This article was first published on or about June 14, 2017, on my Seeking Alpha Marketplace site, where subscribers get early access to many of my articles. You can view these articles here: https://seekingalpha.com/author/anton-wahlman/premium-articles
For several months, Uber has been criticized heavily in the media for all sorts of things that have nothing to do with its financial performance and economic business model. The complaints have had everything to do with Uber employees and management not being sufficiently politically correct for today's left-wing political correctness.
These complaints are pathetic.
There is a problem at Uber, but it's not the one upon which the media has been focusing.
If media reports are accurate, Uber loses approximately $700 million per quarter. That's $2.8 billion per year. I don't know under which accounting method these numbers are yielded, so different accounting standards could show a smaller or larger number.
Uber doesn't own the cars, and should by any reasonable and relative standards have low overhead expense in relation to the size of its business. As a result, financial results should be primarily driven by gross margin, not small fluctuations in overhead expense.
In such a business, it's all about the gross margin, because the difference between gross and net margin should be relatively small. It's an app, for Pete's sake! The overhead expense should be so relatively small that it ought not matter much.
With Uber losing money, and doing so consistently, there can only be one conclusion: Uber has negative gross margin. There is no other mathematical possibility.
What does this mean, in practice? It means that if an Uber ride costs the rider $10, Uber pays the driver more than $10. Let's say Uber pays the driver $11, although it could be more as well as slightly less.
First of all, the entire $11 payment to the driver need not happen right away. It could be a "hold-back" to see if, during the week, the driver has completed 75 rides, or some other type of incentive. Perhaps the driver gets $9 "up front" and another $2 after a week or a month.
I hear anecdotally from drivers that incentives vary, but that one could be getting $180 (the cost of renting a car for a week, plus tax) if 75 rides are completed during one week. There could be other incentives as well, perhaps overlapping.
In any case, it doesn't matter if Uber pays the entire $11 right away, or if part of it comes a week or a month after. The bottom line is the same: Negative gross margin.
The thing about negative gross margin, is that things don't get better if your business grows. Besides, Uber already is well beyond scale, with huge market share. In other words, Uber has no excuse to operate at negative gross margin.
So why are they doing it? There can only be one explanation: Uber is engaged in a price war in which it is trying to drive out competitors.
The problem with this strategy is that it is not one that is likely to work in the taxi business. In the taxi business such as it has now come to exist (LYFT and others being competitors), you can suppress competition only very briefly -- perhaps so briefly that nobody would even notice. In other industries such a suppression could endure years. In the taxi business, such a suppression might not even last more than a few hours, if even that.
That's why engaging in a price war in the taxi business is a fool's errand. Uber is searching for a pot of gold at the end of the rainbow. However, no such pot exists. It's elusive. You don't "get" anything in the future by selling your service below gross margin today.
How will this end? There is only one outcome: Raising prices. That $10 Uber ride will have to cost $12 or $14 or $15 or whatever -- an amount that brings the service first to a level where gross margins are not negative, and then a little more to cover the -- presumably minimal -- overhead expense. And then yet some more to yield a profit for investors.
Gee, why didn't anyone think of this before?
I really shouldn't have to point this out, but price matters. If price didn't matter, we would all be paying a lot more for everything. The whole argument for "shared mobility" is that the price per mile is lower and therefore attractive when compared to individual car ownership.
The consequence of Uber inevitably having to raise prices, is that fewer rides will be purchased. Gee whiz, you mean economics 101 isn't a fantasy?
Uber's $63 billion valuation has been driven to a significant extent by the belief that its services constitute a huge market. Well, if prices have to rise, that market doesn't look quite as huge anymore.
It therefore appears obvious that Uber's valuation, all other things equal, is likely to fall as people (1) Start paying attention to the ongoing losses and (2) Uber cures the financial shortfall by raising prices.
All the other complaints about Uber, relating to "culture" and "employee relations" and so forth? Irrelevant politically correct nonsense. If you don't like working at Uber, you should find a job somewhere else. This is freedom of association, freedom of contract. Diversity means that different companies should be allowed to experiment with different cultures. Uber should not have conform to politically correct pressure.
The pressure applied by financial gravity, however, is a different matter.
Disclosure: I am/we are long GM, F, GOOGL.
Additional disclosure: At the time of submitting this article for publication, the author was long GM, F and GOOGL. However, positions can change at any time. The author regularly attends press conferences, new vehicle launches and equivalent, hosted by most major automakers.