Cheap fares fueled the rise of ride-hailing. But that can’t last forever
In the fight for more customers, drivers, and market share, ride-hailing companies have in recent years embraced a simple but powerful strategy: cheap rides.
Uber, Lyft and other firms have used their ample venture capital backing to subsidize drivers and lower fares, igniting a price war that has benefited passengers at a great cost to the companies themselves.
It’s a policy so common that customers have come to see heavy ride discounts as the norm, but it’s also now facing new questions after Uber opted this week to cede the Chinese ride-hailing market to fierce competitor Didi Chuxing.
If Uber, which is valued at $62.5 billion, is no longer sinking a billion dollars a year into artificially keeping fares low in China, will it redirect those funds back home to fend off competitors such as Lyft, Juno and Via with even more subsidies than before? Or is it a sign that fare subsidies are flat-out unsustainable, with Uber’s retreat from China serving as proof that the strategy doesn’t work?
“A company like Uber has to balance two things: gaining market share while also demonstrating to investors they can turn a profit,” said Arun Sundararajan, author of “The Sharing Economy: The End of Employment and the Rise of Crowd-Based Capitalism,” who noted that as the ride-hailing industry matures, the race to the bottom makes less and less sense.
User growth may have been the dominant metric for success 18 months ago, but if the last year is anything to go by, investors are now demanding a path to both profitability and an initial public offering of stock — one that is likely to remain blocked if Uber continues to spend the way it did in China.
“The U.S. is the market investors are looking to as proof that Uber’s model can be profitable in a way that justifies its valuation,” Sundararajan said. “It’s going to be hard to get to profitability if they sustain a price war with Lyft.”
Lyft isn’t without deep pockets either. Despite being the distant No. 2 behind Uber, it received a $500-million investment from General Motors this year. Sundararajan believes that as a younger company with a comparatively modest $5.5-billion valuation, Lyft will find it easier to continue to raise funds compared with Uber, which has already tapped out venture capital firms and mutual funds, and has since turned to sovereign wealth funds and convertible debt.
Although analysts haven’t ruled out the possibility of Uber driving Lyft out of the game altogether, there are plenty of reasons why Uber — and even consumers — may want to avoid a fight to the death.
If Uber, which is already a market leader in the U.S. and Europe, crushes its competition, it runs the risk of “becoming the 800-pound gorilla” that sparks debates about price regulation and even antitrust concerns, said Mark Skilton, a professor at the Warwick Business School.
And consumers who benefit from a cutthroat price war should expect higher prices if a single company wins out, said Evan Rawley, a professor at Columbia Business School who has researched the ride-hailing industry.
“It’s network economics,” he said. “The classic bargain-and-rip-off strategy. We’ve had the bargain phase, and now we’re heading toward the rip-off phase.”
The tech industry has seen such economics before. Microsoft was sued in 1998 for allegedly violating the Sherman Antitrust Act. Having achieved a monopoly in the operating system and Web browser categories, the company was accused of increasing the price of the Windows operating system while knowing that consumers wouldn’t have an alternative but to pay up. The case was later settled.
Rawley has said since 2014 that Uber will eventually increase fares as soon as it has the market cornered.
Uber hasn’t revealed its market share in the U.S., but outside its home city of San Francisco, where Lyft commands nearly half the market, Uber’s presence dwarfs the competition.
In the years since Rawley’s prediction, Uber’s fares have only gotten lower, dragging its competitors into a costly subsidy battle. But just look to China, he said, where Monday’s news of Didi absorbing Uber China spelled the end for both companies’ cash-draining subsidies.
He described the news of the merger as the start of a transition in the ride-hailing industry from “intense competition to collusion,” in which companies go from giving away a service at a low price to harvesting the investment they’ve made.
Without knowing the inner financial workings of these privately held companies, it’s hard to know how much longer the heavy discounts and driver subsidies will last. But Skilton, the Warwick Business School professor, believes that so long as the competition in the U.S. remains fierce, the main players are more likely to offer premium services at higher costs than they are to change the prices of their basic services, which make up the bulk of their ridership.
Uber already offers its town cars and high-end SUVs as pricier alternatives to UberX. Lyft introduced Premier this year, allowing passengers to pay extra to ride in high-end cars with leather seats.
The race to the bottom is costly, Skilton said, and Uber’s battle in China shows that sometimes it’s simply not worth paying. Ultimately, he said, it makes more sense for ride-hailing services to try to win market share not by seeing how low they can go but how valuable they can be to the customer.
But it was perhaps Uber itself that put it best. Its head of operations in Asia, Allen Penn, told the Financial Times in June: “You can go out, spend a bunch of money in a city and gain some market share, but that’s not real,” he said. “You’re just kind of buying all of it — [though] you’re really more renting than buying.”
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