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A Crash Course for Uber. Dispatches from a Transportation Industry Analyst | Hubert Horan
00:31:26
In this Market Forces segment of Hidden Forces, host Demetri Kofinas speaks with transportation industry veteran and analyst, Hubert Horan. Demetri and Hubert's discussion centers on the ridesharing company Uber, which has received a great deal of nega...
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- [00:00]
A
So, Mr. Hubert Horan, thank you so much for coming on the program.
- [00:03]
B
Happy to be here.
- [00:04]
A
I want to let our audience know you are a 30 year veteran of the aviation transportation industry and I actually came across your work though you've been writing about Uber for the past two years now.
- [00:15]
B
Yes, it's been the last couple years.
- [00:17]
A
Well, there's a lot of stuff of yours online. A lot of that stuff gets posted on Naked Capitalism. But what I've seen, it goes back to 2015, correct?
- [00:26]
B
Correct.
- [00:27]
A
All right, so Uber has been very much in the news and I'm sure as a result of that, your stuff is getting picked up a lot. There's a great deal of interest because when you were writing, I also assumed it was largely in obscurity. There was a large cult of excitement around Uber. I must say I was part of that. In terms of being a customer, I really have taken a delight in the platform, though I must say I found it increasingly less satisfying as the years went on. In particular after it got cheaper. To be honest, I preferred it when it was a little bit more expensive because I felt like the drivers and everyone else were more satisfied. But a lot has happened in the last few months. On February 19, Susan Fowler, who is a former Uber engineer, posted about sexual harassment by Uber executives, which prompted an internal investigation where Uber hired the law firm of Covington and Berling, which is Eric Holder's company, to come in. That along with a number of other issues. I mean, Travis Kalanick, the CEO of Uber, has had longstanding, long running issues for years, ever since he came on board as CEO. He announced his resignation on June 13. The company announced it along with the resignation of Emil Michael, an SVP and a very close confidant of his. In general, there's turmoil at the company. You have done the best job certainly that I've seen. It seems just a really fantastic job of delving into the numbers with Uber, besides also offering a great amount of opinion with respect to what the issues are surrounding its business model, its practices, etc. That's what I would really like to focus on today with you, your work. Maybe to begin with you can tell us a little bit more about yourself and then tell us also, I'd love to understand really what you think the primary problem is with Uber.
- [02:17]
B
Well, you mentioned correctly the phenomenal amount of publicity that Uber has gotten since it started operations in 2010. And when you think about this, it's gotten more publicity than taxicabs had in their entire previous hundred years of existence. And so out of the blue, here was this company that had figured out a way to not only serve the taxi market profitably, but create $70 billion in corporate value while doing it based on stuff no one had been able to figure out in the previous hundred years. And I sort of scratched my head and said, that's fascinating. What is it that we've all been missing and everything? The first thing I noticed was that in all of that publicity over the years, saying how wonderful Uber was and how it was inevitably going to take over taxi service throughout the planet, no one was ever interviewed who knew anything about transportation or urban transportation or taxis specifically. And if you go back to a company like Amazon, where in its early years no one quite knew whether it would ever become profitable, but when the media was covering it, they went to talk to people who knew about warehousing or distribution or E commerce or the book industry. And these independent people would say, well, I don't know whether they'll make money, but this is phenomenally efficient, and this is a major breakthrough from the customer standpoint, and they're going to have huge scale economies and be able to grow. They talked to people who could expertly explain the economics. And I started looking, well, what are the economics? And what I've tried to lay out in the Naked Capitalism series and elsewhere is they have no economics. They are incapable. And so this is the central issue you asked about. Uber is a company that never, ever had any ability to make money in a competitive industry. Their entire strategy from day one was to go straight to monopoly to global industry dominance. They raised $13 billion to wipe out companies that could actually provide taxi service more efficiently than they could in order to achieve that monopoly. And the central issue is that lack of profitability and all of the cultural things you see are not some peripheral thing on the side. It's core to the strategy. If you have a strategy to wipe out more efficient competitors and take over an entire industry worldwide, you have to be a ruthless company. You have to have a monomaniacal focus on growth and dominance. And Travis Kalanick built that company. And the bad cultural stuff that's been going on for the entire seven years but has suddenly gotten publicity is part of that business strategy.
