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Yves here. By virtue of steamrolling local taxi operations in cities all over the world, combined with cultivating cheerleaders in the business press and among Silicon Valley libertarians, Uber has managed to create an image of inevitability and invincibility. How much is hype and how much is real?
As transportation industry expert Hubert Horan will demonstrate in his four-part series, Uber has greatly oversold its case. There are no grounds for believing that Uber will ever be profitable, let alone justify its lofty valuation, absent perhaps the widespread implementation of driverless cars. Lambert has started digging into that issue, and his posts on that topic have consistently found that the technology would be vastly more difficult to develop and implement that its boosters acknowledge, would require substantial upgrading in roads, may never be viable in adverse weather conditions (snow and rain) and is least likely to be implemented in cities, which present far more daunting design demands that long-distance transport on highways.
Tellingly, earlier this month, Bloomberg reported that JP Morgan and Deutsche Bank turned down the “opportunity” to sell Uber shares to high-net-worth individuals. The reason? The taxi ride company provided 290 pages of verbiage, but would not provide its net income or even annual revenues.
By Hubert Horan, who has 40 years of experience in the management and regulation of transportation companies (primarily airlines). Horan has no financial links with any urban car service industry competitors, investors or regulators, or any firms that work on behalf of industry participants.
Uber is currently the most highly valued private company in the world. Its primarily Silicon Valley-based investors have a achieved a venture capital valuation of $69 billion based on direct investment of over $13 billion. Uber hopes to earn billions in returns for those investors out of an urban car service industry that historically had razor-thin margins producing a commodity product. Although the industry has been competitively fragmented and structurally stable for over a century, Uber has been aggressively pursuing global industry dominance, in the belief that the industry has been radically transformed into a “winner-take-all” market.
This is the first of a series of articles addressing the question of whether Uber’s pursuit of global industry dominance would actually improve the efficiency of the urban car service industry and improve overall economic welfare.
For Uber (or any other radical industry restructuring) to be welfare enhancing, it would have to clearly demonstrate:
The ability to earn sustainable profits in competitive markets large enough to provide attractive returns on its invested capital
The ability to provide service at significantly lower cost, or the ability to produce much higher quality service at similar costs
That it has created new sources of sustainable competitive advantages through major product redesigns and technology/process innovations that incumbent producers could not readily match, and
Evidence that the newly-dominant company will have strong incentive to pass on a significant share of those efficiency gains to consumers.
Unlike most startups, Uber did not enter the industry in pursuit of a significant market share, but was explicitly working to drive incumbents out of business and achieve global industry dominance. Uber’s huge valuation was always predicated on the dramatic growth towards global dominance. Thus if Uber’s valuation and industry dominance were to be welfare enhancing, Uber’s efficiency and competitive advantages would need to be overwhelming, and there would need to be clear evidence of Uber’s ability to generate large profits and consumer welfare benefits out of these advantages.
While most media coverage focused on isolated Uber product attributes, or its corporate style and image, this series will focus on the overall economics of Uber, using the approaches that outsiders examining industry competitive dynamics or investment opportunities typically would. This first article will present evidence on Uber’s profitability, while subsequent pieces will present evidence about cost efficiency, competitive advantage and the other issues critical to the larger economic welfare question.
Uber Has Operating Losses of $2 Billion a Year, More Than Any Startup in History
Published financial data shows that Uber is losing more money than any startup in history and that its ability to capture customers and drivers from incumbent operators is entirely due to $2 billion in annual investor subsidies. The vast majority of media coverage presumes Uber is following the path of prominent digitally-based startups whose large initial losses transformed into strong profits within a few years.
This presumption is contradicted by Uber’s actual financial results, which show no meaningful margin improvement through 2015 while the limited margin improvements achieved in 2016 can be entirely explained by Uber-imposed cutbacks to driver compensation. It is also contradicted by the fact that Uber lacks the major scale and network economies that allowed digitally-based startups to achieve rapid margin improvement.
As a private company, Uber is not required to publish financial statements, and financial statements disseminated privately are not required to be audited in accordance with generally accepted accounting principles (GAAP) or satisfy the SEC’s reporting standards for public companies.
The financial tables below are based on private financial statements that Uber shared with investors that were published in the financial press on three separate occasions. The first set included data for 2012, 2013 and the first half of 2014, although only EBITAR (before interest, taxes, depreciation and amortization) contribution was shown, not the true (GAAP) profit that publically traded companies report. The second set included tables of GAAP profit data for full year 2014 and the first half of 2015; the third set included summary EBITAR contribution data for the first half of 2016. There has been no public report of results for the fourth quarter of 2015.
Exhibit 1 summarizes data from 2013 through the first half of 2015. Drivers retained 83% of passenger payments (fares tips) which must cover the cost of vehicle ownership, insurance and maintenance, fuel, credit card and license fees as well as health insurance and take home pay; the balance is Uber’s total revenue. Exhibit 2 shows the GAAP results for the full year ending September 2015 based on the published numbers and an estimated quarterly split of published 2nd half 2014 results. Exhibit 3 compares first half 2016 results to 2014-15 results. There is no simple relationship between EBITAR contribution and GAAP profitability and even publically traded companies have wide leeway as to what expenses can be excluded from interim contribution measures such as EBITAR.
As shown in Exhibit 2, for the year ending September 2015, Uber had GAAP losses of $2 billion on revenue of $1.4 billion, a negative 143% profit margin. Thus Uber’s current operations depend on $2 billion in subsidies, funded out of the $13 billion in cash its investors have provided.
