Uber has effectively sold itself to its investors as a tech company that simulates countless one-on-one negotiations between drivers and riders that, on an infinite timescale and with infinite patience is very much a technological product.
Except Uber isn’t quite doing this– its employing drivers who use their own cars to replace taxis (and delivery vans). Its clearly limited to the physical world, and isn’t infinitely scaleable at no cost. It must incentivize drivers better than the competition and must incentivise riders more than the competition to succeed.
Uber’s financials reflect this: last quarter the company had self declared gross margin of 51%. That is far lower than a typical SaaS Tech company’s gross margin of 70%+ , but that is primarily because the company’s cost of revenue includes insurance, which scales linearly with revenue. The software behind Uber’s marketplaces scales perfectly; except its real business doesn’t.
Our challenge is to understand that Uber’s financials are an incomplete view of the overall Uber experience, because riders don’t simply pay Uber. They also pay the drivers (and Uber also pays the drivers too). And, if you look at Uber’s financials from a rider perspective, the situation looks a lot worse; consider last quarter:
| in US$ millions | Uber’s Financials | The Rider Perspective |
|---|---|---|
| Revenue | $2,768 | $15,574 |
| Cost of Revenue | $1,342 | $14,148 |
| Gross Profit | $1,426 | $1,426 |
| Gross Margin | 51.5% | 9.2% |
Suddenly that gross margin looks nothing like a software company — and keep in mind this is all Uber has to work with before it gets to its huge and growing fixed costs AND without paying its employees as employees.
The only way Uber can work is if it grows to a truly mammoth size such that it has sufficient gross margin to cover fixed costs, but it is that much more difficult to acquire a marginal new customer when you simply don’t have that much margin to play with; spending on sales and marketing simply increases the slope of the hill you need to climb!
None of this is to say that Uber is not a viable business. I don’t think it is. But investors are considering the huge size of the potential addressable market and Uber’s ability to dominate that market because of technology AND the hope Uber can dominate self-driving cars owned by others.
Uber is not a taxi company! At the same time, it’s not a tech company either.
This is also a lesson for many commentators. Uber had a large market and there were tech-like dynamics that meant it could get a big part of that market, but margins — both reported, but especially relative to the customer transaction — still matter. Many commentators thought the size of the total prize meant that margins didn’t matter… in fact as always margins are vital.
We can take these learnings and apply them to WeWork; insufficient time has been invested discussing margins and what it would take to get a company with a direct interface with the real world yet valued as an etherial tech company, because they said they were a tech company
I believe the learning is to be a lot more skeptical about any tech startups that interface with the real world and the attendant drag on margins that follows. The extensive and effective use of technology can make companies different than the incumbents in their space, but they are not necessarily pure tech companies with pure tech returns either.