- [05:29]
A
Let me ask you this, because I want to delve into all of that. I want to delve into the specifics of Uber because it is fascinating. It is absolutely fascinating. For some context, can you please give our audience an understanding, an idea of what urban transportation has looked like, what the business model for urban transportation has been up until it was disrupted by Uber and in part by Lyft and Juno and these ride sharing platforms.
- [05:53]
B
Urban transport has some critical differences from inner city transport, meaning like freight railroads or passenger airlines. Because urban transport, whether you're talking about expressways or buses or subways or taxis, have never really been able to exist on what most people would think of as a private sector basis ever, ever, ever. Throughout the last hundred years. Obviously some systems that started the 19th century but quickly became public sector reason number one, because most of the value of urban transport is it creates the ability to have people live in houses. It creates opportunities to get to jobs that the taxi company or the bus company or the Long Island Railroad can't capture. There are all of these huge positive externalities for the rest of the economy. The second problem is that all transportation companies, and this is just one of the many things as a transportation person looking at Uber and said, well, transportation companies have huge peaking problems. The cost of providing the peak service is much more expensive than sort of the base load in the airline industry for years. You know, if it cost the fare in a given market was $200, it was $200 every seat, every day. Everyone would want to go Friday at 5 o', clock, which meant you had planes sitting around empty the rest of the week and you had to buy planes just to serve the Friday and Sunday night peaks. Airlines were able, through a number of things, including pricing, to smooth that peak out, which was phenomenally efficient. The taxicab peak. For most of urban transport, the peak is rush hour. The expressway, the Long Island Railroad, you can't fix that through pricing. The Long Island Railroad has had peak and off peak pricing for 100 years, but rush hour is still rush hour. No one's going to look at a Long Island Railroad table of fares and say, golly, maybe I should shift work and work on the night shift instead. No one who wants to go out on a taxi cab on Saturday night is going to look at a taxi fare and say, maybe we should go have this big dinner on Wednesday afternoon. The peak is the evenings for a taxicab.
- [08:17]
A
The market for cabs and the market for trains is inelastic by comparison to airlines, because in airlines you can schedule way ahead of time. I assume what you're getting at essentially is that using price differentials to stimulate supply and diminish demand and find an equilibrium is much more difficult with cars than it is for airplanes. And of course it would require great deal of price hiking and perhaps price.
- [08:44]
B
Gouging the planning in advance that you mentioned is a very important point. When people buy airline tickets, they're usually planning an overall trip well in advance. They have perfect information on each airline's fares on any given flight. And they can say, no, I'll pay extra to go Friday at 5 o', clock, that's my schedule, has to work that way and my company will pay for it. Or no, we're taking the kids to visit grandma and if we go Saturday morning, we can save $1,000 on the family's trip.
- [09:16]
A
What about what Uber's claim, and this is in that book by the Bloomberg Reporter, the upstarts that in the Boston car market, which they tested early on in their development, they were able to find that by surging prices at night when a lot of college students were out drinking, that they were incentivized to pay the higher rate and drivers were incentivized to come out and service the area where it wasn't. In other words, is there some value to the surge pricing in certain areas, in certain ways? It's just that simply it isn't effective enough to justify the valuation.
- [09:51]
B
Well, that study was pretty bogus. If you want to say rich people will pay more for taxis, that's true. But even rich people, if the prices go way up, will use taxis less. The key for taxis to understand, and this is true in any large city, is that almost half of the demand for taxis is very low income people. And again, the peak is in the evening because that's when there isn't transit available.
- [10:18]
A
Right. And that's where of course, people with lower incomes have to work all sorts of other right now.
