How Does Uber Make Money?

A while ago, I made the mistake of saying Uber and AirBnB were basically the same. My friend Jim quickly corrected me.

“No AirBnB is the sharing of an existing asset. Uber is the digital disruption of an existing market. Get your business models straight.”

Thanks Jim!

Uber have put cars, drivers and journeys on a platform. This platform is a medium term mechanism to turn profits into rent.

This is because the actions of drivers favors the creation of a monopoly.

Despite what you read, Uber and Lyft are paying drivers more than they need to. The bad news for drivers is this will not last.

Further out, the good news for you, and the bad news for Uber, is that driver-less cars will be the end of Uber.

how does uber make money

Image source: mapbox

Labour versus profit versus rent

Imagine a factory that makes toasters. Two workers do the manufacturing on one huge toaster making machine. This machine sits in a factory building.

The workers get paid for the labor they bring. This is the return on labor.

The business owner gets paid for their entrepreneurship. The investors get paid for the dollars they invest. I’m going to abbreviate these two together as the profits or return on capital.

The owner of the property, the building and the land it sits on, gets paid rent.

Capital gets a bad name, even though it is actually pretty useful. Machines are useful, trucks are useful, and they all cost money.

Property is useful and it costs money. However, again you can split dollar rent into two parts. There is the rent related to the cost of the property. And there is “economic rent” which is what you are paying over and above this cost.

I tried googling for the best description for economic rent, and it’s pretty hard. I’m going to go with my own phrase: it’s a piss take that you the consumer pays for.

Pisstake

A satire, parody, or mockery. “Look at this scary fundamentalist web site. I can’t believe that anyone would say such things and mean them.”

“They don’t. It’s obviously a pisstake.”

Urban Dictionary

Pisstakes happen because they can. Anyone can mock you, but it only hurts when they have the power to hurt you. In the definition above, it’s a joke. However, in my usage, it is mockery based on power.

Economic rent is a situation where someone is charging you money solely because they can. It has no relationship to sunk or recurring costs.

They charge economic rent in San Fran because the municipality doesn’t allow enough building in the Bay area. A policeman charges you a bribe because you REALLY need to get away from that guy in a uniform. Apple charges you a fat price for a pocket computer because they have the best brand and you just can’t live without 128GB of storage. These are all pisstakes where some quirk of limited supply, authority or loyalty means someone can take advantage of you financially.

 Uber’s Business Model

  1. Find lots of drivers with their own cars who want to earn money.
  2. Orchestrate them centrally, through incentives, to offer a highly scaled and distributed transport infrastructure.
  3. Allow people who want to make journeys book these drivers via a mobile application.
  4. Create a review system to ensure great service.
  5. Take a 20-30% cut of all bookings.
  6. Leverage the data collected to minimize wait times and maximize time spent on fares.
  7. Drive ever increasing efficiency.

The existing taxi system

Uber is a scrappy ultra-competitive company that has considerable experience in pushing the boundaries of, often badly written, regulation. It has provided thousands of drivers with jobs and delivered millions of outstanding rides. However it has quite a mixed reputation.

This is necessary in this business because the existing system was really that bad. In many places, taxi drivers had already successfully turned normal business into oligopolistic profits.

In London, UK, a “knowledge” test combined with black cab regulations, limits supply of drivers and vehicles.

In Manila, Philippines, there are buses between some airport terminals, but none between certain other terminals. Hmm, I wonder who benefits from that.

In New York, USA, they split labor, profit and rent in the most explicit way possible. A medallion is issued to represent the regulated right to drive a yellow taxi. Their value peaked at over $1m in 2013. Note that the driver didn’t get to keep the rent. Ultimately when it got valuable, investors and companies took control.

protest against uber

Image: Aaron Parecki

This image is from a protest in Portland. You can spin it anyway you like. That regulations protect consumers. That controls on taxis raise quality. Both of which can be true.

Unregulated taxi markets are like when you fly into a third world country, the streets are lined with cabs, and when you get in one they refuse to turn on the clock. Unpleasant right? But notice that they’re all regulation yellow. Or green, or orange or whatever color that country requires. This horrible situation is a regulated taxi market.

I can concede that some regulated taxi markets have raised quality. However in practice, regulations are ineffective at consistently protecting those looking to get home, and are highly effective at raising fares.

If regulation had benefited consumers, they wouldn’t have created an opportunity wide enough to drive an Uber fleet through.

People have been stuck on the streets at 4am because of regulatory limits.

