As of September 2015, Uber (UBER) has raised $8.2 billion through thirteen rounds of venture capital funding. That is an unprecedented amount of money considering the company was only founded in 2009.
I'm a financial advisor, and in our industry, we all talk about that moment when we're standing around at a social event and someone says, "So what do you think about "Uber?" The room will suddenly go quiet while everyone looks at me. What am I going to say? Right now, we have a rare opportunity at a critical pre-IPO stage to gain a better understanding how Uber's Blue Ocean business strategy works step by step.
I was relentless with a hands-on fundamental trading approach and examined Uber's basic and most popular domestic service model UberX. Is Uber's business model sustainable? Over the last ten months, I lifted the hood and dug deep as an UberX driver taking 1,500+ trips over the last twelve months. Right now, I can answer that cocktail party question by saying what I found is that Uber's long-term outlook appears to be highly profitable ... in theory. Practically speaking, Uber has a few very serious flaws that, unless addressed, could stunt the company's massive expectations and long-term growth. We are also hampered because of Uber's lack of transparency. Its policy is not to release any real market figures concerning the sales cycle. I make no recommendation but caution that you need to know what you don't know.
Uber is the six-year old monster in the sandbox that is defining a new business model with new technology. The cutting edge, privately-held rideshare company, which acts as a taxi dispatch service, created the lead generation software platform that has been steadily gaining market share worldwide with a focus on the new way things are done. Uber is a ridesharing service that matches the consumer looking to pay for a ride with a driver seeking paying passengers. The company's platform is built on a smartphone app and acts as the intermediary by monetizing the exchange for a percentage.
In the sharing economy model, anyone can monetize an asset they own, provide a service based on that asset and participate in the economy as a compensated service provider. What are the clear-cut ramifications on the economic cycle and on the specific business and competitors? What are the social and economic impacts? What does this business model mean for a market economy?
According to Uber, the three basic services it provides are: to make cities more accessible, give more possibilities for riders, and create more business for drivers. While the open market normally dictates choice, it can be argued that Uber's long-term impact and cost to local economies need a much deeper look. Its business model as the new way to take a cab is not revolutionary. Uber's business model as the new way to take a cab that has been replicated in markets worldwide is.
Uber's shares - Where is the trade? For the foreseeable future, there is none. At some point, the company's IPO will happen, and I have to be able to speak intelligently about the subject before and after the offering. There are commodity traders at the CBOT who drive out to that one field in Indiana so they can stick their finger in the earth. Are the fields too dry? Too wet? How does the crop look? They want to know with their own eyes, then they can decide what position they are going to take on the upcoming grain contracts. I took that fundamental trading approach.
I ventured onto the streets as an Uber driver and set out to take 1,000 trips, talk to 1,000 riders, and take 1,000 notes. My goal was to see if Uber's UberX business model and the ridesharing concept work. Who are the service providers that use their own vehicles and what void is Uber filling? I needed to collect enough data so I could understand if this is a one-hit wonder or a long-term market changer. Uber isn't alone in providing ridesharing services; in my area, since Uber is the leading provider, I chose it. I drove random hours, days and nights, weekdays and weekends, 3 p.m. and 3 a.m. I wanted to know everything I could about Uber, from the client's perspective, the driving experience, operations and see the impact on the street.
Full disclosure: At times, this was like bartending on wheels. I had fun. It needs to be said at times it was very hard work, and I learned a great deal. Someone once told me that everyone at some point in their lives should wait tables. I would add that everyone at some point in their life should wait tables and drive a cab or Uber.
Uber Is Risk Management
Uber for the consumer is risk management. The company is attractive because it is easy and also cheap. Effectively and efficiently, it removes the timing risk when you need to go somewhere local and you are not able to drive yourself. Although yes, public transportation and taxi cabs are available, each of those options comes with unmanagable risks. City buses can be at best limiting and at worst unreliable. Taxi cabs may be nowhere around when you need them most. Uber removes those concerns and worries by providing accountability and managing expectations to the minute. No more worries about last minute carpool duties when you have Uber. Uber is reliable, quick, and most importantly in this industry, it is constantly available. Uber can also be counted on to provide client connection and the culture of friendliness. An open concern is will this risk management translate into consumers willing to ultimately pay more?