- [10:22]
B
So in other words, the Saturday night peak for a taxicab in a city like New York or San Francisco or Miami or Chicago is a combination of wealthier people going out for the evening. But more the bigger volume are the people who work in those restaurants washing the dishes that those people are eating at, who have no way to get home at 1am when the restaurant shuts down. If you surge prices by a factor of five, which is what you would need to do in the real world to make the economics work, those dishwashers can't get to work, those people who use cabs to get to late shifts at hospitals and warehouses and post office can no longer have their jobs.
- [11:07]
A
Right. Well, so there is that social component, the social moral quality conversation with respect to the regulations. And that's something I would like to discuss in the context of regulations in general, because one of the reasons that Uber was indeed very successful, I think and popular and has been popular with riders has been because people were so dissatisfied with the taxi industry. Now, in your work, your claim is that what they did was they very effectively Uber did use a PR propaganda campaign in order to sort of capitalize on this idea that there is a cab cartel and that there is sort of this medallion cartel, etc. That is something I want to get into because I am fascinated by it. Because I do wonder really, how do we fix an industry that did seem to me as a consumer to have been inadequate. However, before we go to that, I really, really want to get into because you do such a great job in this paper, the most recent white paper that you have released and that I got my hands on going into the number. So let's talk a little bit about the finances here, because when you compare Uber to Google or to Amazon, the differences are astounding. I think I got this number from you, which is that Uber has 1600 times larger pre IPO investment base that it has received from the multiple rounds of financing. It's gotten $13 billion total with a nearly $70 billion valuation versus Amazon pre its IPO. And from my own math, what I've got here is that Uber has raised 520 times as much pre IPO as Google did, which raised $25 million before its IPO and 2 billion after its IPO.
- [12:49]
B
That goes back to one of the points I was making at the outset when you asked me to sort of summarize that for companies like Google and Amazon, they grew to become powerful because they started by actually creating real economic value. Amazon created this massive retailing system that was incredibly efficient. Google created search products that were wonderful and so forth. Now there are negative things about those companies. What I'm saying is they grew to huge size and power because they had found ways to benefit the rest of society. The Uber strategy was hey, creating valuable products, defining new efficiency, that's really hard. Let's skip that part and go straight to the monopoly part. That's why they needed the $13 billion. Amazon didn't need $13 billion because they could fund their growth out of positive cash flow.
- [13:48]
A
And one of the main sort of obvious differences between these other Internet startups and Uber is that these Internet startups took advantage of what is popularly dubbed the zero marginal cost effect. In other words, the costs for creating the product are pretty much set and baked into the cake. And there is no marginal cost above for each new user, for each new product sold. There is no additional cost for the company in doing that. Whereas with Uber, the cost is real because the cost requires additional cabs.
- [14:20]
B
And that's a perfect example of the kind of things that struck me as transportation person saying, wait a minute, Uber makes no sense. The zero marginal cost is what an economist called scale economies, meaning they're sort of. You put Amazon builds a warehousing and IT marketing infrastructure in place, and then as you grow, it's already your. Your marginal costs rapidly decline and profits go up. Transportation companies don't have those kinds of scale economies. Google and ebay and Facebook had what are known as network economies, meaning the value of the service skyrocketed because users benefited by having a large base of users on that platform. People on Facebook like it because all their friends are there. That's a network economy. Taxi cabs don't have that.
- [15:11]
A
There's some network effect to the fact that. I mean, for example, when Uber first launched its platform, it was not successful when it initially launched because it didn't have have drivers on the platform to service the customers. So isn't there some network effect there to be said?
- [15:26]
B
But catch 22, the reason that they got those drivers and passengers onto the network, the reason you talk about how happy you and other Uber users were as it grew, was because all of that was subsidy. The billions in losses. People all talk, oh, this Uber app is so great. I love the software. No, they don't care about the software. They care about when they push the button. It shows them a lot of cabs available at lower fares. That's because of subsidies. If Uber could only put out the number of cabs that the revenue base would justify and raised fares to cover their true cost, no one would like the app. And think about it. Every other consumer industry in the world uses smartphone ordering to some extent, and it had zero impact on competition. And Uber comes along and says, our app and user interface is so powerful that it will wipe out every other cab company on the planet, drive them into bankruptcy, and create $70 billion in corporate value. And I looked at that and I said, that makes no sense.
