September 27, 2015    5 minute read

Uber’s Fairy Tale: On Track for Success

   September 27, 2015    5 minute read

Uber’s Fairy Tale: On Track for Success

With a $50bn company valuation, revenues 12 times the size of its closest competitor Lyft and self-claimed up to 40% lower prices than traditional taxis, Uber became the top player in the ride-sharing market in less than 6 years. This remarkable story raises questions about the secrets behind Uber’s successes.

First, the market environment will be explored. In 2009, the traditional US taxi industry had a value of $9.4bn. The entry barriers were high (i.e. a NY taxi license was traded for $1m in 2010) and the regulations were strict (i.e. limited number of medaillons) which created an artificial shortage of supply.  The fares were fixed across all providers and the product differentiation was low. These factors turned the taxi industry into one with a limited degree of attractiveness. However, since the early 2000s technological changes impacted consumers’ life-styles. This led to a decrease of driving in the US by young people by 23% (2001-09) alongside a rise in smart-phone penetration which reached 75% in 2014. It is these changes that can be seen as the foundation that enabled Uber’s success.

While life-styles changed, the taxi industry stayed the same since its invention, was characterised by inefficient utilisation, poor consumer value and high prices. This together with the limited attractiveness turned the taxi industry into a market that was ripe for a disruption. The link between the taxi industry’s key success factors and a profitable business model was blurred by regulation and not properly understood. When Uber entered the market it created new rules of the game by breaking the existing value/cost trade-off as seen next.

Uber started as an asset light enterprise that does not own a taxi fleet and has low operating costs. It acts as mediator between private/sub-contracted drivers and passengers, taking a 20% commission fee. Uber reduced pick-up times and prices as well as transaction costs through easy booking/paying and improved the consumer experience through offering an increased product range, high coverage as well as increased pay for drivers. It eliminated factors that the industry took for granted such as medallions, cab cars, dispatch centres and created a new dynamic pricing system as well as established GPS tracking and a recommendation based quality control. Overall, Uber simultaneously pursued a differentiation and low cost strategy which enables superior customer value at lower operating costs.

This new business model explains Uber’s initial success. However, it’s rapid growth and massive market valuation is also due to its pro-active use of network strategies. It is evident, that the ride-sharing platform market is characterised by the ‘Chicken-and-Egg Problem’ (Caillaud & Jullien, 2003):

  1. As Uber recruits more drivers, this reduces pickup times and increases coverage which attracts more passengers.
  2. As there are more passengers, drivers will have a higher utilisation. Hence more drivers are attracted.
  3. The cycle continues.

In this two-sided network both sides of the market, drivers and customers, have to be managed by Uber. The provider that achieves the ‘tipping point’ is inclined to pull away from its competitors and wins. Uber managed to create local supremacy in the US through promising higher pay to drivers and lower prices to passengers using price penetration and dynamic pricing. Uber used its large cash resources to penetrate the market and built up a large consumer/driver base. On the consumer side, Uber has been pricing below its variable costs (i.e. California). On the driver side, Uber offered a $500 starting bonus for new drivers across the USA. It applied a typical ‘dotcom’ strategy: ‘grow the user base as quickly as possible and worry about making money later’. In addition, Uber identified that the taxi market consists of heterogeneous consumers, with different consumers willing to pay different amounts at different times. Uber hence skims the market using price discrimination. This sees rates increase during peak periods (i.e. New Year’s Eve) to push more drivers on the street and decrease during off-peak times to encourage more consumers to take an Uber. This makes Uber capture maximum value from customers and maximizes the utilization of its drivers.

Taking a step back, it has to be pointed out that the success of Uber’s disruption of the taxi market and efficient use of network strategies was also enabled by Uber’s brand equity and human capital. First, Uber’s brand image as disrupter benefits from the power of its narrative as well as its unique historical setting of being the first mover. The firm is associated with finding a cab anywhere, anytime and with minimal hassle, which especially helps the firm when expanding. Second, Uber posses a pool of uniquely talented people. CEO Kalanick is a problem solver with rule-breaking attitude (Mr Boldness of the Year 2014 FT) and VP Plouffe, who was the mastermind behind Obama’s 2008 campaign, is now in charge of relationships with governments. Furthermore, the firm employs a nuclear physicist, a computational neurosurgeon and a machine-learning expert. This unique combination of talent contributed to Uber’s successes.

Last, the role of luck shall not be underestimated. Uber’s biggest competitor Lyft started its ride-sharing service in 2007, two years before Uber. However, it focused on long-distance transportation between cities and neglected the opportunity to substitute taxis – a pivotal mistake as known today.

Overall, Uber’s disruptive business model, its pro-active network strategies together with its brand equity as well as human capital and the role of luck led to the firm’s success and a temporary competitive advantage which can be measured along two dimensions:

  • Economic Performance:
    • Uber’s revenues are 12 times those of Lyft
    • $2bn sales forecast for 2015
    • 50bn valuation
    • 369% YOY growth rate 2012-13
  • Organisational Effectiveness:
    • 20-30% time reduction
    • Claims to charge 30-40% less than normal taxis
    • Transaction costs reduced and consumer convenience increased
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