Limits on taxis are everywhere and always a pisstake. Medallions, to take the most egregious example, are bad for “drivers”. If you own a $1m Medallion, why would you drive?

This article from Vox shows how Uber has impacted the New York taxi business. It has a chart of medallion prices peaking in 2013.

Just to be clear, every dollar that a medallion is worth is a piss take. It is an economic rent collected by a rich guy because of regulation. Its collapse is to be celebrated.

Uber is killing it because they are improving on these weak business models that are dependent on lobbying and regulation. The have used reviews to raise standards, and they can indicate the cost before you get in.

Note how taxi systems have been trying to exploit you monopolistically by REDUCING supply. Uber is unique in that it has the potential to generate economic rents on INCREASED supply of cars and drivers.

How Uber is going to dominate

I believe that Uber has the potential to end up with 90% market share of taxi hailing apps in the majority of cities they have entered. The exceptions will likely be in China.

Google has 90% share in European search. Microsoft Windows has 90% share of desktop PC software. These are all effective monopolies, but all for different reasons.

Why might Uber be able to achieve 90% market share?

It isn’t because of the internet. It won’t be because it is a modern and slick app.

For starters, Uber isn’t an internet company. And winning apps do not guarantee dominance. In all likelihood, multiple messaging apps are going to co-exist.

It will be because a business needs drivers to provide a scaled and desirable service to consumers. It will be because drivers will choose to work on the winning platform because the winning platform will pay more.

Imagine a 50:50 split in drivers between Uber and Lyft in Greenboro, North Carolina. Both charge the same fares, and take exactly the same commission from drivers. Uber have slightly better software such that driver wait times between fares are shorter on their app.

Drivers immediately earn more money on Uber and will start to switch.

Lyft’s disadvantage in this scenario gets worse and worse. Consumers see more drivers on Uber and start to jump to Uber.

There are reports that Uber adds phantom cars to their app – a typically scrappy tactic to gain exactly this advantage.

Throw in almost $9bn of funding and Uber’s aggressive competition determined not to let others make any money, and that’s it. To fight back Lyft subsidizes its driver pay. But as soon as that runs dry, its game over and 90% of Greenboro drivers are on Uber. In any given city there should only be one major taxi app.

What’s going on here is that the drivers are a strategic resource, and they happen to do what is in their interest. Which is dump Lyft.

Drivers are like a copper mine with free will. Whoever they choose will be the sole supplier of copper.

Lyft gets left with drivers who hate Uber, a sizable number but tiny relative to those who prioritize their earnings.

Every city they win subsequently buttresses their brand across the entire country.

I’m not saying Lyft goes bust. Merely that they fall back on cities large enough to support multiple players, like New York, LA and Seattle.

I mentioned China above. There is a good chance Uber will not dominate there because its competitor Didi Chuxing is dominant. Formerly called Didi Kuadi, they have over $4bn in funding and are partnered with WeChat, Alibaba and Tencent. Uber will have to settle for the small player role, but potentially in a market large enough for them to still make money. If Didi Kuadi let’s them.

Drivers’ dilemma

Let’s dive a little deeper into the driver decision making, because it is a classic prisoners dilemma.

Let’s assume there are two drivers and two taxi apps. This is a hypothetical payoff matrix. The titles explain which platform the drivers are on. The numbers underneath are what each driver is making.

uber competition makes money

In this instance, poor Lyft is not as good and doesn’t deliver the same returns to the drivers. When the drivers are split 50:50, then whoever is on Uber gets more fares and earns more. The incentives are such that the other driver also switches to Uber.

In game theory, the only equilibrium is both are on Uber, and Uber wins. If the drivers can split themselves up, then they win because Uber and Lyft try to bid them over to their platform. But because one guy is making more than the other, this is not possible. In this simplified model, their combined earnings go from $320 to $242.

What really kills though is when Lyft is knocked out of the municipality. Then the matrix becomes something of Uber’s choosing. It becomes:

uber monopoly makes money

Where $50 is what the driver would make driving on his or her own.

No competition creates a monopoly. In cities where Uber has “won”, and the competition is out, they can pay down to the next option the driver has available. That could be minimum wage, but it’ll probably be what off platform, unregulated cab drivers are making.

What has happened here, despite all the news articles about how rubbish Uber is currently treating its drivers, is that Uber and Lyft are actually overpaying to get the drivers. They are using drivers to squeeze each other. When one wins they can immediately claim that back. But also, they can convert their dominance into an economic rent.