- [16:36]
A
So according to your estimates in 2015 and the year ending 2015, according to generally accepted accounting principles, Uber registered a loss of roughly $2 billion on revenue of $1.4 billion, which is a negative 143% margin, which is obviously terrifying numbers that you lay out here. But in line with what you're saying, because I don't want to lose sight of that fact, do you have any idea what percentage of that $2 billion was spent on subsidies Were you able to drive that estimation somehow? And by the way, 3 billion was your estimation of their losses in the year ending 2016? I believe.
- [17:09]
B
Well, essentially all of it, 2 billion and 3 billion. That money was subsidizing cab capacity and lower fares that wouldn't be there without those losses.
- [17:19]
A
One of the other things that I wanted to touch on with respect to your work is the fact that there's a certain standard amount of overhead for dispatch and some of the other comp features that cab companies, guys like me, we assumed, and we have assumed that Uber has some magic formula insofar as its algorithm is really efficient at routing cars that is able to squeeze much more revenue out of the same number of vehicles on the road because it'd be able to route them. We all, for example, experience when we order an Uber, we're told, wait, your driver is finishing this ride. I know from speaking with Uber drivers that there is less downtime. One of your other points in talking about this is that in fact, the smaller amount of downtime does not make up for in any meaningful way the cost disadvantages of not operating your own fleet, which would provide you the economies of scale when it comes to the purchasing, to the financing and to the insurance of those vehicles.
- [18:21]
B
Right in the Naked Capitalism series is say, let's take the cost structure of a traditional cab company and I sort of used a representative sample of three big cities say, okay, so much of their costs are the vehicle, so much of their costs are the take home pay for the driver. So much of the costs are fuel, and so much of the cost is overhead, which includes, as you mentioned, dispatching and profits and the corporate office and putting ads in the yellow pages and all that kind of stuff. And you sort of say, okay. And you kept saying, well, I just figured Uber had developed some special sauce. Well, the special sauce would have to be somewhere in that column of numbers. And you go down the list of numbers, well, everyone's paying the same amount for fuel, so there's nothing there. And well, if drivers in big cities prior to Uber were getting 14 to $19 an hour take home pay, Uber was growing because they were paying him more at first, so that's a disadvantage. I think you've clearly seen that the vehicle cost within Uber, again, your fare on Uber has to pay Uber's costs and the driver's costs, and it's way more. And the cost for a driver to get all those vehicles rather than yellow cab with a fleet manager and a central maintenance facility to those vehicles is much more Expensive. Their overhead costs are way higher. So you go down the entire list of costs and fuel's the same and everything else is worse.
- [19:54]
A
What about the fact that Uber has gone after and hired a number of fleet operators? I mean, directly, don't they also work with fleet operators?
- [20:03]
B
No. The Uber vehicles are owned by the drivers. That's their system. Again, from a transportation person, this is again, you know, every transportation company in the world, be it Federal Express or the Union Pacific Railroad or an Ocean Line or Chicago Transit Authority, has absolute central control and ownership of all the capital assets, meaning the planes or trains or whatever, and all the labor that works. And they have very sophisticated, in some cases really leading edge programs for figuring out how to manage those resources. Uber comes along and say, no, all those transportation companies are out to lunch. The way to make tens of billions of dollars is you just have random guys show up when they feel like it, and we put an app on their phone and if they feel like doing work for us, they hit the app. Which is like going to UPS and Federal Express and saying you want to sell all your trucks and your warehouses and your computer systems and just put an app. And, you know, guys with pickup trucks, when they feel like it, will come deliver packages for you. And when you put it in those terms, people say, that's the stupidest ID in creation. And I say, yes, that is Uber's business model. It's the stupidest ID in creation.
