Uber: Regulation is Coming
Recent coverage of Uber and the ride-sharing industry has been disappointingly focused on the potential opportunity of the platform rather than the likely regulatory recapture that poses a mortal risk to the industry and guides their innovation.
Uber was founded on four important market insights that led to rapid market share expansion:
There are un/under -employed potential drivers that would drive for a living
Drivers could be paid based on completed rides
Taxi companies, their competition, were poor technology adopters
Where regulation existed, Uber could strong armed the enforcement mechanisms either by lobbying municipalities or garnering public opinion to force change.
They were useful insights, but the technology was undifferentiated. Lyft and others walked through the door Uber opened shifting dynamics from tech focused innovation to retail competition. Every business is ultimately retail, but the ridesharing business model shifted to rely on the marketing skillset of selling to more people, selling more to the same people, and driving higher margins for the same service - remarkably quickly. Further complicating the switch is the need to sell to both the consuming public and to drivers.
The business case for Uber Eats in conception, is great. It earns a commission from the consumer and the merchant on each order, builds Uber’s brand, while also making more potential jobs available to drivers. More job density, makes driving for Uber more attractive, and may also increase the density of drivers, making it easier for consumers to use Uber for transport. In reality, however, experienced drivers advise that Uber Eats has much worse profitability. The non-revenue generating time spent parking, picking up food and waiting for residents at delivery make driving for Uber Eats is much worse than people transport and to be avoided.
And compensating the drivers appropriately is the problem across the business. To compete in transport, Uber needs as many available drivers as possible, in as wide a geography as possible, as densely as possible. They need drivers to have enough income to incent driving and to encourage others to drive for Uber. Since Uber doesn’t own the cars and bares negligible risk and cost of ownership, most rides are positive for the financial health of the company. They want cars to be available, always, for every possible. Their competitors’ business models are similar and they similarly want drivers available. That’s where the negative externalities magnify and threaten to spark a negative regulatory response.
Retail businesses maximize cash flow by minimizing their inventory’s cost and the risk of being sold out. A simplified version is:
Safety stock = Service Level * (Time to stock inventory + time to deplete inventory)
In most retail businesses, the items in inventory don’t affect sales. With a ride-sharing service, inventory is costless to the company offering the service, while also sitting on the streets, impacting the time to stock and deplete inventory and increasing the total number of cars needed to maintain the service level. And given the ease which a dissatisfied customer can use another service, service levels need to be maintained at a high level. With the prospect of over stocking drivers carrying virtually no negative impact for the car sharing service or it’s competitors and the reasonable response of all actors to be to increase the number of available drivers, negative externalities are born by the municipality in the form of traffic.
New York City leads the nation in dealing with the traffic problem. While legislation to implement a congestion tax for cars driving in lower Manhattan received a lot of nationwide coverage, recent actions that have gone under the radar - capping the number of drivers Uber and Lyft are able to register to drive - is at least as important.
For investors, its increasingly likely that these businesses built on deregulation will have to navigate an environment where municipalities recapture lost authority. The aforementioned driver cap seems like a potentially smart measure that allows for shared ride services while also improving traffic. To my mind, a tax on mileage driven without a passenger that motivates drivers to park is similarly effective. But I’m not a legislator.
I think it’s useful to understand the risk to Uber’s base business because their headline grabbing expansion moves can be better understood within that context. From an ESG perspective, ride sharing businesses in White Brook’s view currently violate an environmental threshold. I think it’s likely that metropolitan residents become more focused on the negative externalities of these businesses. The CEO of Uber, Dara Khosrowshahi seems to understand the challenges and the dismissal of C-suite executives last week mirrors a similar move when Expedia failed to perform early in his career. I think understanding those challenges also shines a light on this week’s developments in drone and helicopter deliveries which have fewer negative externalities for municipalities and can be profitable and less complicated despite a capex investment. Diversification for diversification's sake is questionable, with, I believe, limited synergy by expanding across product line and geography versus focused competitors. But in the context of diversifying away from regulatory risk, make all the sense in the world.
As always, feel free to reach out to discuss this or any other topic.
Regards,
Basil Alsikafi
All investments involve risk, including loss of principal. This document provides information not intended to meet objectives or suitability requirements of any specific individual. This information is provided for educational or discussion purposes only and should not be considered investment advice or a solicitation to buy or sell securities. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. This report is not to be construed as an offer, solicitation or recommendation to buy or sell any of the securities herein named. We may or may not continue to hold any of the securities mentioned. White Brook Capital LLC and/or their respective officers, directors, partners or employees may from time to time acquire, hold or sell securities named in this report. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.