Uber for the driver "business owner" is also risk management. The transactional business model of monetizing a personal asset is the driving force of what is referred to as the sharing economy. Risk management because there is already the need and ownership of a vehicle, which hopefully was not bought simply as a means of becoming a business owner. Ideally, an Uber driver is simply monetizing the ownership, and their free time, in a cost-effective manner. Inefficiency for a driver is whenever the meter is not running and/or prolonged periods of no passengers. Now the driver/business owner has the ability to control the customer flow by paying a percentage to the rideshare service middleman. Uber's current platform plays matchmaker for those looking to pay for a ride with those looking to be paid for providing the ride. The entire transaction from client search, transaction to payment is tracked to an exact calculation through an app on the smartphone. Drive as much or as little as you want bearing in mind Uber's once-a-month minimum in order to stay active. To be clear, Uber's contract with the drivers' state it is the driver's limited payment collection agent solely for the purpose of accepting the Fare and applicable Tolls.
A Compelling Purchase
The sales cycle is devastatingly easy and quick. If you are in an area serviced by Uber, all you have to do when you need a ride is open the Uber App that you subscribed to, pick your level of service, and order your Uber. The estimated wait time is built into the app for your convenience and reflects the current availability of a driver. At the same time, you place your order, the nearest Uber driver is pinged on their Uber Drivers App and has the option to accept your request. If both parties agree, a short time later, the driver arrives at your pickup location. That driver will be driving his or her own car to take you to your destination and get paid for doing so. When the driver shows up, they click on "start trip" on the app so the Uber App can determine the fee by measuring the distance traveled and the elapsed time of the trip using the GPS function that is tied into the app. At the end of your trip, the passenger's credit card on file is billed and the driver receives the credit for the trip, plus tolls, minus Uber's percentage and fees.
Breaking down Uber's most common domestic business modes, we see they currently offer several types of car services listed from least to most expensive: UberX is the cheapest and most commonly used with vehicles containing at least four seats and a model year 2000 or newer. UberX's drivers (predominantly non-professional drivers) go through and are held to a bare minimum of accountability and oversight. No daily time or mileage restrictions; they are not required to be commercially insured or licensed. UberXL seats at least six passengers and the car will be an SUV or a minivan. UberPlus/UberSelect is a luxury sedan that seats up to four riders. UberPOOL is a carpool for adults; share your ride with another person and split the cost. This service is only available in select areas. UberBLACK (Black Car) is Uber's luxury car service. These are commercially registered and insured livery vehicles. UberCab is the service where existing licensed cab drivers subscribe to the Uber platform.
In my market, Uber currently takes 20% of the UberX drivers' total weekly fare totals plus $1 for each fare. Uber's take for the premium services from the drivers ranges from 25-28%. The company has been testing several markets for a tiered payout structure that would mean lower payouts for the drivers. The level of oversight and licensing requirements required by the drivers is different in each category. UberX drivers have a minimum hurdle of entry and very minimal oversight from the management, which might present additional liability concerns.
What The Investor Needs To Know
Driver fatigue is one such potential liability; a common scenario has drivers that work 8-12 hours in their "day job" and then go out and drive Uber for another four to six hours. Another person might drive Uber 24-36 hours nonstop. Professional drivers are held accountable and required to keep logs of their working hours to prevent catastrophic driver fatigue. They are also required to submit to random drug testing.
In my experience, I was not faced with any current mechanism in place to monitor these factors. Uber could easily implement a solution since all driver access to the network is monitored. The company could simply set a network policy to restrict driver access after a predetermined maximum continuous driving shift or restrict the maximum total driving hours in a 24-hour period. If Uber implemented these policies, however, that would mean fewer drivers driving fewer hours collecting fewer fares resulting in a smaller profit for Uber. Based on my experience and rider feedback, this is a potential public safety issue and a call for greater public scrutiny and government oversight.
