Friday, 23 June 2017

Running Out of Road

The "Uber endgame" is an increasingly ironic term used to describe how the San Francisco behemoth is expected to finally become profitable. This has evolved over time from simplistic stories of disruption (Uber will undercut traditional taxi firms because it has a cool app), through the promise of monopoly (having killed the competition, Uber will then jack up prices), to expansion into other transportation markets such as mass transit (UberPool reinvents the bus) and home deliveries. In its latest and possibly final incarnation, the phrase refers to the plan to start using autonomous vehicles (AVs), the expectation being that removing the cost of labour will finally allow the service to move from the red into the black. After the evidence of imperial overreach in its retreat from China last year (it sold its operations to the more successful native business Didi Chuxing in return for a 20% stake), and now the sidelining of its CEO Travis Kalanick for being a douchebag, there are hints that the company may in fact be facing an existential endgame. If it cannot crack autonomous vehicles, there are doubts that it can ever turn a profit and little evidence that it could spin another story to satisfy both investors and the tech media.

For all his evident faults, Kalanick had the chops to convince many people that Uber's ascent to global domination was inevitable and the chutzpah to finesse the repeated delay in reaching that goal. Just as the con-man relies upon the mark's credulity, so Kalanick deployed stories that dovetailed with wider claims about the economy, from the efficient exploitation of otherwise underutilised assets (the story that puts Uber and AirBnB in tandem) to the tendency of the modern economy towards monopoly (the one that equates Uber with Google). Even those sceptical of the company's potential see its CEO's fall as a representative story: "Kalanick’s management culture, while repulsive on many levels, was actually brilliantly aligned with its business strategy and its investors’ objectives. Companies that can make money in competitive markets by creating real economic value do not have to create ruthless, hyper-competitive cultures where there are no constraints on management behavior as long as they are totally loyal to the CEO’s vision and can rapidly capture share from more efficient competitors. None of Uber’s bad behavior was aberrant—it was a completely integral part of its business strategy. Without this culture, Uber would have never grown as rapidly as it has, and would have never had any hope of industry dominance".

Though Uber and AirBnB are often cited together in articles about the birth-pangs of the sharing economy they are quite different. AirBnB earns an agent's fee that depends on limited and immobile supply (property in prime locations) and the avoidance of regulatory overheads. Its real "users" are landlords sweating capital and avoiding tax. Its exploitation of labour is indirect, the result of traditional hoteliers under competitive pressure pushing down on employee wages and conditions, while its plans to evolve into a travel services business are likely to be complementary to those hoteliers. Uber's real users are not its "riders" but its drivers, who are labour in search of an income, and it is the company rather than the users that gains most of the benefit of regulatory arbitrage. Whereas traditional taxi firms would lease the cars to the drivers, giving themselves a fixed revenue while the drivers got the upside/downside on fares, Uber requires the drivers to provide the capital (the car) and then proceeds to take a cut on all fares. Uber's problem is that it has no real economies of scale. Indeed, it actually relies on the inefficient use of capital - i.e. the spare capacity of its drivers' cars. If that inefficiency were ever to be lessened it would have to increase prices or cut margins to attract drivers.

The just-so story of the sharing economy imagines an exchange between equals, but the reality is typically unequal when viewed in terms of capital and labour. The recent observation of Andy Haldane, Chief Economist at the Bank of England, that we are seeing the return of conditions familiar from the era before the industrial revolution, characterised by weak labour rights and flat wage growth, has much truth to it, but the near-bucolic emphasis on "artisanal, task-based, divisible" work elides the role of capital. An Uber driver who owns (or leases) his own car is comparable to a weaver who owned (or leased) a hand-loom under the pre-factory putting-out system. While the weaver had a degree of control over his working hours, he was also at the mercy of fluctuating piece-rates and required to advance cash deposits for materials. The "weightless economy" is not one in which capital has evaporated but one that no longer requires the concentration of capital and labour together. In practice, this means that as labour is atomised capital becomes ever more globally concentrated but also less visible (think of Google's data centres). The key to understanding Uber's endgame is as much about its potential concentration of capital as the atomisation of labour.

