Uber Should Be Judged On Its Own Merits, Not Amazon’s (Ahmet)

Posted on by bm11c

In its recently amended IPO prospectus, Uber acknowledged that its quarterly core platform revenue growth rate in Q1 2019 declined to only to 5.8%, while its quarterly losses deepened over $1 billion. It is not uncommon for relatively young companies to invest in rapid growth.  But Uber now finds itself saddled with steep losses and low growth. Facing intense competition in its core businesses, the company has been operating at an increasingly negative contribution margin for the past six months, while corporate outlays for sales and marketing, G&A and R&D remain stubbornly high. With the company’s IPO only a few days away, these discouraging results should raise tough questions about Uber’s future business potential.

Uber CEO Dara Khosrowshahi (AP Photo/Richard Drew) 

Uber CEO Dara Khosrowshahi (AP Photo/Richard Drew)

To calm nervous investors,  Uber has cranked up its PR machine to promote the narrative that Uber is on track to become the “Amazon of transportation,” well positioned to penetrate an $8.5 trillion addressable market (yes, that’s trillion).

This is the latest in a series of narratives that Uber has floated over the past four years to distract attention from an inconvenient truth that the company has, and continues to lose more money faster than any US venture in history.

Year Uber Narrative Prevailing Reality
2016 Uber’s losses have been adversely impacted by intense competition in China. With the successful divestiture of our Chinese operations, we should show significant improvement in our financial performance. Uber’s losses from operations have actually deepened since the company divested its Chinese operations
2017 We are making progress In our autonomous vehicle (AV) research program and expect to begin deploying AV’s by as early as the end of 2018, which should improve our economics. In March 2018, Uber experienced a fatal pedestrian accident with one of its AV test vehicles, despite the presence of an onboard safety driver. Uber suspended its AV road test program for nine months, overall progress has slowed and the company now only refers to deployment of AV’s as “an important part of our offerings over the long term,” with the caution that “new ventures are inherently risky, and we may never realize any expected benefits from them.”
2018 Uber Eats has emerged as a growth star, propelling us to become the largest food delivery service in the world outside of China. Last mile food delivery has always been a financially fraught category. Several well-capitalized competitors are engaged in fierce competition in this sector, including DoorDash, Postmates, Grubhub and Uber Eats, none of whom made money in 4Q 2018. Grubhub’s stock price has declined by ~50% from its Sept. 2018 peak, reflecting an extremely challenging competitive environment. The ability of Uber to earn sustainable attractive returns in this segment is far from certain.
2019 Uber’s platform now incorporates multiple modes and product line extensions, making Uber the “Amazon of transportation,” unlocking enormous growth potential. This is an attractive narrative for Uber for two reasons. First, it plays into a common belief that Amazon was not profitable for nearly two decades, so Uber’s early losses need not be of great concern. Second, Amazon has emerged as the second highest valued publicly traded corporation in the world, indicative of Uber’s vast upside potential. But neither of the premises behind Uber’s current narrative is remotely true.   Amazon has been far more profitable throughout its history than commonly believed. And Uber’s operations have virtually nothing in common with Amazon’s extraordinarily successful business model.

The NY Times was intrigued enough by Uber’s latest spin to publish a feature story on April 28, which posed the following question in its headline: Which Tech Company Is Uber Most Like? Its Answer May Surprise You. The lede went on to say:

Pop quiz: Which technology company does Uber, the ride-hailing
giant on the cusp of an initial public offering, consider itself to be
the most like?

Is it Lyft, its rival North American ride-hailing firm? Nope.

How about Didi Chuxing, Uber’s equivalent in China? Nah.

It’s Amazon, the e-commerce giant.

This story served Uber’s interests well, and not surprisingly so, as the only sources referenced in the Times article were Uber’s CEO Dara Khosrowshahi and two of the company’s early-stage VC investors.

But despite the Times’ catchy headline, it should not be surprising that Uber would rather be compared to Amazon – the second-highest valued publicly traded company in the world — than to money-losing Lyft, whose IPO tanked last month, or to Didi Chuxing whose ridesharing business lost $1.6 billion last year, two years after Uber’s departure gave it seemingly monopoly control over the largest ridesharing market in the world.

