I recently read “Super Pumped: The Battle for Uber” by Mike Isaac. In this piece of investigative journalism, Isaac exposes the scandals behind one of the world’s largest former unicorns. I learned how Travis Kalanick built his position in the company and was subsequently ousted, how Uber cleverly escaped regulatory hurdles, how the #DeleteUber movement took off, and why the company failed in China. The book was entertaining, and it was undoubtedly a page-turner for me.
As Isaac tells the tale of Uber, he also piqued my interest in ride-sharing. The industry is rife with unicorns and well-known household names like Uber, Didi, Grab, and Ola. These companies are flush with cash, but are they profitable? Why do many of them branch into adjacent services? What’s the big deal about autonomous driving?
I decided to set aside time to research the industry. Here are my top five takeaways.
1) The unit economics of ride-share shows that it is insanely hard for ride-hailing companies to make money.
I ran a unit economics analysis of Uber and Lyft, referencing the IPO prospectus that they had filed in 2019. For Lyft, the loss on each ride was $0.93 (2017) and $0.37 (2018). For Uber, the loss per trip on a pure-direct cost basis was $0.02 in 2017, and it turned positive in 2018 (Figure 2).
Ride-hailers have limited levers to increase profitability. The revenue that ride-hailers pocket from each booking called the take rate determines the top-line performance. While ride-hailers would like to raise the take rate, they risk drivers leaving their platform or breaching minimum wage guidelines in certain jurisdictions. As an industry average, the take rate is approximately 22.5% (Figure 3).
Aside from the payments and incentives to drivers, the next largest cost item is the cost of revenue (COR), followed by sales and marketing expenses. COR primarily consists of insurance costs (typically required under city regulations), payment processing fees, and platform operating expenses (such as hosting data centres). As the ride-hailers scale, COR is likely to increase. However, they may be able to gain bargaining power and negotiate for better rates, although the impact on profitability is probably small.
Ride-hailers may have room to adjust sales and marketing expenses. However, cutting promotions is certainly not the wisest decision considering that ride-share platforms are susceptible to multi-homing. After all, loyalty is a somewhat foreign concept in the ride-share industry. Open two (or more) apps, compare the prices of the ride, and check if any discount codes can be applied. Sounds familiar? In the competitive ride-share industry where the service offered is like a commodity, users typically gravitate towards the platform with greater discounts or incentives.
The need to provide drivers with pay and incentives coupled with the massive spending on publicity to attract riders make for weak unit economics and an arduous path to profitability.
2) Ride-hailers strive to scale to strengthen the value of their network. The more users, the more powerful the network effect.
The concept of network effect frequently appears in the discussion of businesses with marketplace models. What it essentially means is that a network becomes more valuable as more users, in this case, drivers and riders, use the service or product. The following chart illustrates the importance of network effect to ride-hailers (Figure 4).
As drivers sign up, ride-hailers can increase their geographical coverage and reduce average wait times for riders. More riders will be attracted to the platform, and this creates a higher earning potential for drivers as they service more rides. More such drivers will come onboard the platform to seize the earning opportunity, and the cycle repeats to strengthen the “flywheel.”
Understanding network effects puts the competitive ride-share landscape into perspective. Ride-hailers need to scale rapidly to enhance their network effects. Therefore, many aggressively dish out promotions and incentives to entice more users to their platforms, especially when they enter new markets. When a new entrant arrives with discounts, the incumbent also tends to match the incentives to compete. As a result, sales and marketing expenses are typically significant, and ride-hailers hardly have room to lower them. Similarly, there is a ceiling to how high these companies can increase the take rate without risking drivers leaving for competitor platforms.
3) Ride-hailing companies are eager to increase user stickiness. They typically achieve it by offering adjacent services and loyalty programmes to keep users within their ecosystem.
Bringing onboard users helps to achieve scale. But that alone is insufficient. Ride-hailers also need to sustain the scale.
Maintaining the scale is a challenging task because of multi-homing, which describes the scenario where users connect to multiple platforms at the same time. Multi-homing is pervasive in the ride-share industry because the switching costs are low. The rider simply has to download two (or more) apps and register for the accounts. Both steps can be performed within seconds. It may be slightly more tedious for the driver due to the background screenings. But once they have completed the checks, subsequent multi-homing becomes almost effortless.
Therefore, ride-hailers attempt to increase the users’ stickiness through building switching costs to drivers and riders. One common way to achieve this is by introducing reward programmes tied to the amount of usage to incentivize users to accumulate points for redemption. As users collect more points, their stickiness to the ride-hailer intensifies, and it becomes exponentially more “painful” for them to leave the platform.