Many readers will think business inevitably attempts to form a monopoly. That may be, however that doesn’t mean they have an ice cube’s chance in hell of getting there. AirBnB operates in a market, vacation rentals, where there is lots of room for new entrants.

Uber is unique in being a human business, but with characteristics like a mining company. Just because McDonald’s can pay more than Burger King doesn’t mean squat.

What factors are reinforcing Uber’s model?

  • A barrier to entry to being a driver – notably a car.
  • A single mobile application aggregating consumers. Seriously who is going to regularly compare trips across two apps?
  • A scale effect where the more taxis on your platform the better your service.
  • An employee pay advantage from having the best software.
  • A fare advantage because regulations have limited the supply of taxis.

To be clear, in unregulated cab markets, this rent mostly won’t come from consumers, it will come primarily from drivers.

In regulated markets, like New York or London, Uber will also earn the rent that the regulated cabs are currently taking. When the other mobile apps are beaten, Uber will likely raise fares to match the price the regulated cabs charge. The only instance where that doesn’t happen will be because Uber decides to drive the regulated cabs out of business.

Those regulations, which are leading to people being over charged now, will become Uber’s price ceiling. In that case Uber will get a rent from consumers too.

Driver pay

Uber has claimed that its full time drivers were making a median wage of $90,000 in 2014. Many drivers keeled over in laughter and rage at this – they responded through the media that some were earning below minimum wage, and noted figures closer to $10k to $40k.

A research paper by Jonathan V Hall and Alan B Kruger, “An Analysis of the Labor Market for Uber’s Driver-Partners in the United States”, was published in January 2015.

Broadly it found that UberX drivers received median net fares of $19 an hour, compared to typical taxi driver earnings around $13. The paper provided no data of the car and mileage expenses that Uber drivers have to cover.

Blogger Felix Salmon reported that Uber advised him that fuel, gas, maintenance, depreciation and insurance would cost a New York driver $15k. Assuming a 40 hour work week, that works out around $7.20 per hour. New York is special – the paper mentioned above notes that Uber drivers  in New York make $30 on average compared to $15 for taxi drivers. In other words in New York an Uber driver is taking home $23 an hour instead of $15.

Despite everything you read, Uber drivers are making good money. It is not life changing, but its higher than the market would pay them.

There are too many excellent drivers out there, to get rich ferrying people around in the back of your Chevrolet.

The caveat is straightforward. It won’t last.

A Flash of the Numbers

Leaked financial data for the first half of 2015 suggest that Uber have gross bookings (what the customer pays) of $3.6bn. That compares to less than $3bn for the WHOLE of 2014.

Net revenues were at $663m 1H’15. This is a solid jump from 2014’s $495m.

The implied revenue yield is 18.4% 1H’15, and is up from 2014’s yield of 16.9%.

The only thing more impressive than these revenue numbers are what Uber is doing with its losses. Uber lost almost $1bn in the first half of 2015. Its losses in the WHOLE of 2014 were $671m.

Some analysts hate unprofitable companies. They have a great point that anyone can lose money. However, sometimes losing money is a great idea.

Unfortunately that great idea is to kill the competition and to turn profit into rent. The bad news for the rest of it is that the industry they operate in makes it possible.

Uber’s rivals

If you’re in the States, the one you will have heard of is Lyft, who I mentioned above. They have raised $2bn and offer a similar selection of cars over a similar mobile app.

An alternative is Curb, which is similar to Hailo in the UK. These apps partner with fully licensed cab drivers.

These guys are struggling to compete with Uber. Uber has better brand recognition and are using high driver commissions and low fare prices to squeeze them into the ground.

As long as you have competition, taxi fares are broadly fair. Unfortunately as I have described, a single dominant taxi app is extremely likely. The reinforcing cycle of more drivers leading to more customers leading to more rides just keeps making Uber stronger and stronger.

The prices Uber charges now are better than fair, they are generous. Don’t enjoy the low prices too much right now though. Because once Lyft and Curb are out of it, you can rest assured Uber’s profitability is only going to go one way. A plausible contributor to that will be higher fares.

This is what Uber’s $9bn in investment is paying for.

Secretly you’d prefer a driver-less taxi

Although Uber may not enjoy it so much.

google car doesn't make money

Image: smoothgroover22

Nobody has made a bigger contribution to driver-less cars than Sebastian Thrun. He was part of the Stanford team that won the DARPA Grand Challenge in 2005, where a re-engineered self-driving Volkswagen renamed Stanley covered a 12km course involving 3 tunnels and a hundred sharp turns.