Uber’s pitch as the Amazon of transportation is a false narrative that belies fundamental weaknesses in its business model that investors should evaluate on its own merits. In that regard, from its inception, Uber’s business plan was predicated on six profoundly flawed assumptions.

  1. Uber’s asset-light business model and strong network effects would yield huge economies of scale and an unassailable first mover advantage in each of the markets it entered.
  2. Uber’s prodigious fundraising success would give it ample reserves to drive competition from the market and establish global monopoly control and pricing power
  3. Uber’s scale advantage and sophisticated AI algorithms would power a superior service, translating into shorter wait times for passengers and drivers, and improved driver productivity, which in turn will allow Uber to achieve the trifecta of low fares, attractive driver compensation and corporate profitability.
  4. With consumers on its side, municipal governments would be unwilling or unable to restrict its ever-expanding operations, even after recognizing that Uber’s business priorities conflict with public policy goals for sustainable, efficient modes of public transportation and adequate compensation for a large and growing sector of city employment.
  5. Product line extensions would provide profitable growth opportunities to offset lingering losses in the core ridesharing business
  6. Over the longer term, the combination of available funds from capital markets and retained corporate earnings would fund a seamless transition to autonomous vehicle operations, promising an even more utopian future.

If all of these assumptions turned out to accurately reflect Uber’s business potential, it could easily justify becoming the second highest valued US company IPO in history (behind Facebook). But Uber’s first five assumptions have already proven demonstratively false, and the last one is highly uncertain, and at best remains to be seen in the distant future.

To understand why comparing Uber to Amazon is a false narrative, it is instructive to start by recognizing that Amazon historically has not been nearly as unprofitable as is commonly believed. It’s easy to see where the conventional wisdom of Amazon’s aversion to profits comes from, as evidenced by the chart below comparing Amazon’s revenue to net income since its inception.

Amazon revenue vs. net income, post-IPO

Amazon revenue vs. net income, post-IPO

SOURCE: AMAZON ANNUAL REPORTS

But when Jeff Bezos penned his first letter to shareholders in 1997, he clearly stated his intentions as follows:

When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.

In short, Bezos meant from the beginning to maximize cash flows, rather than accounting profits, for two reasons.

As shown in the charts below, Amazon has been generating huge amounts of operating cash since its fifth year, post-IPO (which was its eighth year, post-startup), reaching almost $31 billion in 2018. In contrast, Uber’s negativeoperating cash flow over the past three years (culminating in its eighth year since launch) was nearly $6 billion.

Amazon cash from operations vs. net income

Amazon cash from operations vs. net income

SOURCE: AMAZON ANNUAL REPORTS

The reason Amazon’s growth and operating cash flow are vastly superior to Uber’s is rooted in profound differences between the two companies’ business models.

  1. Amazon dominates a far larger realistically valued serviceable addressable market (SAM) than UberIn its S-1 filing, Uber incredulously pegged its serviceable addressable market for personal mobility services at $5.7 trillion dollars across 175 countries. This includes all forms of personal transportation for trips under thirty miles. Adding in Uber’s estimate of the $2.8 trillion SAM for Uber Eats brings its total estimated addressable market to over 10% of the world’s gross domestic product!Thus Uber is touting the traditional pitch of startup entrepreneurs who claim “we only need to get a small share of this enormous market to get really big!” In its S-1, Uber’s version reads:”We believe that we are just getting started: consumers only traveled approximately 26 billion miles on our platform in 2018, implying a less than 1% penetration rate of our near-term SAM.Uber’s hubristic view of its growth potential belies several harsh realities. First is that there are severe physical constraints to Uber’s continued growth, namely available road space and driver availability. Many urban areas are already choking on congested roadways, which is particularly notable since 25% of Uber’s current rideshare revenue comes from only 5 cities (of the over 700 cities in which the company operates). It is simply neither feasible nor desirable for Uber to gain significant market share from public transit systems in major metro areas, and its economics and service advantages are far lower in smaller, less dense locales.

    Moreover, until and unless autonomous vehicles become widely deployed, Uber will have to rely on human drivers to deliver its labor-intensive service. There are obvious limits to how much farther Uber can scale with this resource constraint. And finally, focusing on inflated SAM estimates ignores the realities of intense market competition, which Uber faces in all its major markets and businesses.

