Guest Post, Maryann Keller, Principal at Maryann Keller & Associates LLC and Ken Elias
David Ruggles speaks regularly with Maryann Keller; we cross-post from LinkedIn with her permission. She is the single most highly regarded auto industry analyst, and has sat on the boards of rental car companies (and was president of priceline.com) so has a good understanding of the economics of ride sharing in one of its "traditional" segments. David took her on her first UBER ride in Washington DC in February 2016. She's since done research on this new "disruptor." They do huge business but lose money doing it. What can be their end game?
Ride-sharing Apps: Low Fares Can’t Last
Published on March 6, 2017
It’s no secret that Uber, Lyft and other ride-sharing apps offer fares less than taxis; exactly how much less depends on metro area, time of day, and ride length. Lower fares, the ease of using the app to summon a car, and cashless payments have built a large user base for the dominant players, Uber and Lyft. But with both companies losing hundreds of millions of dollars a quarter, how soon will investors demand a path to profitability? (TechCrunch.com reports that sources suggest Uber lost three billion dollars last year!)
Silicon Valley-supplied capital often funds disruptive business models that require subsidizing users to gain market share or influence partners. During our early days at priceline.com, Ken Elias and I saw the company establish itself by using investor money to purchase airline tickets at retail prices and then resell them to consumers below the company’s cost. However, rapid consumer acceptance of priceline.com’s opaque pricing model helped prove to the airlines that enough consumers were indifferent to the airline and departure time in return for a lower fare. The subsidies proved the case; airlines could see the power of the internet to fill unsold seat inventory without destroying their posted fares under the priceline.com program. Airlines soon provided priceline.com with special “hidden” fares thus allowing the start-up company to eliminate the subsidies and earn profits on ticket sales.
...enjoy the low fares while you still can...
While conceptually Uber, Lyft and their clones are using the same strategy, there are significant differences that might produce results very different from the priceline.com airline (and hotel) experience. Underpricing a service to buy market share only works if there are levers in place to find ways to lower expenses, which in the case of priceline.com did happen when hotels and airlines provided lower pricing for expiring inventory. Or, alternatively with other examples, consumers become hooked on a service – such as with DirectTV – and are willing to pay more for it after the expiration of subsidized trial offers.
In the case of ride-sharing companies, the market price that equates to profitable operation has already been determined by the taxi industry. Why? Because whether it’s a taxi company, a limo service, or Uber or Lyft, every ride requires a car and a driver. Gasoline, vehicle depreciation, insurance, and maintenance are a given in all cases and they are identical irrespective of the provider. There are costs to driving every mile with or without a fare. For the airlines, there is a fixed cost to making every flight whether the plane is full or empty; selling unsold seats at even lower prices than published, but at a price consumers cannot see and must make tradeoffs to get, just adds to the marginal revenue of the flight.
Ride-sharing app companies promote their services for individuals to earn additional income as drivers. Use your own car to make extra cash is an appealing proposition in one sense. But these drivers may be financially unsophisticated individuals who might account for their activities on a cash basis until they realize that the added miles reduce the value of their vehicles while accelerating maintenance. Depreciation is the single largest expense for any vehicle fleet operator but it is not realized in cash terms, so to speak, until the vehicle is disposed. Because ridesharing drivers use their own vehicles, pay for all gas and maintenance, and ultimately bear the expense of depreciation, the remaining dollars, including necessary accruals, represents their actual income which is less than the cash received from net fares.
It is more than likely – and recent evidence suggests – that the drivers are catching on to the real costs of driving what is effectively a taxi – but not achieving their expected income. High turnover among drivers suggest that many individuals ultimately realize that the economics don’t work at current fare levels. In effect, these drivers are subsidizing the ride-sharing services too.
The recent video exchange between Travis Kalanick, CEO of Uber and Fawzi Kamel, an UberBlack driver, highlights the plight of the drivers – fares have fallen (due to competition from other app ride services) only because investors and drivers are willing to subsidize fares. It’s certainly not because there’s a way to lower the costs of vehicles and drivers.
Actual data from a Sharepost report demonstrate this. The analyst who wrote the report actually became an Uber driver for a short stint. He claims to have driven 11 hours for UberX and received $225 in total compensation or roughly $20 per hour.
He drove 175 miles for UberX around the San Francisco Bay region. For argument’s sake, using the IRS’ standard mileage deduction for 2016 at $0.54/mile, which includes variable and fixed costs for an automobile, his vehicle costs for the trips totaled $94.50. Effectively, he netted only $130.50 for his time or $11.86 per hour which is less than the minimum wage in San Francisco ($13 per hour). And no mention is made or attributed to the costs of driving excess mileage to return to his home base or driving empty. Worse, the government reimbursement rate per mile is likely too low since it reflects a national figure for an “average” vehicle; mileage costs are probably higher in major urban areas.
There is no way to eliminate the fixed and variable costs of delivering transportation in vehicles piloted by hired drivers. And these costs are comparable to that of taxi companies. Uber and Lyft cannot reduce these costs since they are determined by the nature of the business. Fares will have to rise to adequately compensate the drivers (and eventually the investors in the ride-share app companies as well).
As we wrote previously on LinkedIn, fully autonomous vehicles are not a solution, and they will wreck the app-based companies’ balance sheets. While an auto manufacturer might produce these vehicles for purchase, the manufacturer will not want to take on the financial obligations of owning and maintaining that fleet. Even assuming that the ride-sharing company could find a fleet management company to own and maintain the cars, that fleet provider would price its service to make a good return on investment. This is something the individual ride-sharing driver probably doesn't consider at first and is therefore likely not reflected in current rates.
While Uber, Lyft, and other mobility apps in the U.S. gain traction with consumers, one might believe that once again, Silicon Valley (or its subsets in other big metro markets) has again wisely invested and created untold value from little more than a modern ride demand/supply matching system. But without investor subsidies, and drivers willing to make less than minimum wage, fares can only rise to those comparable with taxi companies, if not even higher.
Consumers should enjoy the low fares while they still can.