Uber's Secret Sauce

| About: Uber (UBER)
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Historically, customers have preferred car ownership to all other options, including taxis and public tran.

I believe this is an economic decision, not an emotional one, reflecting the value they place on a specific series of benefits.

All other alternatives have lacked at least some of the benefits car ownership offers.

What makes Uber different is its ability to offer all of the benefits of car ownership.

UberPool means it may also soon be cheaper, which is why car ownership and car sales may plunge rapidly.


I recently posted an article to Seeking Alpha outlining a bullish thesis for Uber (UBER) and Lyft (LYFT). Among my conclusions was one that said that the proliferation of "true ridesharing," that is Lyft Line and UberPool, would cause automotive sales to fall, and that this was why GM (NYSE:GM) and Ford (NYSE:F) would soon seek to enter the ridesharing market before the first-movers got too far ahead of them. Since a lot of readers seemed unsure why I saw Uber and Lyft as so threatening to traditional auto companies, I published a second article explaining more fully why auto sales will be negatively impacted by ridesharing and why the impact would be so substantial.

That article has itself generated quite a bit of criticism, some of it more constructive than others. One in particular, Greg, asked a series of insightful questions about my thesis. I say insightful because Greg had clearly thought carefully about where one might look for real-world evidence to test my theory, as well as some of the conceptual questions behind it.

I stand by my thesis, but Greg raised a number of points that deserve an explanation. The purpose of this article is to address two of them in particular, and explain why I remain convinced that we are on the verge of a substantial reduction in Vehicle Miles Traveled (VMT) in the United States, which must produce a concurrent reduction in vehicle sales.

In His Own Words

In the interest of conciseness, I will not repeat my argument here. The link to my previous article should bring any readers just tuning in up to speed. The simple summary is I believe that our transportation market is rapidly being replaced by a mobility market, which has real implications for all the incumbent players. But rather than risk truncating Greg, and his point being lost, let me reproduce his questions in full.

Is there anything different about ride-sharing vs. other forms of mass transit that would affect car ownership? I mean, if you live in Chicago, own a car and never use it now, why would the availability to take an Uber make you change that behavior? It can't just be price, I don't see Uber rides dropping below the price of a bus token." - GregWL

Let me break that down. There are actually two questions here. One, what makes Uber different from other alternatives to car ownership already available? And don't tell Greg it's just price. And two, if "true ridesharing" is so brilliant, why aren't people already taking advantage of its precursors in the economy, i.e. public transportation and/or simply not owning a car?

Consumer Preference

While there is no doubt that the vast majority of Americans continue to prefer car ownership to public options, I disagree with Greg - and others - about what that means. Rather than signifying any real attachment to the idea of car ownership for the sake of car ownership, I interpret that decision as an economic expression of the value customers attach to a specific series of benefits cars provide.

Consumers seek out a specific list of benefits, and find car ownership, whatever its faults, to be the lowest-cost option that provides all of them. Thus, the other options on the market either lack some of those benefits, or they cost more than car ownership.

Taxi Competition

The closest thing to a complete alternative to car ownership is taxis. Like personal vehicles, they offer convenience - pickup and drop off at a location of the rider's choice - and the flexibility of being available at whatever time the rider needs to call them.

But while they came closer to replicating the car ownership model than any other alternative, they still didn't quite nail it. Traditional taxi companies were both capacity limited and random-routed: to find a taxi you had to be both standing near one and looking at the right time of day when the taxis were not already all taken. Worse, because cities regulated taxi companies to a fixed number of medallions, there could never be more than a particular number of taxis on the road at a given time.

Like any fixed average number, the number of medallions was rarely the right number: there were either too many taxis, like say late at night or the middle of a weekend afternoon; or there were far, far too few, on weekday rush hours and weekend nights. This was actually good for individual medallion owners: fixed supply meant they could charge outrageous prices. But it was fatal to the business of hired transportation as a whole, which never expanded enough to meet demand.

Public Transportation

Of course, as Greg pointed out, public transportation does not have these problems. It is neither capacity-limited - cities can and do put on more buses and trains during rush hour - nor is it random-routed: everyone knows exactly where to go to catch their ride home. And it is far cheaper than a taxi. But it has problems of its own.

