(Aug 21): For several weeks now, the focus of attention in the so-called sharing economy has been the internal turmoil at ride-hailing giant Uber, the largest startup in the world. From allegations of sexual harassment at the company and fracases with drivers to founder and CEO Travis Kalanick’s abrupt resignation and his subsequent attempts to reassert control, from original venture capital (VC) investor Benchmark Capital filing a lawsuit to a court battle with Google on using stolen self-driving car trade secrets, Uber clearly has had more than its fair share of distractions lately. 

Challengers, such as Grab in Southeast Asia and Ola in India, have used the turmoil at Uber to boost their own coffers, raising billions of dollars of new funding as they seek to defend their turf. For its part, Chinese ride-sharing giant Didi Chuxing, earlier this month announced an investment in Estonia-based Taxify, expanding its global strategic alliances to Europe and Africa. Didi’s major investor, Japan’s SoftBank Group, already has large stakes in Grab (which also counts Didi as an investor), Ola and Brazil’s 99Taxis. Indeed, SoftBank has been making audacious overtures to grab a stake in Uber itself by wooing some of its directors.

Yet, as the land grab in the ride-hailing space gathers pace, focus is turning to why the big players, such as Uber, Didi, Grab and Ola, have yet to reach anywhere near the scale that guarantees a pathway to profitability nearly nine years after their founding. What will it take for them to make money? Are the big ride-hailing players really worth what the VCs are currently valuing them at? Uber, valued at US$69 billion ($94.35 billion) at its last funding round, for example, reported US$20 billion in gross billings and US$6.5 billion in net revenues, including revenues from uberPOOL, last year. It posted a loss of US$2.8 billion (or US$3 billion if you include the US$1 billion loss on its now discontinued China operations).

To be sure, most of the large sharing-economy players are still relatively young, private companies and they are still expanding. It takes time for a new company, particularly one that depends on the “network effect” — the more customers sign up for Uber, the more drivers sign up, making it tougher for rivals to mount a competitive service — to get global scale and reach profitability, Beijia Ma, a London-based strategist for Bank of America Merrill Lynch, tells The Edge Singapore in a recent phone interview. 

Ride-hailing business ‘not sustainable’
Until now, many of the big players have been willing to pay a very high price for customer acquisition to get scale and that has delayed their path to profitability. Uber, Didi and Grab have traditionally heavily subsidised both customers and drivers to gain market share. “When you have VC firms funding you for years, you initially see more value destruction than value creation, unlike in the public listed space, where shareholders need to see profits every quarter and if you can’t perform, your stock gets punished,” Ma says. “So far, the VCs have been happy to throw more money at ride-hailing firms because they believe the platform will lead to a huge payoff eventually, but we are reaching a stage where the most generous backers — even those with fairly long-term horizons — would start demanding some traction towards profitability.”

“The ride-hailing business, as it is currently structured, is not sustainable,” says Aswath Damodaran, a professor who teaches equity valuation at New York University. “What Uber and other ride-hailing companies have found is that it is easy to grow the business, but actually very difficult to make money,” he notes. “What allowed Uber to grow as fast as it did was its creation of a low cost-of-entry business,” he adds. “It’s really an asset-light, low-capital-intensive business. They don’t own the cabs. They go into a new city, hire drivers and ramp up the business, but the drivers don’t work for them.”

Unlike Amazon.com, which is focused on making it easy for customers to make a purchase, Uber or Grab “must serve the conflicting needs of two competing stakeholders — the drivers and riders”, Damodaran points out. He adds that a system focused on luring and pampering drivers will drive away riders, and one focused mostly on the riders’ needs is more likely than not to antagonise drivers. The drivers are essentially free agents without contracts who go back and forth between Uber, Lyft (in the US), Didi (in China) or Grab (in Southeast Asia), he says. “It’s a really tricky balancing act, unlike Amazon, which has a very customer-focused model.”

Uber and its ilk “must also figure out a way to make their platforms as sticky as Amazon’s Prime or Apple’s ecosystem, which will help make their business more viable”, Damodaran argues. While they have yet to come up with a sustainable model, he points out, ride-hailing firms are trying hard to change the structure of their business by experimenting with a range of things, from delivery services to driverless cars, in the hope that something will work. “They really need to go into Google’s or Amazon’s or Apple’s turf and become real technology companies” with proprietary technology and a sticky ecosystem, says the NYU professor. 

So, is Uber’s US$69 billion valuation justified? Is Didi (in which Uber has a 20% stake) really worth US$50 billion and should Grab command a US$6 billion valuation? The big question analysts and investors should be asking is: Can Uber convert 60 million or so global users, or ride-hailing subscribers, and lock them in, the way Amazon does with Prime or Apple with its iOS? “Unless they can lock the customers into an ecosystem that generates repeat business, I am afraid they may never have a sustainable business model,” the valuation expert says.

So, what is Uber really worth? A good way to value a ride-hailing company is to put a value on its users, says Damodaran, who adds that investors are currently valuing each Uber user at around US$900. By his estimates, however, Uber users should be valued at around US$410. That means Uber should be worth just over US$33 billion. Other ride-hailing firms are probably worth not much more than half as much as their current publicised valuations. Indeed, a big chunk of Uber’s valuation is its 20% stake in Didi.