For instance, the GrabRewards programme places users into four tiers depending on the number of points accumulated from their transactions. Each tier accords a different set of benefits to the user, ranging from discounts to priority services and partner exclusives. While Grab started as an app for transportation, it has gradually extended into other areas, including payments (through GrabPay), food delivery (through GrabFood), as well as other digital services (through partnerships with heavyweight companies like Bookings.com and ZhongAn Insurance). These efforts, part of Grab’s ambitions to be a “super-app,” increase the touchpoints with users to enable transactions and keep them glued to the platform (Figure 5).
Another example that I particularly like is Didi’s initiative to keep drivers within its ecosystem of services. Didi has an automotive solutions business, called Xiaoju Automobile Solutions (XAS), that is a “one-stop” automobile solutions provider. Services offered include leasing, vehicle insurance, financing, refueling, maintenance, EV charging, and even roadside assistance. Drivers can access services from more than 7,500 partners on XAS. Such scale and convenience is unrivalled and incentivizes drivers to stay with Didi.
4) The ride-share industry has seen a rationalization of competition, and it is largely a winner-takes-all-market.
It is apparent that vital to the success of ride-hailers involves two things — (1) attain a mass of users quickly, and (2) keep the users within the ecosystem. The former is arguably more critical and requires aggressive spending on incentives, promotions, and advertisements.
However, not all players have a deep enough war chest to support the expenditure. Or not all of them have investors who are patient enough to withstand prolonged bleeding. We have witnessed examples of ride-hailers entering a particular market, failing to capture market share, and retreating the market to cut losses. Consider the case of Uber in China. The company entered the market in 2014 and reported to be burning over US$1 billion a year in China competing with Didi. It eventually exited the country in 2016 and sold its operations to Didi.
There has been a rationalization of competition, and the industry has primarily consolidated to one or two players in each region (Figure 6).
After the ride-hailer has achieved supremacy (or is sufficiently confident that it has achieved dominance), it may decide to adjust parameters to find its way towards profitability. The ride-hailer may consider increasing the take rate, lowering the sales and marketing expenses, and implementing other cost-cutting measures. For instance, Grab, having established a majority market share in Singapore, tightened its rewards programme in 2020 to cut expenses.
5) Autonomous vehicles (AVs) have great potential to lower barriers to entry and transform the mobility industry.
The winner ride-hailer deserves credit for forcing competitors out and gaining majority market share. However, there is no room for complacency. The competitive landscape could be altered with the advent of autonomous driving.
AV is a double-edged sword for ride-hailers. No doubt, AVs bring many benefits to ride-hailers. Firstly, ride-hailers can lower the cost of operating ride-share. Today, the driver pockets, on average, 77.5% of the gross booking fee in the form of salary, incentive, and other benefits, which is by far the most significant expense for ride-hailers. Ride-hailers can expect their unit economics to improve significantly without the need to pay drivers.
Secondly, AVs facilitate market expansion. Ride-hailers no longer have to recruit drivers in the new market. Instead, they simply have to co-locate the supply with demand by moving the car.
Thirdly, ride-hailers can free themselves from the regulatory challenges and the cost of compliance. For instance, Uber has long been embroiled in debates over its decision to classify drivers as contractors instead of employees. When Beijing and Shanghai required drivers to have a local hukou, Didi scrambled to conduct the necessary checks to comply with the new regulation.
However, AVs also carry a potent threat to the ride-hailers, and that is the potential to disrupt the industry. Today, the barrier to entry is the network of drivers and users. AVs eliminate the need for drivers and make the network effect vulnerable. What is required to operate ride-share is simply to have a ready fleet and an algorithm to match them to riders. Therefore, AVs open up entry possibilities to a wide range of companies, and the AV industry has seen a surge in interest and investments in recent years (Figure 7,8).
There are broadly three groups of interested parties vying for a share of the mobility pie. The first group is the ride-hailers who wish to reap the benefits of AVs as described above. The second group is the automakers and original equipment manufacturers (OEMs) like Volkswagen, BMW, and Toyota, who already have control over supply and strong dealer networks. The third group is the tech giants like Google, Apple, and Baidu, who are developing intelligence software and hardware to enable autonomous driving. All of these participants are rushing to create a robust and safe enough AV tech for mass commercialization.
AV is set to be a game-changer for urban mobility. Most, if not all, of the ride-hailers are involved in some form of AV development. Instead of playing catch-up, the ride-hailers are eager to be the frontrunners in AV, so that they may get a chance to write the rules of the game. After all, ride-hailers have successfully disrupted taxi services in an unprecedented way, so now they must self-disrupt before they get disrupted.