The company's revenue model is 100% dependent on its product being delivered exclusively by drivers who are independent contractors. According to Uber, it is a technology service, not a transportation company. Uber's contract of service partner agreement states that each driver is an independent contractor. The company states that the Uber Services enable an authorized transportation provider to seek, receive and fulfill requests for transportation services from an authorized user of Uber's mobile applications.
According to the State of California in a recent case, each Uber driver was determined not to be an independent contractor per Uber's partner agreement, but an employee of Uber. The findings by the State of California might have a point. The IRS says that "You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done)." Unless different findings are given upon appeal, Uber does appear to control multiple key functions of the relationship and Uber's claim that drivers are independent contractors will not hold up. The California ruling that has drivers being classified as employees raises the stakes significantly against Uber's current revenue model. As employees, the scope of liability could increase dramatically for Uber. It remains to be seen what the long-term impact on the business model and economics for the company will be.
Greater profit and reduced liability is why Uber wants its drivers to be independent contractors. The company has taken the stance that its drivers are independent contractors, which translates into a revenue model that maximizes profits and minimizes liability. An independent contractor receives a gross wage for the accomplishment of agreed upon work. In this arrangement, the entire tax burden falls 100% upon the independent contractor, the Uber driver. As an employee, the wage earner receives the net pay after all state and federal taxes are taken out, including the portion for matching employee, unemployment etc. paid by the employer for the employees benefit. Although from the time a driver accepts a trip until completion, Uber provides the driver a basic master policy coverage option. A driver who is an independent contractor gives Uber a layer of protection from liability whereas an employee does not. If the California judgment sticks, and the company is forced to treat drivers as employees, its entire UberX revenue model could be at risk.
In a strategic move to capture market share, Uber under-prices its service in every market. The standard tariff for UberX on a regular weekday is published, and that number is significantly less than the market rate that local taxis would charge. The catch is when supply and demand, 2 a.m. Friday and Saturday nights when the bars close, comes into play, Uber deploys "surge pricing." This increases the passenger fees in multiples based on Uber's proprietary software. Without surge pricing driving, UberX is a minimum wage job; with it, driving UberX can be attractive. According to Uber: Surge is Uber's way of making sure that the platform is reliable 100% of the time, 24/7. At times of peak demand, prices increase to encourage drivers like you to head that way! Riders pay more, drivers make more, and everyone can get a ride.
Uber controls the surge pricing; surge is balancing the flow of customers with the availability of drivers, between with floating price point. Drivers and consumer alike are told it is simply a supply and demand issue. Airlines and Amtrak all use this model and now Disney (NYSE:DIS) apparently will be rolling out surge pricing in its parks. The market rules for the consumer when UberX surge pricing lights up, here is the price, feel free to not order or wait it out until the surge is over. The market allows the drivers to see the surge areas and adjust their locations to be in those areas and take advantage of more lucrative fares. The byproduct is when surge pricing is turned up, the Uber premium services become more attractive as the price curve flattens. Since Uber takes a higher percentage from the premium service drivers, there might be an appearance that the company is manipulating the surge pricing in order to drive more customers to the premium service? Uber took a public relations beating during Hurricane Sandy when surge pricing escalated to the point of allegations of price gauging during a national emergency. Lesson learned - Uber suspended all surge pricing during the recent Baltimore civil unrest.
Uber had a recent legal challenge that could be an ominous sign; Philadelphia decided to ban Uber. This appears to be within Philadelphia's right to license any and all fee for hire transportation services within its boundaries. I could imagine a court case winding its way through the US Judicial system regarding this issue, and what if the ultimate ruling upholds a municipality's right to ban Uber? London, Paris and other cities have their own policies of requiring all professional drivers to obtain licensing by passing stringent exams. The ability of a municipality or governmental agency to arbitrarily ban a ridesharing service might be a red flag regarding the long-term stability of Uber.
