There aren’t many brand names that turn into every day household names. Google, Hoover and Escalator are just a few examples. Today, hardly anyone will disagree that Uber is already part of that growing list!
“We ignite opportunity by setting the world in motion” - Uber's S1 filing
In this article, we breakdown Uber’s business model. We start by analyzing how Uber makes money, dissecting its sources of revenue and cost.
With never ending headlines of Uber’s cash burning ritual, we also discuss Uber’s business strategy and how does Uber stay in business. We conclude by summarizing our analysis and investment view on Uber.
Brief intro to Uber Technologies
Founded in 2009, Uber Technologies Inc. (because "Tech" in your company's name yields higher valuation), commonly known as Uber is a global ride-hailing and food delivery company.
Acting as a platform via its website and mobile app, Uber offers “on-demand” taxi and food delivery services, by connecting businesses/drivers with end-users.
Arguably one of the most innovative and influential company founded in the past decade, Uber’s business model create a whole new ecosystem in the startup scene today. Here’s a list of companies proclaiming to be “The Uber of”.
How Uber makes money
Broadly speaking, Uber acts as a middleman and charges a fee for every successful transaction on its platform. This business model applies to ride-sharing, Uber Eats and its freight shipping business, Uber Freight.
Traditionally, Uber derives its revenue primarily from its ride-sharing services. Since 2016, Uber began to diversify its earnings with Uber Eats, its food delivery business. Consequently, this reduced its dependency on ride-sharing revenues from ~99% to ~70% (as of 1Q20).
Covid-19 brought two significant milestones for Uber in 2Q20. In particular, this is the first ever quarter that Uber Eats delivered >$1 billion in revenues and overtook ride-sharing as the largest revenue contributor. On the other hand, the mobility impact from the pandemic negatively impacted 2Q20’s ride sharing revenue, a decrease of ~67% vs prior period.
Uber cost breakdown
As for all startups / growth tech companies, cost remains a sticking point for many old school investors. On the whole, Uber’s operating expenses are evenly distributed among operations & support, sales & marketing, R&D and general & admin expenses.
The sharp jump in R&D in 2Q19 is largely driven by the recognition of expense related to restricted stock units (RSUs), a form of stock-based compensation, with a performance condition satisfied as per the IPO.
For Uber, because the enormous cash burn and high operating expenses continue to persist, understanding the cost breakdown often provide important clues into the viability of its business model. We discuss this in more detail below.
Is Uber profitable?
Other than a one-off gain from its divesture of its Southeast Asian business to Grab, Uber has never been profitable. At the time of writing, Uber has been operating on a net loss and free cash flow negative since records began.
There’s light at the end of the tunnel, fortunately. Before the Covid-19 crisis took center stage, Dara Khosrowshahi, Uber’s CEO, expects the company to be profitable by the end of 2020. Obviously, this now seems improbable given what happened.
In July, Mr Kosrowshahi reminded the market that he remains confident profitability will be achieved in 2021. The announcement also coincides with its latest acquisition of Postmates, a food delivery business.
How does Uber stay in business?
With profit being an elusive target for Uber since the beginning, how does Uber stay in business?
The answer lies in its cash balances. Besides its cash buffers, Uber has also issued ~$7 billion of borrowings, equivalent to ~12% of its current market cap ($56b).
The divesture of its Southeast Asian operations provided cash at hand for the Group’s continued reinvestment. Notice the spike in 2Q18 in its cash balances
Uber has been aggressively reinvesting in its business, which explains the persistent cash burn. Moreover, acquisitions are primarily funded by stocks. For example, the Postmates is funded entirely by stocks. Consequently, Uber is able to maintain a reasonable cash buffer to fence for its loss-making operations.
Uber's business strategy
Uber’s business strategy very much revolves around building and investing in infrastructures needed for future growth. The main reason that Uber has been unprofitable is its continuous reinvestment to its businesses, from expanding to new markets and verticals to R&D, human capital and acquisitions.
On the ground, Uber is effective in aligning both profit and user experiences. Over the years, Uber realized that it cannot pursue growth at any cost. This prompted Uber to retreat from unprofitable markets, divesting its operations to Did Chuxing in China and Grab in Southeast Asia.
Uber’s initiative to diversify away from ride-hailing is interesting. Its pivot towards the food delivery business has been bolstered with the recent acquisition of Postmates. It offers a barbell approach to its revenue stream, especially evident during the current pandemic.
The path to profitability for Uber is a difficult one to answer. Indeed, one can always cut cost. And with a little financial engineering and voila, profit!
Similar to most tech-driven growth companies, the key question is if growth can persist despite a cut costs. For example, should Uber stop advertising tomorrow, how will it affect its growth trajectory?
“In businesses, we’re looking for companies with durable competitive advantage” – Warren Buffett
At present, we chose not to add Uber into our portfolio largely driven by the uncertainty we have on its business model. The path to profitability exists, but we're not confident on the sustainability of it. Here’s our case.
We start off by considering the individual business segments.
First, leaving financials aside for now, we find that the ride-sharing business remains a broken business model. Essentially, the product offered is “getting from point A to point B”. Don’t get us wrong, we love the idea of ride-sharing.
But, from a business stand point, this is a pricing game that has no loyalty. Specifically, there is little visible competitive advantage or product differentiation across the ride-hailing industry. A commoditized product, one can argue.
Drivers are attracted to companies that maximize their pay, whereas passengers are most interested in taking the cheapest ride. Combining both and adding the fact that there are numerous competitor offering essentially the same product, this creates an extremely challenging business climate to operate in. Hence, why we dislike the ride-sharing business.
On the other hand, we find the economics of the food delivery business, Uber Eats, relatively better. This is in part driven by structural trends that have seen explosive growth in demand in recent times. Structurally, the food delivery business charges either a fixed fee per delivery or a subscription-based pricing structure.
We are attracted to the subscription-based model for two reasons. First, it provides predictable revenue. Secondly, subscription-based pricing builds customer loyalty, potentially reducing unit costs upon reaching critical mass.
Overall, while we’re comfortable with its current cash position, we’re not certain on how Uber will develop as a business, especially with the looming legal issues regarding classification of its drivers/riders. Despite having preferences for its food delivery over its ride-hailing business, the economics for the company as a whole remain subpar.
Until we can figure out how Uber can leverage on its platform, we shall remain on the sidelines. The big question remains unanswered: what will happen to its revenue if Uber starts reducing costs?