The economic principles behind Uber’s success
Prior to its IPO, Uber was the highest-valued private company in the world. Its valuation toppled the likes of Airbnb, Lyft, and SpaceX combined. Every day around 15 million rides are taken across 500 cities in 78 countries.
Everywhere from Silicon Valley to the southern tips of Africa to the kangaroo corners down under, your ride shall only be a few taps away.
Uber is so successful because it’s so convenient. Anyone from its vast network of 2 million drivers shall be at your service in the blink of an eye. Open the app and choose a ride. Standard or luxury or in India, a ride in a rickshaw. Soon we may even travel in flying taxis! Talk about being a part of the Jetsons!
After your ride, you rate the driver and they rate you. 1 through 4 stars depicts a horrible experience, whereas a 5 star is on average mostly required to indicate optimal satisfaction.
Anything less than a 4.6-star on average can get a driver deactivated from the company’s list of drivers, which is still better than Netflix’s thumbs up or down in my opinion.
This is how Uber calculates your fare: Start with a regular base fare + (Per minute rate X time spent inside the car) + (distance X per mile rate) all of which depends on the city. A $40 ride in Tokyo costs about $3.20 in Dhaka and $1.62 in Cairo. Add the booking fee, and possibly airport toll cancellation, claims, and lost item fees to arrive at the concluding sum which may occasionally bamboozle the best of us.
Unless there are riders and not too many drivers, then a multiplication with a surge factor occurs. 2, 3, or on New Year’s Eve 2011, 7 times the normal price. And as we know, algorithms can be manipulated. If a lot of drivers log out at the same time it creates a shortage and causes prices to surge unnecessarily! It also uses machine learning to track user behavior, and how much they typically pay for similar routes.
Despite this, Uber is almost always cheaper and faster, and in most cases easily accessible. It challenged a century-old conventional business, sprinkled a dose of technology into its inefficient framework, and reinvented the wheel for an optimal future.
During the great depression of the 1930s, which was neither great nor depressing enough for the elites but devastating for the masses. Every fourth American was unemployed and desperate for work, especially, low-skill, low barriers to entry jobs. So, they resorted to driving taxis. But few people could then afford a ride. But with the mismatch of supply and demand, drivers weren’t getting their dues in a perfectly competitive market.
This led drivers to protest and required government intervention to strengthen the licensing process. This led the authorities in New York to write and implement the “Haas Act”, which stated that to legally operate a taxi an individual would require one of 17,000 licenses called “medallions”.
But 83 years later, with a million more people, it is only around 14,000. You can see the problem. The number of medallions issued is more political than it is practical. Before extreme competition made prices unsustainably low. Good for drivers, bad for riders. Then the pendulum reversed. Too little competition made operating taxis inefficient. This highly benefited riders and continued to damage the earnings and morals of drivers.
One medallion, the right to operate a single taxi was once worth over a million dollars!
But due to the oversupply of drivers on the road, empowered by the likes of Uber, who do not require medallions, the typical taxi industry has taken a beating. It has drained the value of medallions drastically. High competition, low prices, and angry calls for further regulation.
This time we might not be in an economic depression, but two-quarters of negative growth does indicate a recession is on the cards meaning many new drivers could be out on the road avoiding a dead end to feed their families.
For you and me, Uber is revolutionary. The low prices of the last decades plus the magic of technology have reduced our pathetic waiting times near a taxi stand.
But if you ask the average Uber drive what they make per hour, they point you to a particular study titled, “An Analysis of the Labor Market for Uber’s Driver-Partners in the United States”( https://www.nber.org/papers/w22843 ) which states that the average per hour wage is $19.19. Not too bad considering a side-gig for most. Unless you look under the hood. What they don’t include is the car, its depreciation, maintenance, gas, and fuel expenses along with the vehicle’s insurance. Sounds scary right? It actually is because these charges bring down the median hourly earnings of a driver to around $8.55.
Another study titled, “The economics of ride-hailing: Driver revenue, expenses, and taxes”, showed that “per hour worked, median profit from driving is $3.37/hour before taxes, and 74% of drivers earn less than the minimum wage in their state.
30% of drivers are actually losing money once vehicle expenses are included. On a per-mile basis, median gross driver revenue is $0.59/mile but vehicle operating expenses reduce real driver profit to a median of $0.29/mile.
For tax purposes, the $0.54/mile standard mileage deduction in 2016 means that nearly half of the drivers can declare a loss on their taxes. If drivers are fully able to capitalize on these losses for tax purposes, 73.5% of an estimated U.S. market $4.8B in annual ride-hailing driver profit is untaxed”. The analysis involved over 1100 drivers from both Uber and Lyft who provided detailed vehicle information and insights about the ride-hailing industry’s giants.
As a result, it’s evident that around 54% of drivers are making less than the median wage. 8% actually end up losing money! But some might say, “Uber is supplementary, it’s a great side hustle between jobs.”
Although it’s mostly true for 60% of the people who have a primary income source, the freedom Uber provides is one of the main reasons people sign up for such schemes. The drivers aren’t considered as employees but independent contractors, who aren’t provided minimum wage, gas reimbursements, overtime pay, breaks, collective bargaining, paid-leave and health insurance, and other company benefits most employees are entitled to.
This would end up costing the company $4 billion a year. Uber simply acts as a facilitator connecting drivers to riders. But Uber does control the prices. If drivers are independent contractors, Uber fixing the fares could be considered price-fixing, a violation according to certain government regulations around the world.
But something doesn’t add up. The golden age for drivers came from regulating competition the same regulation Uber spends millions of dollars fighting, going back to the days of high competition and pricing.
If Uber takes a cut from drivers, their interests should be the same. Regulations slow down its growth, but there’s also another reason.
Drivers compete amongst themselves, but Uber makes the same competition regardless of who picks a customer up. Uber makes more money with more drivers, but drivers prefer having fewer drivers to compete with. The same theory that Amazon vendors have when it comes to selling their products on Amazon. Amazon continues to get a cut from the seller’s final earnings, but the vendor has to compete with thousands of others online to get his/her product through to the final customer.
As long as Uber continues to find more drivers, they can continue to keep fares low and still profit in the long run. The real winners of “The Haas Act” weren’t cab drivers who couldn’t afford million-dollar medallions, but their owners. Instead of drivers giving away their first $100 a day to rent a medallion, it’s around 25% of the fares all-day now. For many drivers, it is still a useful opportunity. But it’s not a ground-breaking revolution that was once promised. The chances of its survival are slim.
On paper, Uber has the perfect business model. Its huge network of drivers occupies all corners of the globe, but it need not buy a single car, gallon of fuel, or pay for maintenance. All the perks for minimal works!
So why exactly did Uber lose money early on?
The same reason why many start-ups lose money early on. Many start-ups sacrifice profit for growth.
The company’s main issue isn’t frugality or controversy, but basic potholes in its business model. The magic of so many companies is the ‘network effect’. Every new customer makes it that much easier to get another. I joined Facebook because my friend Riasat was on it. He joined Facebook because his friend Ayman was already a member.
For Uber though, this is only regional. More drivers in New York do nothing for Dhaka. Every city is a new chicken-egg problem. Riders need drivers, and drivers need riders. This vicious circle keeps profits low in a skeptical society. It’s inescapable. Hence one way to obtain higher premiums would be to remove the driver altogether!
Tesla and GM are already working on it, but will my boy Elon Musk manage to launch an app to outweigh Uber itself? I don’t know, but a journey to Mars for a low fare is certainly a trip I’d fancy!