Since drivers are Uber's service providers, the apparent low retention rate is a concern. The company doesn't disclose the numbers, but the high turnover between the three- and six-month mark that I saw appears to reflect a reality that when new drivers have enough trips under their belts, they are able to differentiate between Uber's advertising of "making life changing income" and the hard costs of the of running one's own business using their own car. In this day and age surprisingly, the company does not provide a published Terms of Service, code of conduct manual to the drivers.
C-Suite Vision Versus Reality
Social engineering - Uber wants to ensure they provide service to everyone and they designed their platform to prevent a driver from denying service to underserved and ethnic neighborhoods. During the recent unrest in Baltimore, Uber drivers faced serious safety concerns. I sent several emails to Uber asking for clarification of the terms of service every driver is expected to uphold. I was answering calls in areas that were suddenly overrun with unprecedented gang violence. I received a response from Uber operations reminding me that in the Partner Agreement every driver is expected to provide service without exception to every neighborhood in the service area. Until that point, I never had any issues or concerns for my personal safety in any Baltimore neighborhood any time of the day but that week things changed quickly and for the worse.
This situation was potentially dangerous and called for prudence. I emailed Uber operations and proposed that it consider coordinating with local police to determine if service should be suspended in any areas the local police felt were too dangerous. While my email was not acknowledged, I did get an answer more than once from a different source. Several times while driving in neighborhoods where violent crimes had just been committed, I was pulled over by Baltimore PD and asked politely to leave the area immediately for my own safety. I respect the mission statement that Uber is trying to serve all communities equally as well as the greater good. I respect more the Baltimore PD when it advised me to leave a dangerous area immediately. Sound corporate governance might suggest that safety is paramount to a mission statement.
Uber's apparent aggressive growth strategy has been promoting special car finance arrangements including very interesting sub-prime lease payment options to get more potential Uber drivers on the road. Uber's finance initiative aim appears to remove the barrier of entry and might lock in drivers from leaving for other rideshare companies. This arrangement conveniently ties in the weekly Uber driver payments to a weekly auto payment for the sub-prime lenders. I have a concern when your paycheck is tied to your house or car that your boss had sold you.
Social Impact And Unintended Consequences
I expected to find the typical Uber client to be hip, young urban male professionals, predominantly white and middle class to wealthy. What I found I believe bodes well for broader market appeal. In my experience, the majority of passengers in my market were women, often older and working class Hispanic and African-Americans. The Friday night and Saturday night drinking crowd is legendary with Uber, but what isn't spoken about is the crucial inexpensive transportation option that the company provides working women and men. The local public transportation system is limited in how it can serve the population. A trip across town using buses and trains may cost a person $3-5 in fares and 2+ hours in time each way. With UberX, they may pay $7-8 for 15-20 minutes door to door. Uber provides an affordable, reliable, and efficient transportation service for lower-income Americans; this is the hidden gem. Is the pricing model of UberX a loss leader? A thought is if Uber can maintain a low-cost market option for the UberX model that may be the key to its ultimate sustainability. What will remain to be seen is if Uber, after securing long-term market share, begins to raise its pricing models to a captured audience.
Thanks to the Uber culture, the public has learned that they can leave their cars at home and take Uber when they go out drinking. I would like to see studies on the correlation of the number of DUIs in the markets that Uber services versus non-Uber areas. I would imagine we would see a decrease in arrests and fatalities. Regardless, if this benefit is an outcome that came about by design or as an unintended social consequence, the result has the potential for being a significant contribution to society.
Driving Uber - The Real Math
Uber's real job creation is debatable. Claims on the website that you can turn your car into a "money machine" and you can "cash in on the action" did not hold up as accurate, based on my experience. Uber has been exceptionally aggressive with recruiting drivers; retention is a different matter. I've frequently seen ads in print, radio and TV that claim "make $1,500 a week driving for UberX." The sampling of the drivers I spoke with in my area and my own experience tells me that the net pay after all drivers costs are covered, gas, depreciation, state and federal taxes, tickets, dings, wear and tear etc. and Uber's cut, works out to about $10-12 an hour to full-time drivers over the course of a 50-hour work week. The calculation for a typical UberX driver in my market: Drive 50 hours in the course of a week, averaging $20 an hour in generated fares to generate $1,000 gross fares. Uber takes 20% and a $1 fee per ride paying the driver $667 for the week. All in on the UberX platform that averages out Uber's take to approx 33%. Cost to the driver in gas, approx $1 a mile driven, $100. Cost to run the vehicle including depreciation, wear and tear, tickets, misc., $5,000 a year, $90-100 a week. This translates to an approximate hourly rate of $10 and about $25,000 annually.