    As a result, Uber’s growth in core platform adjusted net revenue (reflecting its rideshare plus Uber Eats businesses) has slowed to only 1% over the past six months, belying what one would expect if Uber really was successfully attacking an $8.5 trillion SAM, from only a 1% current penetration rate.In contrast, Amazon – The Everything Store – is the dominant global e-commerce provider of an extraordinarily broad array of retail merchandise.

    Adding in Amazon’s market-leading position in cloud IT services, its fast-growing advertising business and a surprisingly robust business in consumer electronic devices, gives the company a realistically huge, unbounded, serviceable addressable market. Amazon’s growth numbers back up its potential: Amazon achieved a revenue growth rate of 31% last year on sales of $233 billion. No company has ever achieved as high a sustained growth rate on an operation of this scale.

  1. Compared to Amazon, Uber does not enjoy superior network effects or economies of scale it asserts are conveyed by the structure of its two-sided market or Uber’s dominant market shareUber undeniably is the ridesharing market leader in most of the countries in which it operates, which the company claims (without substantiation) conveys superior network effects, scale economies and margin potential. However, since Uber doesn’t own its distribution assets – vehicles or drivers – and ridesharing entry barriers are relatively low, Uber cannot actually lock in its assumed network effect advantages.To see this, consider that in the US, ~80 percent of Uber drivers also are enrolled with one or more other gig driving ventures (e.g. Lyft, Postmates, Doordash, Grubhub).As such, smaller competitors can easily gain access to most of Uber’s large pool of drivers to compete aggressively for each and every trip. At the same time, an increasing number of consumers view ridesharing as a commodity service, flipping between apps to find the cheapest or fastest alternative (or using increasingly popular rideshare comparison apps like Bellhop).

    This competitive reality puts severe constraints on any player– including the largest rideshare company – from exploiting scale advantages to achieve pricing power or competitively advantaged wait times in any given local market.The lack of network effects is evident in Uber and Lyft’s reported driver counts. Uber’s S-1 claims the company currently has 3.9 million drivers worldwide. The company doesn’t break out its US total, but Uber does state that 46% of its revenue and 74% of its trips occur outside the US. It is reasonable to assume then that roughly half (and possibly fewer), or 1.9 million of Uber’s drivers operate in the US.Lyft, who only operates in the US and a smattering of Canadian cities, claims in its S-1 that it engages 1.9 million drivers. Therefore the two companies are served by roughly the same number of US drivers, despite the fact that Uber’s US revenue is roughly 2.5 times greater than Lyft’s. So much for Uber’s supposed network effect advantage that assumed it could attract more drivers because it has more riders, which in turn would attract more drivers, in a market-dominating virtuous cycle.

    As another data point on the lack of ridesharing network effects, when Uber pulled out of China (the world’s largest ridesharing market) it 2016, it was assumed that the remaining market leader, Didi Chuxing, would gain unassailable network effect advantages, economies of scale and monopoly pricing power. As such, many believed that Uber’s negotiated exit deal, giving it a 20% stake in Didi would become a significant value creator, allowing Uber to ditch its money-losing operations in exchange for a share of the winner-take-all incumbent.

    But fast forward two years, and Didi Chuxing reported 2018 losses of $1.6 billion as local entrants aggressively competed for Chinese market share in selected metropolitan markets, often by recruiting from Didi’s pool of contract drivers.Uber has also asserted that its superior scale would convey sustainable economic advantages against smaller competitors. But given the structural characteristics of the rideshare business, there are limited economies of scale because the three largest cost components of running a rideshare business are not very sensitive to scale.

    Driver Costs

    About 78% of Uber’s gross bookings are paid out to drivers, and this percentage has actually increased as Uber’s scale has increased tenfold over the past three years. Uber may run an asset-light business, but that simply means that Uber operates with a largely variable cost structure. Until and unless drivers are automated out of the business, more than three-fourths of Uber’s gross bookings will go to drivers (and possibly more, if Uber needs to raise driver compensation to recruit enough drivers to support its growth targets).