If you think of Uber's business model as parasitical - i.e. taking a cut of other businesses' revenue (the fares paid to self-employed drivers) by controlling prices and marginalising competitor intermediaries through market-flooding - then the current "endgame" looks surprisingly risky. Not so much because it alienates drivers but because it requires a capital-light company to become capital-heavy by owning autonomous vehicles. Up until now, the Uber value proposition has centred on capital gains through a future flotation and the promise of dividend yields should monopoly pricing ever arrive. The $13bn raised among investors to date was valued at $68bn earlier this year but has already slipped on the secondary market to $50bn. While a public offering is still likely, if only to raise the capital needed to buy all those robot cars, the focus of investors is shifting towards the longer-term return on capital post-IPO. Given that Uber isn't delivering a unique product and can't charge a premium for its basic service, this will mean raising the rate of capital exploitation. In practical terms, that means increasing the number of revenue-generating hours on the road.

The problem is that while customer demand can fluctuate up, a fact that Uber has exploited with surge-pricing, it can also fluctuate down. Up until now, Uber has been able to offload that "downtime" cost onto the drivers, but the AV endgame means it must absorb any under-utilisation itself, hence the diversification into moving goods (logically, when people are not travelling they are more likely to be receptive to deliveries). A further problem is that Uber can do relatively little to shift capacity to meet demand. While AVs will be more mobile than human drivers, it would be impractical to roam far as the transfer time would be revenue-negative. This points to the wider issue: Uber's lack of economies of scale that it can feasibly exploit. Indeed, if it shifts to being a capital-heavy company based on AVs its realistic leverage will be limited to lowering the cost of capital, probably through exclusive deals with selected motor manufacturers, however they may in turn push for a leasing arrangement that raises their own return on capital.

The AV endgame also requires a company that has been arrogant in its dealing with metropolitan authorities and state regulators to change its ways. It is one thing to bend the rules on taxis and ride-hailing, which will be seen by many as advantageous to paying customers and disadvantageous to often unpopular incumbents, but it is quite another to bend rules on passenger and pedestrian safety. Given the logistical challenges involved in the introduction of autonomous vehicles in urban areas, any firm that plans to operate a fleet of robo-cars in a city will need a good relationship with both the local authority and transport regulators. One way to achieve this might be to bid to provide mass-transit services, but the resulting conflict of interest between public and private provision could prove difficult to reconcile. The safest route would be to work with local government on AV systems that help moderate urban congestion. Kalanick's fall from grace may well signal a cultural shift at Uber but it is more likely that this is being driven by pragmatic concerns over future relationships with external parties not by any principled awakening to internal abuses.

I'm inclined to take a pessimistic view of Uber's future prospects. The AV nirvana may not arrive quickly enough, and at sufficient scale, to stop the business running through its cash pile, IPO or not. Even if it did, Uber isn't a technology leader and the most plausible scenario for future AV dominance is a tie-up between a business with leading data and sensor capabilities, such as Google, and an established motor manufacturer with advanced engineering capabilities, of which there are a number. Given that the ride-hailing sector remains competitive (see Lyft et al), it seems unlikely Uber can ever achieve a monopoly position and so dictate terms, and it is only maintaining its current market-leader position by heavily subsidising fares and drivers in a manner that is ultimately unsustainable. Indeed, it may already have peaked and the realisation may be dawning on many that it is essentially a bubble fuelled by a limited app and a well-known (if increasingly tarnished) brand. Assuming Google sees its future in selling smarts to car manufacturers, and further assuming that the future motor industry concentrates capital through AVs and an all-in rental model, then the smart move might be for a motor business (say Daimler) to buy Uber once its value drops far enough and so guarantee a large slice of the global market for its products. Uber looks like it is running out of road.

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