A good accountant might be able to tweak expenses and there might be additional deductions to be considered. At the end of the year, the driver still has state and federal taxes to pay on income earned. No benefits, no paid time off. Uber covers the drivers with a blanket policy in the event of an accident, as long as you were either responding to a call or in the midst of a call. If a driver gets into an accident however, they are on their own; Uber does not even provide them a complimentary ride home. Great for Uber, not so great for the driver who most likely won't stay for very long, which makes it not so great for Uber's bottom line long term.
Sustainable - Maybe Yes
So now, back to the original question: Is Uber's business model sustainable? Yes, under these circumstances: Even if you go through the fundamentals with a microscope and find reasons to be concerned with Uber, there is the real fact that this is a behemoth. Its product is an impact service, and right now, it is selling globally. Right now, it is also raising an enormous amount of cash, especially considering Uber was founded in 2009. We should expect Uber to grow real market share for the near future, but after that the market will dictate the next innovation.
The company's current business model appears to work in a poor economy. With a record number of people not participating in the workforce, the driver compensation provides a parallel wage replacement. Uber is dependent on the driver as the service provider, but what will it do when the economy improves and drivers migrate to higher-paying and more stable jobs? Maybe the solution is found in the published stories reporting a strong push by Uber to develop a driverless car. What doesn't build trust are comments made by a top Uber executive intimating that it can cut driver commissions at any time "because it can."
Sustainable - Maybe No
Is the UberX model sustainable? No, under these circumstances between liability and antitrust issues, ultimately Uber may be forced to spin UberX off. According to Uber, it provides an on demand lead generation to independent (transportation) providers of ride share/peer-to-peer passenger transportation services. It wouldn't be surprising eventually to see Uber offering a subscription service for any qualified driver or livery company to use their backbone on a fee service, but without Uber being a direct service provider. There are already markets that offer the "Uber Cab" option through local taxi companies. Considering compliance issues, I wouldn't be surprised if the company's premium services would adapt to a higher level of scrutiny through internal tracking and mandatory driver licensing.
With the California state ruling that declared Uber drivers to be employees, the company now has to factor in the enormous related expenses. How can a business sustain itself if the entire sales cycle at the point of transaction passes through a bottleneck with only one delivery option and the cost of providing that specific point in service is now in question? Through an in-depth exploration of Uber as a business model, including my time spent as an UberX driver, I discovered the discrepancies between UberX as an advertised business model and UberX in real life.
Price manipulation is also a concern. When Toyota (NYSE:TM) opened its Lexus line, it started by selling its only model (what was to become the 400) for well below market to comparable cars. It set out to gain market share and was accused of price manipulation until it could raise its prices over time as it gained market share. We have seen Uber adapt this approach by entering a market at higher tariffs and over a short period dropping its prices significantly to gain exposure and market share. When the eventual fallout of local competitors happens, how much can we expect to see Uber's prices to increase? As a business strategy, I am concerned about potential antitrust issues when an international conglomerate controls a significant chunk of local transportation.
Uber's strategy appears to be to open in new global markets, offer hip, cheap alternative for transportation and attack the existing laws of the land that prohibit this type of unregulated service. This is not the first time we have seen slash-and-burn marketing with the results appearing to be working domestically while crashing very publicly overseas. My concern is, as a self-described lead generation platform, Uber doesn't produce anything. Uber created a logistics platform that is disseminated on a smartphone app. There is no widget that it makes in a factory. Eventually, someone will build a better mousetrap, and we will see if Uber is as successful as Microsoft (NASDAQ:MSFT) was in buying up smaller ideas.Where do we go from here? Google, Facebook and now Uber each created a new business model that embraced an emerging technology.
