is not sustainable in the long run, and there are no easy solutions to this problem. If the company raises prices, demand will decrease.
Competitive Advantage: ??
Ride-hailing is like air travel — competition is mostly on prices.
Ride-hailing is fundamentally a commodity, meaning a ride from Uber is effectively no different than a ride from Lyft. With commodity products, the profit margins almost always migrate to levels just barely above the marginal cost to provide the product.
This forces companies to compete only on pricing, so they subsidize the costs of the trip to stay competitive, but with huge losses and no easy path to profitability. Uber says that they’re going to solve this problem and decrease costs dramatically in the future, here’s how.
Autonomous Vehicles will Not Help Much
Under the current business model, it’s very difficult if not impossible for Uber to eventually become profitable and grow in a sustainable way, but investors keep supporting it, why?
They bet on autonomous driving. The company is also striving to build its autonomous driving system. It could reduce the single largest expense incurred by the ride-hailing networks: compensation to human drivers.
In 2015 Uber founded its self-driving-car division, Advanced Technologies Group (ATG) with the aim to bring AVs on the road. Mastering self-driving-car technology is a matter of life or death for the ride-hailing firm. But since its inception, the unit has failed to live up to its promise, suffering from infighting, legal issues, and a deadly crash.
Even if we assume that Uber will eventually do it and bring AVs on the road, the problems are far from over. Let me explain.
Some data has shown city-level gross margins to be approximately 10%, meaning that a ride that costs a customer $2 would cost Uber ($UBER) or Lyft ($LYFT) $1.80 to provide, leaving them with a 20-cent gross profit.
Under widely held assumptions in the AV space, the cost of providing that same ride could drop from $1.80 to $1 and eventually lower. So, a $2 ride would then earn Uber or Lyft $1 in gross profit—five times the profit as a human-driven ride.💰 It looks great but it’s impossible for them to keep their prices at current levels.
In order to stay competitive, they’ll engage in a price war again, lowering their prices until they barely exceed costs, resulting in subsistence profits. In our example where an autonomous ride costs $1 to provide, we would expect the price of that ride would drift down to around $1.10, earning the ride-hailing company a similar 10% margin. AVs are unlikely to solve the dynamics that lead to aggressive price-cutting.
Now, ride-sharing companies are facing a new and potentially deadly threat.
Drivers: Contractors or Employees?
Gig-economy platforms like Uber and Lyft are fighting California which is trying to force them to reclassify their drivers/contractors as employees. If the state eventually wins, it’ll be a huge blow to ride-hailing companies. Their business model relies on cheap driver services to stay competitive. Reclassifying their drivers as employees would be catastrophic.
I’ll Stay Away
Uber provides a convenient service for people to move around, but its business model and financials are not viable in the long run. I’ll skip the stock and look for other more promising companies.
What do you think about ride-sharing companies? Do you believe in their future? Do you have any positions? Comment below👇
👇DON’T MISS THE LATEST INVESTING STUFF!👇
Whoops, you're not connected to Mailchimp. You need to enter a valid Mailchimp API key.