Lyft lost $911 million last year on revenues of $2.16 billion. That’s not just a matter of research-and-investment costs; Lyft’s core business is unprofitable — it loses money transporting people — and it hasn’t demonstrated a way it plans to change that in the future. Lyft went public earlier this month, and, naturally, it is worth $16 billion.
Uber is an even bigger company that loses even more money, so it stands to reason that Uber is worth more than Lyft. The company has filed to go public and is hoping for a valuation around $100 billion.
Of course, when stock-market investors decide a company is valuable even though it’s losing money now, the usual implication is that it will make money in the future. But how? In its S-1 filing — the big prospectus that tells potential investors in the initial public offering what they’re getting into — Uber lays out a vision. It is not compelling.
Let’s walk, line-by-line, through a paragraph from the S-1 that explains Uber’s pricing strategy. It’s titled “Increasing Scale, Creating Category Leadership and a Margin Advantage.” I’d note having a “margin advantage” means you’re more profitable than your competitors. But in an industry where everyone is losing money, the best margin is still negative.
Uber says: “We can choose to use incentives, such as promotions for Drivers and consumers, to attract platform users on both sides of our network, which can result in a negative margin until we reach sufficient scale to reduce incentives.”
This means, “We sell our product below cost.”
Uber says: “In certain markets, other operators may use incentives to attempt to mitigate the advantages of our more liquid network.”
This means, “Our competitors also sell their products below cost.”
Uber says: “And we will generally choose to match these incentives, even if it results in a negative margin, to compete effectively and grow our business.”
This means, “We regularly get into price wars where we and our competitors vie to see who can lose the most money.”
Uber says: “Generally, for a given geographic market, we believe that the operator with the larger network will have a higher margin than the operator with the smaller network.”
This means, “At least we don’t sell our product as far below cost as our competitors do.”
Uber says: “To the extent that competing ridesharing category participants choose to shift their strategy towards shorter-term profitability by reducing their incentives or employing other means of increasing their take rate, we believe that we would not be required to invest as heavily in incentives given the impact of price and Driver earnings on consumer and Driver behavior, respectively.”
This means, “We hope our competitors will eventually stop selling their products below cost.”
Uber says: “In addition to competing against ridesharing category participants, we also expect to continue to use Driver incentives and consumer discounts and promotions to grow our business relative to lower-priced alternatives, such as personal vehicle ownership.”
This means, “Even if our direct competitors stop selling their products below cost, we will still have to sell below cost to compete effectively with non-ridesharing transportation options.”
And Uber says: “And to maintain balance between Driver supply and consumer demand.”
I want to take a little longer teasing out this last clause, because it gets at a particular weirdness of the ridesharing business model, and a particular problem for Uber’s eventual goal of being profitable.
Uber is supposed to be just a platform, connecting drivers who want to sell their services with riders who want to buy them. Some platforms let sellers and buyers name their own prices — eBay, for example — but one of the functions Uber provides is setting ride prices. Uber has two core goals when it sets prices: One is to ensure that there are roughly equal numbers of buyers and sellers in any given place — there should be enough drivers to serve the people trying to call an Uber now, but not so many drivers that they mostly sit idle — and the other is to set a wide-enough spread between fares and driver pay so that Uber makes a profit.
In a normal market, you’d expect a platform trying to meet both of these goals to set high rider prices at times when demand outstrips supply and low driver pay when supply outstrips demand. But look what Uber says it intends to do: It’s going to boost driver pay to ensure enough supply (“driver incentives”) and cut consumer prices to generate enough demand (“consumer discounts”). That is, Uber gets the market to clear by selling below cost; it focuses on clearing the market and sets aside the goal of making profits.
There are reasons for this: If you want drivers to come back tomorrow when demand is high, you don’t want to alienate them by sharply cutting their pay today. Ride-sharing companies have had increasing difficulty retaining drivers of late, partly because of the strong job market and partly because drivers come to realize over time how little money they are making after expenses like depreciation. And consumers have a visceral, negative reaction to price spikes, which is a reason Uber has moved away from the emphasis on surge pricing that was once central to its brand. But the need to sell below cost significantly undermines Uber’s goal of being an eBay-style middleman that takes a profitable cut of each transaction.
That all makes the business model seem doomed to me, but what do I know? A lot of people with a lot more money at stake than me disagree; they squint and they see profit down the road, somehow.
I really want those investors to be right, because I am a big beneficiary of this apparently irrational economy. Money-losing start-ups whose business model is to sell services below cost constitute a mass transfer from venture-capital investors to consumers. As one of those consumers, I want to keep getting that sweet VC money. But if they lose money forever, I assume they’ll eventually stop giving it to me.
Eventually.
An unsustainable business model can’t go on forever, but it can go on for a very long time. U.S. airlines had negative cumulative profits from 1979 to 2014; people who invested in airlines over that period made less than no money, and we, as consumers, enjoyed the benefits of fare wars and persistently low prices. Finally, the party ended; airlines are profitable now in large part because they have finally constrained supply growth and succeeded in pushing fares up. But 35 years was a good run.
All of which is to say: Even if Uber can’t go on like this forever, it may go on like this for a very long time. I certainly hope it will.
