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Is Uber a smouldering hulk of bad unit economics?

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23rd Mar 2018
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Uber’s spent $10bn disrupting the taxi sector, winning a dominant position in a large number of cities. But the nine year old company still requires large cash injections to grow a business with questionable unit economics.

Uber is an extreme example of a well-capitalised startup balancing growth with funding; the need to get airborne before they careen off the end of the runway.

It’s particularly tricky for marketplaces, which require sufficient volumes of both buyers and sellers. Getting that traction can be expensive.

That means having sufficient Uber drivers to keep wait times low and enough customers to make it worth their while. Surge pricing – increasing prices when fewer cars are available – is a tool to correct a short-term imbalance in this relationship.

“That liquidity is absolutely essential,” explains WhoCanFixMyCar.com’s CFO Fred Parkes. “A driver needs to have the choice in their vicinity. From a garage’s perspective, there has to be enough work to log in on a morning.”

As you would expect, WhoCanFixMyCar is a marketplace that connects garages with people that need their car fixed. It raised £1m in its first institutional investment round and has taken on debt funding. Revenue has been “roughly doubling” every year, according to Parkes.

The first step for marketplaces is to achieve critical mass. The second step is to push the unit economics and volume above the overhead base.

Parkes says they are moving into the second stage after seven years. Although, it’s worth noting they bootstrapped the business until they had confidence in the model.

Perhaps we’re being too hard on Uber?

Growth vs. investment

WhoCanFixMyCar checks its burn rate and runway in terms of how much cash it has, and the rate of growth against that.

“You can almost look forward to the point where it becomes cashflow positive and breaks even. That's being constantly tracked against the KPIs,” explains Parkes. “Those unit economics are really important in terms of margin contribution and cash contribution to the business.”

Over time, the overhead base should grow at a slower rate than the revenue and contribution lines; they're looking at the resources matched against that growth and at what  point those two meet.

The question for WhoCanFixMyCar, Uber and other startups is whether they increase resources to scale the revenue and contribution lines. Burn rate will go up in the short term but the growth curve will steepen, so they can get to break even on a faster trajectory.

Understanding marketplace KPIs

Parkes joined WhoCanFixMyCar as the first full-time finance hire, albeit the founders have a background in banking. With scale comes richer marketplace data and the company is even developing machine learning. However, the most important KPIs remain the same.

“It boils down to is net lifetime value, versus the cost of acquiring that customer. That applies to both sides of the market in terms of signing up new garages and drivers,” says Parkes.

They then monitor metrics that feed into that, including volume, frequency and average value of purchases, retention rate and churn.

There’s a further complication with the Customer Lifetime Value vs Customer Acquisition Cost analysis. Drivers use garages infrequently, so the cost of acquisition is immediate but the payback period can be quite long.

“It's one thing having a high net lifetime value,” as Parkes puts it, “but if you're not going to realise that in cash terms for some years you've got a funding issue to think about.”

They have introduced several value-added services for garages, like a website builder, to help the business front-load its cash return.

So, what do we know about Uber costs?

Company-wide statistics are limited but The Wall Street Journal has the top line, somewhat eye-watering, numbers:

  1. First-quarter revenue was $3.4bn, up 18% from the fourth quarter
  2. Loss excluding employee stock compensation and other items was $708 million, narrower than the $991 million reported three months earlier
  3. The company has raised around $15bn in equity and debt funding and has $7.2bn of cash left on hand

InvestorConnected’s brilliant look at Uber London’s operation, which is based on Companies House filings, shines some light on its fundamentals. It’s making approximately 63p net profit on every £10 taxi ride, with the driver and staff accounting for the bulk of its costs. The breakdown is shown in the below waterfall chart.

From InvestorConnected’s December 2017 analysis of Uber London’s unit costs

Uber could become profitable as revenue increases and costs fall. Customers could stick with the platform for years, for example, causing the market cost of delivering a £10 ride in a saturated city to fall towards zero.

Uber London’s revenue has been growing at 121% their cost base at 120%, meaning their profit margins are barely improving after six years in the city. It’s not atypical for tech startups. But the maturity of the company and sheer level of investment it’s needed is worrying.

A theory about the future of transportation

There’s another road to profitability. Parkes speculates Uber’s team have a thesis about unit economics trends for the future that allows them to get through that burn rate. And the addressable market is enormous – it's the movement of anything.

Driverless cars are one possibility. As InvestorConnected somewhat ominously explains: “People are by far Uber’s biggest cost and risk, and these costs are more likely to rise rather than fall. So it is not surprising that the main way in which they can raise the profitability is through the elimination of their largest cost – people.”

Uber’s investors have already bet billions of dollars on a thesis like this being correct. Not only that, they’ve bet Uber will be able to obtain whatever additional capital it needs for a situation like this to be realised.

Current unit economics are poor even though its achieved scale. So, it becomes a two-fold question: is their long-term thesis correct? Can the current low-margin model and loss-making business absorb shocks in the meantime?

The low net margin makes Uber vulnerable. We’ve seen the kind of issues that could have an impact in the short-term. Uber’s taxi licence was temporarily revoked in London last September. It’s unclear whether they should be paying VAT as a transportation service. Perhaps that’s why their UK operation is sitting on a £3m war chest (with Uber HQ ready to top that up if any more serious issues arise).

It’s also possible there are problems with the long-term thesis. I’m writing this days after one of Uber’s driverless cars killed a pedestrian in Arizona. It’s unlikely to prevent driverless cars but it’s easy to see how long delays in new technology could void Uber's big idea.

Uber’s ambitions are breathtaking. Perhaps it’s heading to a break-even point in a similar fashion to other startups but at a different order of magnitude. However, achieving that is by no means a given thing. It faces the potential for short-term shocks and issues with its long-term thesis. And it needs to maintain investor confidence to have enough cash to survive.

Uber’s growth is not healthy per se. It’s a startup on steroids. It could play a central role in the future of transportation but the growth rate could well prove fatal.

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By rememberscarborough
23rd Mar 2018 12:03

Uber might work well in the metropolises but outside of that it's pretty useless. Given that its competitors have even worse customer service I suspect customers will look to other alternatives possibly walking away from the whole industry completely.

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