The greatest threat to Uber's sustainability is Uber itself. The question I am hearing from astute investors is will Uber's C-Suite survive the IPO? If we look back to other models that introduced both new tech platforms with new tech products such as Microsoft, Apple (NASDAQ:AAPL) and lately Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB), we see the line of success linked with stability and maturity. Founder's syndrome hit Apple due in part to a lack of maturity at the cost of the direction of the company. Apple later righted its ship, but it was almost too late. There is a legitimate question stemming from a stream of immature comments out of Uber's C-Suite as to whether or not it will survive long-term post IPO when a very different set of rules comes into play.
It is important to understand from a regulatory perspective the impact of an unregulated business model providing a public service. The State of New York I don't believe gets caught up in the hip factor with Uber or other ridesharing options. What is important to the State of New York is that Uber's fleet is ADA compliant. New York has been working for years to bring the aging fleet of cabs throughout the State into compliance so it can truly serve the public and has in place guidelines to ensure this. Not only are cabs at a competitive disadvantage, but also progress the American with Disabilities Act has brought into the public transportation sector is seeing a setback because UberX does not have to comply with ADA guidelines.
New York State also has a serious concern of significant lost revenue from Yellow Cab per-ride fees. New York has been struggling to tell the story of the economic impact on the loss of this revenue, how much and what this revenue is earmarked to pay for. This is a very real impact on our economy and begs for greater transparency. By adopting a usage tax in the taxi and livery business, New York is able to spread the burden and encourage small business. Currently, Uber is circumventing this, and the question is why and for how long.
Are we seeing the end of the Yellow Cab? No, but like with any other business presented with serious competition, it is being forced to change. I have a personal perspective in that my father-in-law was a Medallion NYC cabbie and drove for years to support his wife and seven kids. I learned from him there may not be a more difficult and thankless job day after day. Some citywide cab systems were proactive and have already adopted Uber as their dispatch service. I have no doubt there will be fall out until these type of personal transportation services work themselves out. The model that Uber deploys has already been replicated and will constantly be under attack in a healthy market economy.
One strategy that I have not heard, but that could be a game changer is an eventual partnership with Uber or other ridesharing services being contracted out by local municipal transportation authorities. These agencies are often limited by aging infrastructure and limited budgets to serve the public. The working poor who are most reliant on public transportation are often limited in taking advantage of income growth opportunities for lack of time and money that their local transportation authority can provide. I saw in my travels, the weakness the local system has in providing cost effective and efficient east-west travel options and the role that a ridesharing option fills. We talk a great deal about hanging realities for the working poor in urban America, this is a market-driven option that is working.
Is Uber socially responsible or is Uber a predator? The current state of Uber is similar to Apple and Microsoft in the 1990s when Apple was far and away a better consumer product with a legion of socially conscience fans while Microsoft was painted as the evil empire. Apple was seen as cutting edge, and Microsoft seemingly brought to the market an OS and software that was often seen as poorly designed and executed with no vision. When it came to Apple and Microsoft hip wasn't always it. Microsoft ended up with 90% of OS market share before the Justice Department stepped in and forced it to essentially bail out Apple by ensuring AAPL retain a minimum market share. Apple survived and then prospered, but that happy ending wasn't guaranteed.
Recently, I was whisked away blindfolded to an unknown location. In front of a campfire on a moonlit night, I was sworn into a secret, but inclusive society and awarded a secret decoder ring app in recognition for my 1,000th trip driving for Uber.
During my trips, I made it a point to tell my passengers about my project and get their feedback. After 1,500+ rides and my secret decoder ring app I am able to conclude a few things: Uber and the other ridesharing companies have had a profound impact. There is a need for ridesharing. There is a market, and there are products/services that address this need. Consumers are buying the product over and over again. Uber is here, but its challenge is to keep the next innovation in its market space from turning it into yesterday's Yellow Cab.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.