Moreover, changes in US accounting rules are likely to affect ride-hailing firms such as Uber the most. Uber’s revenues are likely to be cut in half once new changes to the rules, or generally accepted accounting principles, for American companies are adopted later this year. Uber had revenues of over US$3.4 billion under the old GAAP accounting in 1Q2017, but under the new rules, it would only be allowed to show revenues of US$1.5 billion for the period. Until now, Uber has been counting its commissions from regular rides plus the entire fare of carpool rides as revenues. Under the new GAAP rules, only the actual commissions from both regular and carpool rides can be counted as revenue. Over 20% of Uber’s rides in North America are now carpool rides through UberPOOL. Although the accounting change does not affect the ride-hailing firm’s bottom line, it does affect investors’ perception of how soon they can find a pathway to profitability.

VC investors paying sky-high valuations for Uber, Didi, Grab and others at this late stage argue that the economics of ride-hailing are likely to change over time. The advent of autonomous technology, for example, is likely to open up a new market for driverless on-demand taxis, which will replace not only regular cabs but also parts of the larger public transport system, particularly in large urban centres such as Seoul, Sydney and Singapore. “Players such as Uber have huge outsized valuations because they still have a lot of room to grow,” says Ma. “VCs are willing to keep funding platform providers such as Uber because they believe there is still a lot of value to be captured.”

Self-driving vehicles for ride-sharing
A McKinsey study published earlier this year forecasts that “robotaxis” will drive the wider market for car-sharing and ride-hailing, which was worth US$53 billion last year and could be worth US$2 trillion by 2030. General Motors Co and Ford Motor Co are investing US$2 billion each to develop self-driving vehicles specifically for urban ride-sharing beginning in 2021.

The biggest expense in ride-hailing is the driver, says Ma. “Sixty to eighty per cent of your Uber bill is the driver-related costs. Cut the driver and you have cut the cost dramatically.” If the real advantage in ride-hailing is the autonomous car, companies such as Uber, Didi or Grab that have spent years and billions trying to build relationships with drivers may not necessarily have a head start in a business where driverless cabs dominate.

It is hard to say whether Uber has an advantage over GM, which has a joint venture with Uber’s rival Lyft, or over Tesla, Apple and Google, says Ma. Alibaba Group Holding, Apple and Tencent Holdings already have stakes in ride-hailing companies, she notes, and Google is experimenting with its own ride-hailing service so that when it starts rolling out driverless cars in four years, it will be able to sell them to Didi or Lyft.

So far, Uber has raised nearly US$16 billion in what has been described as “a mad scramble to starve the competition of cash” in a war of attrition. Uber’s money-grab was once seen as the use of “shock and awe” to deter investors who might reconsider supporting Uber’s competitors. But instead of keeping out challengers, Uber’s attempt to aggressively build a huge wall of cash has only forced the likes of Didi, Ola and Grab to keep raising the ante with more cash-raising of their own, particularly from Japan’s SoftBank, which itself has raised nearly US$100 billion, mainly from Middle Eastern sovereign wealth funds. 

So far, regulators have tried to stop ride-hailing companies in cities such as Vancouver in Canada or Austin in Texas. But increasingly, cash-strapped municipalities searching for new revenue streams have allowed ride-hailing companies such as Uber to operate as they try new ways to make up for the loss of revenues from taxi licences. “Regulators are in a tough position right now because the reason consumers are switching to Uber or Airbnb is better service at a lower cost,” says Ma. Governments need to balance their need for revenues with customers’ need for cheaper and more efficient services, she argues.

Call for ‘robot tax’
As the tax burden shifts from carmakers and taxi licence plate owners, there is a debate about how that yawning tax gap will be plugged. Ma says governments want a share of the pie. Microsoft founder Bill Gates recently suggested the imposition of a “robot tax” — robots that replace humans should pay taxes. Since Uber’s autonomous cars will be robotson-wheels, governments will feel free to impose a tax on them. “With the Platform Effect and the Network Effect being the key in the sharing economy, you have the Winner-TakesMost phenomenon, so how governments deal with the winners will be important,” Ma says.

Current car ownership in the US costs 95 US cents a mile. That is likely to go down to 42 to 47 cents a mile with the arrival of autonomous cars. Over the longer run, BoAML estimates that costs are likely to drop to 17 to 19 cents a mile. “If Uber or Grab are taking down the cost of transport by 50% to 80%, the regulators would want to help facilitate that because the taxpayers are benefiting,” says Ma. “If auto demand in Germany was set to fall 50%, BMW, Daimler and Volkswagen will all be in trouble, so German regulators would need to think seriously about what that means.” 

The jury is still out on whether the likes of Uber and Grab will ultimately create a viable and sustainable business model, says Damodaran, but he concedes that the disruption they have created is here to stay.

Assif Shameen is a technology writer based in North America

This article appeared in Issue 793 (Aug 21) of The Edge Singapore.