- [21:26]
A
Well, a few things, because like I said, I've learned a great deal going through your numbers. The one thing I'm saying right now in this context is that from what I understand, it has been in the interest, and Uber has in fact pursued relationships, business development relationships with aggregate suppliers of cars and drivers. In addition to the fact that of course as an individual driver you can sign up to Uber, that in fact they've also looked to consolidate, in some ways similar to what Amazon has done with retailers, that they've looked in some ways to consolidate the retail outlets so that they become the distributors, they become the software, and the other guys just basically become the leasers, equippers of insurers, et cetera, and then just put the drivers out on the street and that's it.
- [22:10]
B
Well, this has been covered a lot over the years. Alison Griswold had a piece on courts just today with new documentation. Those fleet people you're talking about are people who turn around to very low income people who want to maybe drive from Uber and lock them into the most awful contracts, vehicle contracts. I mean, it's like people in a company mining town in the 1930s who are being paid next to nothing and then the company town fleeces them for the cost of their housing and food. This is not market economics.
- [22:50]
A
This goes back to something else as well, which deals with the fact that, and I have investigated this matter myself as well, speaking with Uber drivers over the years, which is that the financing of their vehicles, they're locked into long term financing agreement. So when Uber proceeded to change the pricing model and allocation of income to the drivers that obviously they had a captive audience. I mean, there are a lot of aspects of the story, one of which is what you're getting to, which is the fact that Uber's attempt from the beginning has been to use political arbitrage to hire people like David Plouffe and David Cameron's adviser in the UK for their entry out into England. They've been interested in using sort of heavy handed anti competitive practices, working the political angle, which something that we hadn't really seen certainly in our last big tech boom in the 90s to build a large market which they could then dominate. But the thing for me, since we're running out of time, I want to say this. What I found most fascinating from your work and it was the reason why I reached out to you because I had spoken with Evan Lawrence, who you know from grants we spoke about. This is just the numbers. The numbers to me are staggering because you're Talking about a $70 billion valuation of a pre IPO, $13 billion thrown in there, which is massively hemorrhaging cash with no clear business model for dominance, and which has also lost the Chinese market. There are a lot of factors here and I think it speaks to not only the mistakes potentially within Uber itself and the investors, but to a larger issue that I've spoken about and I want to continue speaking about on this show, which is the income wealth disparity across our capital markets which allow for these types of hunts for yield, searches for economic opportunity, fomo, fear of missing out essentially as well for these investors and also a regret that they missed these larger opportunities in the past like Facebook and Google, and they're willing to blow out a valuation on a company like this with the hope that it'll become the next Google. I think this could be a huge canary in the coal mine within Silicon Valley and a harbinger for things to come because we have seen a shift from IPOs, from public offerings, from companies issuing shares to companies being able to fund this level of cash in private Markets pre ipo.
- [25:17]
B
Well, everything you said is correct. But notice also that in all of the negative publicity that you've seen about Uber in the last few months and sacking of the CEO even, none of it mentioned the fact that they can't make money and have no plan to make money money. None of it mentioned, you know, there was a rebellion of the investors, but there was no discussion. Maybe that was because they see no path to ever getting a return on that investment.
- [25:44]
A
How do we know that they don't have a strategy for that?
- [25:47]
B
Well, if they had a business model, somebody could, who wasn't on the company payroll could lay out how they get from 2 billion losses in 2015 and 3 billion losses in 2016 to sustainable profit profits. Nobody can do that.
