Zipcar's Emerging Competitive Advantages

| About: Avis Budget (CAR)
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In this post, I focus on what I see as Zipcar's (ZIP) emerging competitive advantages.

Barriers to entry for car sharing are extremely low. Over time, the technology that enables members to independently locate, schedule, and access vehicles has become commoditized. Furthermore, nearly anyone can acquire vehicles, parking spots, insurance, and so on. Competitors have continued to pile on the car sharing bandwagon, ranging from traditional rental car companies like Hertz (NYSE:HTZ) and Enterprise, to companies with differentiated approaches like Car2Go's one-way rentals and RelayRide's person-to-person car sharing. Of course, Zipcar also continues to face competition from copy cats of its own business model, such as I-GO.

It is possible that low barriers to entry will mean that no one ends up making much money from car sharing, in much the same way that traditional car rental is a hyper-competitive, generally lousy business. Several competitors have eliminated annual fees. They may feel a need to price hourly rentals aggressively, even if it means generating losses. However, I see several reasons to believe Zipcar can succeed despite competitive headwinds.

Membership model: First, there is a big difference between the transaction-driven traditional car rental business and Zipcar's membership-driven model. Becoming a member of a car sharing network isn't terribly difficult, but it does involve enrolling, establishing billing, possibly paying an application and annual fee, and familiarizing yourself with the company's policies, vehicles, mobile apps, and web portal. The most active car sharing enthusiasts may be willing to sign up for a second service, but I very much doubt many users would be willing to mantain three or more memberships with competing companies.

This is an important point, as it creates switching costs. Customers are choosing a car-sharing platform, rather than a particular car for a single ride. If I am traveling somewhere and need to rent a car from the airport, I go on Expedia (NASDAQ:EXPE) or a similar site and choose the cheapest option. In contrast, if a Zipcar member needs to borrow a car, his first stop is Website users can be remarkably sticky, which seems counterintuitive considering how easy it is to click to a different site. But how many people regularly switch between Google (NASDAQ:GOOG), Yahoo (YHOO), and Bing for search? For that matter, how many people are members of both Costco (NASDAQ:COST) and Sam's Club? Price, including hourly rental rates and annual fees, will certainly be among the most important considerations in choosing a car sharing platform. However, it is not the only consideration.

Network effect: I think Zipcar's greatest advantage comes from its wide selection of vehicles dispersed throughout the cities where it operates. Car sharing is a replacement for car ownership, which means that it needs to be convenient. Successful car sharing platforms need to offer multiple options within a short walk of where members live and work. If the cars in one location are booked, members can walk a few more blocks to the next location. Zipcar members also have the option to book a BMW, or a small sedan, or a cargo van, depending on the demands of a particular errand. It's not enough for traditional rental car companies to allow online booking and keyless entry; they also need to move their vehicles away from centralized storefronts and into distributed parking spaces to compete with Zipcar.

Here is where the network effect comes in. The more members a car sharing service has, the more cars it can justify maintaining across a city. And the more cars it has, the more members it can attract. It is expensive to park and service a distributed vehicle fleet. Vehicle utilization is critical to profitability, but the average car sharing member does not utilize the service very often. I calculate that Zipcar had 76 members per vehicle in the first quarter, yet it still wasn't profitable. In an ideal scenario, vehicles are simultaneously almost all booked, yet there is still almost always a vehicle available (because of people coming and going). This is only possible with a large membership base.

For this reason, I think the large fleets maintained by traditional rental car companies-Hertz has more than 350,000 cars, compared to Zipcar's 9,000-aren't much of an advantage. First, these cars are located primarily near airports and are needed to support the core business. Hertz has only 8,500 locations worldwide, spanning 150 countries. It's not as if Hertz on Demand members can conveniently walk to an existing agency to borrow a car for a few hours. Second, it won't make economic sense for Hertz to distribute its vehicles across cities unless it has the membership to use them.

Economies of scale: This brings me to the third potential source of competitive advantage. Some of Zipcar's costs are fixed for a single car, such as depreciation and parking. Other costs are likely to be leverageable across cars within close geographic proximity, such as cleaning and maintenance. There is little reason to think that a traditional car rental company or new entrant to car sharing would be able to maintain a distributed fleet more cheaply than Zipcar, which already has leading share in key markets. That means Zipcar should either be able to offer rentals more cheaply than its competitors, or it should be able to charge the same prices while earning higher margins. More on Zipcar's cost structure here.

I've heard concerns that Zipcar's $60 annual fee may be unsustainable, since competitors are beginning to offer car sharing without an annual fee. Fees-as opposed to usage revenue-accounted for about 14% of 2011 revenue. I think Zipcar's pricing structure is the right one. First, access to a wide vehicle network has value, even when vehicles aren't utilized. Members don't always know ahead of time when they are going to need a car, and just knowing that one would be available creates flexibility and peace of mind. Second, if you believe that competitors' costs will be comparable to Zipcar's, not charging an annual fee means that hourly rental rates need to be higher to achieve similar profitability. The annual fee is a sunk cost as soon as it's paid. This should help Zipcar to keep members using its vehicles, even if they have signed up for a second car sharing service. Finally, $60 is really very low compared to the upfront costs of owning a car. While it's easier to attract members without an annual fee, these won't necessarily be the kinds of members who are serious about using the service. In the meantime, Hertz and others are incurring advertising and enrollment costs with no offsetting revenue.

Brand: Finally, I believe Zipcar has a brand advantage. As the first mover in the industry, Zipcar's brand is synonymous with car sharing, which lowers its customer acquisition costs. Furthermore, the company has established itself as a "lifestyle" brand. Borrowing a Zipcar is actually seen as fun and cool, sentiments I have never heard associated with traditional car rental. Many members are fiercely loyal to the brand and provide free word-of-mouth advertising. Branding has tangible manifestations beyond just a warm-and-fuzzy feeling. seems to have a more intuitive and welcoming interface than, for example, Hertz's or Enterprise's portals. I suspect that members are also more likely to trust that Zipcar's customer service will be helpful and responsive if a situation arises, such as an accident or a car returned late. At least for now, Zipcar can brag that it offers $300,000 of liability insurance coverage, compared to much lower levels at most competitors.

Conclusion: Competitive advantages will be particularly important for Zipcar, considering the low barriers to entry and intense interest in this new industry. I see early indications of a number of potential advantages, spanning switching costs, a network effect, branding, and economies of scale. However, we are still in the very early stages for this industry, and I intend to keep a close eye on competitive developments.

On the other hand, it is worth remembering that Zipcar competes in the broadly-defined transportation industry, not just against car sharing alternatives. Its biggest competitor is really car ownership, and there are more than 250 million passenger vehicles in the U.S. alone. If car sharing can make even a modest dent in overall rates of car ownership, there could be plenty of growth ahead to support a few successful companies. I tend to believe management's assertions that new entrants into the space are serving to increase awareness of car sharing, helping Zipcar. I also agree with management that alternative models like one-way rentals and peer-to-peer sharing could turn out to be complementary to Zipcar's model.

Disclosure: I am long ZIP.