    Costs of Revenue

    Cost of Revenue is Uber’s second highest expense category, accounting for 50% of total revenue. Cost of Revenue consists primarily of rideshare and Uber Eats insurance expenses, credit card processing fees, mobile device and service expenses, and amounts related to fare chargebacks and other credit card losses. The bulk of these costs are directly related to the number of rides Uber delivers, so not surprisingly, Uber’s Cost of Revenue has grown almost as fast as Uber’s revenue over the past three years (152% versus 193%).

    Marketing

    Marketing costs are as much a function of competitive intensity as scale economies. One could argue that Uber’s initial marketing outlays were high, reflecting the need to penetrate new markets, and attract new riders and passengers as it pursued global expansion. But Uber is now well established in more than 700 cities in 63 countries, with a leading market share in most of these locations, and as such should be able to now enjoy some economies of scale. However, Uber has had to maintain high marketing outlays against smaller players, given the intense competition to attract and retain riders and drivers in virtually every market in which Uber operates.

    In theory, network effects and scale effects can be a powerful profit generator, but only if a market leader owns proprietary mission-critical assets (e.g. Amazon fulfillment centers) that are difficult or expensive to replicate, and/or if customer loyalty and switching costs are high (e.g. Amazon Prime; AWS contracts). Uber enjoys neither of these two structural advantages, as its dismal P&L attests.

  1. Amazon has built enormous barriers to entry, investing for over 20 years in extensive physical assets, yielding industry superior order-to-fulfillment cost-effectiveness and cloud services scale economies.Uber’s asset-light business model leaves it vulnerable to new entrants, chronic competitive intensity and difficulty in achieving attractive returns. In contrast, Amazon has patiently invested in creating mission-critical hard assets, which serve as a barrier to competition in protecting its leadership position across several business categories
  2. Compared to Uber, Amazon enjoys extremely high customer loyalty and recurring revenue streamsThanks to its Prime program, Amazon enjoys high customer loyalty and a strong recurring revenue stream. Despite steady increases in its membership fees over time, Amazon has attracted over 100 million Prime subscribers and enjoys approximately a 90% annual renewal rate.In contrast, many Uber customers view the company’s services as a commodity, toggling between rideshare apps on every trip to find the best competing service. This profound difference in business models winds up being extremely costly for Uber. It’s Sales & Marketing expenses last year accounted for 28% of total revenues, compared to Amazon’s comparable figure of only 6%.
  3. Amazon has launched highly profitable product line extensions, notably AWS and advertising, whereas Uber’s product line extensions have only deepened their lossesThroughout its history, Amazon’s underlying business model flywheel – named as such and reportedly sketched out on a napkin by Jeff Bezos many years ago – has allowed the company to add a profitable range of new products and services over time.

    Amazon's business model flywheel

    Amazon’s business model flywheel

    SOURCE: AUTHOR ARCHIVES

    In its early years, Amazon’s product line extensions consisted mainly of new categories added to its e-commerce platform — from books to DVD’s to personal care products to “The Everything Store.” More recently, Amazon has leveraged its own internal IT capabilities to launch the highly profitable AWS cloud services business, and an even higher margin advertising business, exploiting the trend that consumers now do more product searches on Amazon than on Google.

    In contrast, Uber has been unable to achieve profitability in its core ridesharing business, let alone leveraging its platform to profitably extend into adjacent businesses.

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Bottom line, business models matter!

Amazon has painstakingly built one of the most effective business models in history, as measured by its ability to achieve unprecedented growth, cash flow, and market value.

Uber faces intrinsic weaknesses in its business model that has caused it to lose more money faster than any venture in history. This is not for lack of talented management, as the company deserves considerable credit for effectively scaling its highly complex global operations at an unprecedented pace.

But the harsh reality is that the rideshare industry suffers crippling weaknesses in its underlying business model: low barriers to entry, the lack of network effects or scale economies, undifferentiated services, low customer loyalty, a lack of recurring revenues, intense competition and abundant access to capital (at least until now). As a result, the elusiveness of profitable growth is not an Uber problem, but an industry problem, as no major ridesharing company has been able to achieve attractive financial performance on a global scale.

Uber’s attempt to ride on Amazon’s coattails may be brilliant PR, but investors should judge Uber on its own merits.

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