- [26:03]
A
I think taking a stab at it. Again, this is a complete speculation because I don't have access to this information from the company because it's highly guarded. There's another good point you make as well in your work, which I should note in the context of this, which is the fact that the response of Uber has been much more to intimidate journalists and those looking to acquire information about its long term plans for profitability rather than be very open, which was the case with Amazon, which did have a very rough year in 2000, but then subsequently recovered. So that's an important point. But I will say I've always assumed that Uber's plan was, like you say, very much in terms of establishing a monopoly. This is classic dumping strategy in terms of undercutting competitors. When Lyft comes into their market, or Juno, they always look to subsidize their offering, to undercut the competitor, bleed them out and have them leave the market so they could eventually control the market. But as you point out very clearly, they have huge business model challenges with the current model. So how do they sustain? How do they hold that market territory? I've always been of the mindset that they have been and looks like potentially have grossly overestimated the time in which they would be able to deploy autonomous driving vehicles. I think that was a big part of their strategy because the autonomous driving vehicle fleet would address directly the rational arguments you have made with respect to economies of scale.
- [27:25]
B
Well, actually it wouldn't because they never even thought hard about driverless cars until they were realizing that China was about to collapse. None of their investors put money into the company because it was going to pursue driverless cars. And if you think about it, there's no reason Uber should be able to win that market.
- [27:47]
A
That's a very good point.
- [27:48]
B
Driverless cars mean staggering amounts of capital to buy all these cars.
- [27:53]
A
No, Absolutely.
- [27:54]
B
They have no capital to do this.
- [27:55]
A
Absolutely. No, there's no question about it. It.
- [27:58]
B
It's again, driverless cars was just the latest PR thing, you know, before that, as though we're going to do food delivery and logistics and, you know, all of these other new business. You can't do new, more difficult, riskier businesses until you've got solid profits in your core business. Amazon built up a book retailing thing. It chose to invest money in new businesses rather than show a P and L profit. But it had strong positive cash flow. It had a core business, core infrastructure. It could then expand into lower margin things like selling electronics or clothing or investing in cloud infrastructure. Uber doesn't have a profitable ride sharing business and it's nowhere close. And it's not going to ever get.
- [28:44]
A
There, certainly if they're struggling to fill their COO position, which is a very important position if you want to be an effective operator or something like this. Absolutely. And I would also say, I think this is one of those things where, where besides all the facts that I was hoping and we couldn't get to everything today, which I wanted to discuss, that you've written about, but I think for anyone that sort of looks it over a bit and then reads and engages with the company will understand that it doesn't pass the smell test, which is that if they had an effect, because the value proposition here would suggest that they have, as I had mentioned before, and as you repeated, that they have a special sauce, that somehow their software, their routing software has the ability to solve the problem of empty backhaul, that they would fix this with rideshare, they'd be able to dramatically reduce costs and provide a better product. There is no evidence that even if they have managed to do that on some level, that it justifies in any way this valuation. And on top of that, they've got a huge problem with competition. They have huge competitors, they have very low barrier to entry. There is no switching cost for the driver. There is some switching costs. There is, I think, a network effect. I think there is a network effect for the consumer. You did say they did achieve that network effect by using subsidies. That's true. But I do think there's some value there. In other words, I do think there is value to the platform, I think there's value to the software, but certainly not based on what I've seen, anything near the valuation that we're talking about. I think in that context, this has the potential to lose a lot of people, a lot of money. A lot of people made their names off of being early investors in Uber. And Uber had become, in many ways the darling of this new Silicon Valley culture, which in my estimation is starting to smell and seem more and more like the financial system. I'm not saying it's anything like the financial system pre 2008, but it certainly doesn't have the cachet and the class and the sex appeal that it had in the late 90s and certainly in the early part of this boom. So, Mr. Horan, I already took too much of your time. I want to thank you very much for taking the time to speak with me. And I want to tell our audience that if they want to read any of your stuff, most of it, as you said, is on naked capitalism. But how is the best way for them to go through this? And in particular, the paper of yours that I read, which is a 45 page white paper, your most recent, which breaks down some of these numbers.
- [31:03]
B
Yeah, that'll be a law journal article that's coming up in a couple months that's close to being finalized. That's available at ssrn. Just Google my name and ssrn, you'll find it. And Social Science Research Network. A lot of academic papers are available.
- [31:20]
A
Well, thank you so much for coming on and taking the time to speak to us and to our audience.
- [31:24]
B
Always happy to.