Public transportation achieves its low prices by foregoing many of the benefits that people have come to expect from mobility services. First, there is the whole matter of delays: most city dwellers will tell you horror stories about missing meetings because the train or bus simply didn't show up. But what's worse is actually the flip side of the delays.

"Delayed" necessarily implies that there is a schedule to keep and measure its punctuality by. While those who use public transportation are counting on that schedule, it can also be the reason so many others choose not to use it: public transportation means forfeiting their own flexibility and structuring their schedule around the train's. Trains and buses are also not flexible in terms of pickup and drop off, which both take place at defined points from which the rider must walk to and from their final destination.

The Brilliance of Uber

Uber is determined to offer a service that replicates all of the benefits of car ownership for a lower cost. So basically it is trying to be a better taxi service. In fact, when Uber first launched, it was called UberCab, just to make sure customers understood what they were doing. Certainly, the ability to tap a button on a smartphone and drop a pin nearly to the centimeter of your location beat standing on the edge of the corner with your thumb sticking out looking for a ride.

But as Greg says, that alone doesn't really explain it. After all, it wouldn't be difficult for traditional taxi companies to launch an app of their own, which they have in many cases.

What makes Uber revolutionary, as opposed to just better, is actually not a secret sauce. It's something everyone already knows about it, though most of them would not list it among their favorite Uber attributes. And Greg is right, it's not just about low prices. In fact, in a way, it's almost the exact opposite. The single most salient advantage of Uber is this:

Uber has surge pricing.

Old Reliable

When I say that, I obviously do not mean that customers like surge pricing. And I do not mean that Uber has surge pricing, and so it makes more money for drivers. What I mean is that Uber has surge pricing, and so it is never without drivers.

As I explained in my last article, those few ridesharing companies who have succeeded in the marketplace have found that in order to be successful, they must be more than just cheap: they must be reliable as well. In fact, ridesharing doesn't really take off until wait times fall to under three minutes. Lyft's delay in matching Uber's ubiquity owes to its failure to hit this mark early in its existence. But even worse than a late cab is a no-show.

For most people, an Uber is a two-way trip. Whenever you leave home, you need a way back home. The fixed number of medallions for cabs meant that riders could never be certain of this before: even if you found a cab to take you somewhere, there was no guarantee there'd be another cab later to take you back. But Uber operates off the medallion system.

Uber assures customers that they will not be stranded if they choose to leave their car behind when they go out, as surely as if they'd driven themselves. And they do this with surge pricing. Surge pricing allows Uber to encourage more drivers to come onto the system when they are most needed. In fact, many Uber drivers say that they only drive for Uber to pick up surge fares. No matter when riders call for a ride, an Uber driver will be available to pick them up. The absence of a cap means that drivers can always move dynamically to match supply and demand, no matter how high demand goes. And surge pricing ensures that drivers have an incentive to do so.

Price Competition

So now, finally, we come to price. Greg was right it's not just about price, but the price is still a huge part of the equation. With both Uber and ownership offering flexibility and convenience, and no reliability questions thanks to surge pricing and uncapped numbers of drivers, customers no longer have a reason to take a higher-cost car over the public option. If car ownership wants to win now, it has to beat the prices rideshare is offering, summed to all of a rider's trips over the course of a month, including whatever surge pricing occurs over that timeframe.

So, can Uber and Lyft offer full mobility service to customers for less than the all-in cost of their cars? Before the advent of Lyft Line and UberPool, the answer was, probably not. But with price savings of up to 40% on these new ridesharing options, the gap is narrowing fast. And what's more, Lyft and Uber are still reaping the benefits of the network effect. The better their networks become, the more riders and drivers join them, the better still their networks become, etc. That is why I think the announcement of Line and Pool are potentially so groundbreaking, and so troubling for automakers.


While public transportation is cheaper, consumers value flexibility and convenience more than the marginal cost of car ownership over bus tokens. Meanwhile, taxis will offer those extra benefits, but they are horrendously expensive and worst of all, they do not guarantee availability of service at any time the way bringing your own car does.

No one has ever offered all the benefits of car ownership at a price competitive with car ownership before. Uber and Lyft soon will, if they don't already, and given the crucial role true ridesharing will play in that endeavor, it is all but certain a substantial decline in VMT will take place.

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.