Afterwards he joined Google and worked on Streetview.

Odd jump right?

No, not at all. Thousands of miles of video footage from all around the car, collected with precise data on the drivers speed, braking and maneuvers.

Plug it all into the latest in machine learning and you have Coursera for cars.

Uber have been quite open about joining this revolution. CEO Travis Kalanick said “The reason Uber could be expensive is because you’re not just paying for the car – you’re paying for the other dude in the car. When there’s no other dude in the car, the cost of taking an Uber anywhere becomes cheaper than owning a vehicle. So the magic is there, you basically bring the cost below the cost of ownership for everybody and then car ownership goes away.”

Asked what he’d say to drivers that will some day be replaced, he replied “I’d say ‘Look this is the way of the world, and the world isn’t always great.’ We all have to find ways to change with the world.”

The best analogy for this is that there used to twenty million horses in the UK. They were the only way to move vegetables to market and soldiers to war.

With the invention of the motor car, they were all surplus to requirements. Now there are 800k horses in the UK, and they are ridden for fun.

The end of Uber

Uber should not be looking forward to driver-less cars. Although it will not be the end of its business model, it will be the end of its dominance.

How? Imagine a future world where a new competitor raises $2bn and buys fleets of cars with autonomous driving systems. Can Uber force this competitor out like it is doing now?

No it can’t. This new player can establish a scaled operation in each city. The competitor’s $2bn becomes a sunk cost and this competitor establishes itself as a strong number 2 market by market.

Uber’s market share rapidly declines from 80% to 50% as it cuts prices to defend share.

If that competitor is the provider of said driving systems to the market, say Google, then Uber will be toast.

Uber understands what is at stake. In 2015 it poached half the robotics staff from Carnegie Mellon. If its strategy is to succeed, its self driving cars have to be a little bit better than its competitors.

If they are not, then new entrants will keep coming in and investing in driver-less cars until there is zero economic profits in taxi rides. But in a steady state no one is losing money, so well done Lyft!

Uber may not have fully realized it yet, but drivers are not only an input cost, they are its strategic barrier to entry.

I wrote an article on YouTube and was surprised to discover it isn’t making any money. If you have already read that, perhaps you might prefer discovering how Duolingo is killing it. Thanks for visiting!

Yuen Lo

4 Comments

  1. I feel that you are using a very complicated method to explain an obvious phenomena caused by monopoly.

  2. Hello! Most of what I read on Uber is that drivers are underpaid and that Uber can’t wait to introduce driver-less cars. I argue that both these things are misunderstood.

    You’re right that the effects of monopoly are obvious. However when it happens isn’t. I recently wrote something on Quora about how AirBnB will never be a monopoly.

    Tl;dr Uber tends to monopoly in the presence of drivers, and tends to perfect competition in the presence of robots.

    Uber is probably unique in the amount of love hate it inspires, and for very good reasons.

    Thanks for the comment!

  3. Hi
    Great article, it goes into much more detail than most of the things I could find online on Uber and you actually explain things to the bottom.

    What I don’t quite understand: In San Francisco I had Uber-drivers that were driving for both, Lyft and Uber. They would accept clients opportunistically from either platform. Also, contrary to your statement:

    “Seriously who is going to regularly compare trips across two apps?”

    I did. The people around me did. People got a day-to-day impression on what company offers the best prices in relation to expected waiting time.

    Thus I don’t quite see how it will be easy for Uber to dominate a market at all. Once their investor money dries up, Lyft can rise anywhere and compete again.

    I have read, though, about Uber negotiating with local authorities – basically to obtain a licence to run their business. In that way, they would become an actual government-approved monopoly. But this doesn’t work just everywhere.

  4. Thanks for the comment, really appreciate it. The key to the points you make is the drivers who drive on Uber and Lyft, and the users that compare prices across apps, are a minority. The fact that you and I save a bit of money when we can does not change the fact that half of Americans cannot afford to pay an unexpected $400 bill like changing the brakes on their car. And because the majority are the other way around, then the flywheel, or monopolistic tendencies persist. Now, of course Uber has done a lot to shoot themselves in the sexist foot, so maybe I’ll be proven wrong, but it’ll be because they throw it away, not because they had a poor hand of cards a year ago. Yea there are a whole bunch of countries, like in France where they have an old school license from the Government.

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