http://knowledge.wharton.upenn.edu/article/growth-vs-profits-ubers-cash-burn-dilemma/
Growth vs. Profits: Uber's Cash Burn Dilemma
Wharton School of Univ of the Pennsylvania, Jan 2017
excerpts... click to read the full study.
Bull and Bear Case
For this model to work, Uber needed to reach critical mass. The company's pursuit of growth is largely the reason behind its rapid cash burn. Berman says that for companies to reach critical mass under these circumstances, they need to subsidize both sides of the market - pay them to join the system. He notes that the costs for Uber are high: "They are losing about $3 for each $1 they make." However, getting to critical mass also typically results in a "winner-take-all effect," which is what happened with Google in search and Facebook in social networks, he adds. "In this case, Uber's strategy to try and grow as fast as possible at the expense of making a profit makes a lot of sense."
Uber could be positioning itself to thrive in the long run. "Another way to see it is that Uber's playing a very long game. We're not used to startups playing such a long game. We're used to startups eventually getting to something that makes them profitable, [going to] IPO and exiting," Hernandez says. "The closest example we can find to Uber is Amazon, where [founder and CEO] Jeff Bezos was willing for decades [to prioritize growth over profits] - and even to this day, Amazon really hasn't been a very profitable company." Pundits also wrongly predicted Amazon's demise.
Spending heavily to corner the market also makes sense from a regulatory standpoint. "If it were just about competing against [ride-hailing startup] Lyft and [Chinese rival] Didi, then there is some value to the argument that they're burning cash too fast," Hernandez says. "But the regulation angle actually justifies the cash burn." Uber needs leverage, money and legitimacy in order to get regulators to accept its service even though it threatens the entrenched taxi industry in many cities. By subsidizing rides at first, Uber gets more people to use and like the service. That's a major advantage when the company goes in front of regulators.
"It needs the public on its side and it needs ridesharing to be a significant portion of the economy so that regulators have an incentive not to kill it but to regulate it in a way that preserves jobs and infrastructure around ridesharing. That requires size," Hernandez says. "You're not going to the city council of New York and say, 'We're just a local New York company.' Whereas if you say, 'We're everywhere and we have this brand and people love us,' then you [become] the 800-pound gorilla."
The bear case for the cash burn is that Uber's tactic of lowering prices to get more riders, even if it means taking a loss, is problematic in the long run. In order to succeed, "that strategy would count on its dominance of the market after all significant incumbent taxi businesses exit," says Arkadiy Sakhartov, a Wharton management professor. "I do not believe the strategy would be sustainable."
Despite its cash flow issues, Uber is by far the dominant global ride-hailing startup - and it is expected to stay that way. Hernandez believes that in many markets, there will be an oligopoly composed of Uber and perhaps one or two local startups - not more. "The barriers to entry [have risen.] You need a brand, you need cash," especially since Uber, with its big war chest, is always in the background. Berman adds: "I don't see the market having more than two or three ride-hailing apps that will be profitable in the long run, unless prices increase and go back to [being comparable with] taxi companies."
excerpts... click to read the full study.
Growth vs. Profits: Uber's Cash Burn Dilemma
Wharton School of Univ of the Pennsylvania, Jan 2017
excerpts... click to read the full study.
Bull and Bear Case
For this model to work, Uber needed to reach critical mass. The company's pursuit of growth is largely the reason behind its rapid cash burn. Berman says that for companies to reach critical mass under these circumstances, they need to subsidize both sides of the market - pay them to join the system. He notes that the costs for Uber are high: "They are losing about $3 for each $1 they make." However, getting to critical mass also typically results in a "winner-take-all effect," which is what happened with Google in search and Facebook in social networks, he adds. "In this case, Uber's strategy to try and grow as fast as possible at the expense of making a profit makes a lot of sense."
Uber could be positioning itself to thrive in the long run. "Another way to see it is that Uber's playing a very long game. We're not used to startups playing such a long game. We're used to startups eventually getting to something that makes them profitable, [going to] IPO and exiting," Hernandez says. "The closest example we can find to Uber is Amazon, where [founder and CEO] Jeff Bezos was willing for decades [to prioritize growth over profits] - and even to this day, Amazon really hasn't been a very profitable company." Pundits also wrongly predicted Amazon's demise.
Spending heavily to corner the market also makes sense from a regulatory standpoint. "If it were just about competing against [ride-hailing startup] Lyft and [Chinese rival] Didi, then there is some value to the argument that they're burning cash too fast," Hernandez says. "But the regulation angle actually justifies the cash burn." Uber needs leverage, money and legitimacy in order to get regulators to accept its service even though it threatens the entrenched taxi industry in many cities. By subsidizing rides at first, Uber gets more people to use and like the service. That's a major advantage when the company goes in front of regulators.
"It needs the public on its side and it needs ridesharing to be a significant portion of the economy so that regulators have an incentive not to kill it but to regulate it in a way that preserves jobs and infrastructure around ridesharing. That requires size," Hernandez says. "You're not going to the city council of New York and say, 'We're just a local New York company.' Whereas if you say, 'We're everywhere and we have this brand and people love us,' then you [become] the 800-pound gorilla."
The bear case for the cash burn is that Uber's tactic of lowering prices to get more riders, even if it means taking a loss, is problematic in the long run. In order to succeed, "that strategy would count on its dominance of the market after all significant incumbent taxi businesses exit," says Arkadiy Sakhartov, a Wharton management professor. "I do not believe the strategy would be sustainable."
Despite its cash flow issues, Uber is by far the dominant global ride-hailing startup - and it is expected to stay that way. Hernandez believes that in many markets, there will be an oligopoly composed of Uber and perhaps one or two local startups - not more. "The barriers to entry [have risen.] You need a brand, you need cash," especially since Uber, with its big war chest, is always in the background. Berman adds: "I don't see the market having more than two or three ride-hailing apps that will be profitable in the long run, unless prices increase and go back to [being comparable with] taxi companies."
excerpts... click to read the full study.