Uber passengers were paying only 41% of the actual cost of their trips; Uber was using these massive subsidies to undercut the fares and provide more capacity than the competitors who had to cover 100% of their costs out of passenger fares.
Many other tech startups lost money as they pursued growth and market share, but losses of this magnitude are unprecedented; in its worst-ever four quarters, in 2000, Amazon had a negative 50% margin, losing $1.4 billion on $2.8 billion in revenue, and the company responded by firing more than 15 percent of its workforce. 2015 was Uber’s fifth year of operations; at that point in its history Facebook was achieving 25% profit margins.
No Evidence of the Rapid Margin Improvement That Drove Other Tech Startups to Profitability
There is no evidence that Uber’s rapid growth is driving the rapid margin improvements achieved by other prominent tech startups as they “grew into profitability.”
Assuming that the unusual spike in EBITAR margin in the first half of 2014 (157%) was due to one-time events or accounting anomalies, Uber has been steadily producing EBITAR margins worse than negative 100% since 2012, and the absolute magnitude of losses has been increasing.
Uber corporate revenue for the year ending June 2015 was over 500% higher than the year ending June 2014, but the EBITAR margin barely changed, moving from negative 115% to negative 108%. Uber had a negative $1.2 billion EBITAR contribution in the first half of 2016, suggesting full year GAAP losses approaching $3 billion. Uber’s EBITAR contribution margin improved from negative 108% in the first half of 2015 to negative 62% in the first half of 2016, but this margin improvement is entirely explained by Uber imposed cuts in driver compensation. As shown in Exhibit 3, Uber only allowed drivers to retain 77% of each passenger dollar in 2016, down from 83% in 2014-15. If drivers had retained 83% of 2016 passenger payments, Uber’s EBITAR contribution would have been negative $1.8 billion, and its EBITAR margin would have fallen to negative 122%. Uber’s EBITAR margin did not improve because its productive efficiency or market performance was improving; capital was simply claiming a higher share of each revenue dollar and giving less to labor.
If rapid growth could not drive major margin improvements between 2012 and 2016, there is no reason to believe that Uber will suddenly find billions in scale economies going forward. Fundamentally digital companies like Amazon, EBay, Google and Facebook had massive operating scale economies because the marginal cost of expanded operations was close to zero. Aggressive pricing fueled the growth that drove major margin improvements and also created major consumer welfare benefits.
By contrast, in the hundred years since the first motorized taxi, there has been no evidence of significant scale economies in the urban car service industry. That explains why successful operators never expanded to other cities and why there was no natural tendency towards concentration in individual markets. Drivers, vehicles and fuel account for 85% of urban car service costs. None of these costs decline significantly as companies grow. As the P&L data above demonstrates, Uber has not discovered a magical new way to drive down unit costs.
Uber Losses Not explained by Uber China and No One Can Explain How Profitability Can Be Achieved
Several of the new stories reporting Uber’s financial results quoted anonymous sources attributing a significant portion of the losses to Uber’s failed efforts in China. Uber China may have lost a lot of money but those losses are not included in (or are not material to) the losses discussed here. Uber China did not begin operating until 2014 and operated under a separate ownership structure prior to its sale to Didi Chuxing. Uber Global only had a minority shareholding. Thus Uber Global could not have included Uber China results in any of its EBITAR contribution or GAAP operating profitability numbers, and could only have included the percentage of China losses assigned to its minority shareholding as a non-operating expense. The news reports of Uber’s first half 2016 losses said that Uber had not yet incorporated any Chinese losses onto its Global balance sheet, some of which will be offset by Uber’s new 17.5% shareholding in Didi, and Didi’s $1 billion investment in Uber.
The press has reported numerous unsubstantiated assertions that Uber was on the verge of profitability, or that operations in individual markets were profitable. In September 2015, Travis Kalanick said that Uber’s North American operations would be profitable by early 2016, but did not explain whether this meant actual (GAAP) profitability, or an artificial interim contribution measure such as EBITAR or positive cash-flow. Uber has not presented any evidence that Kalanick’s promise has been achieved.
Since Uber’s corporate expenses are almost entirely joint/overhead costs that cannot be directly linked to current operations in specific markets, it would be easy to claim positive contribution numbers despite massive actual GAAP losses. The article reporting Uber’s 2015 losses said “the company expects older markets in developed countries to generate billions of dollars in profit in the coming years.” But the $4 billion profit improvement needed to convert today’s $2 billion losses into a $2 billion profit would require some combination of the most staggering efficiency gains in the history of private enterprise (total Global Uber expense in Exhibit 2 was $3.4 billion) and humongous fare increases (fares would need to have quadrupled to have produced a $2 billion profit in 2015).
Uber’s refusal to consider an IPO may best be explained by the recognition that publishing detailed, audited financial data confirming these massive losses and the complete lack of progress towards profitability could undermine public confidence about its inevitable march to industry dominance.
There have been hundreds of articles claiming that Uber has produced wonderful benefits, but none of these benefits increase consumer welfare because they depended on billions in subsidies. Uber is currently a staggeringly unprofitable company. Aside from the imposition of unilateral cuts in driver compensation, there is no evidence of any progress towards breakeven, and no one can provide a credible explanation of how Uber could achieve the billions in P&L improvements needed to achieve sustainable profits and investor returns.
Uber’s growth to date is entirely explained by its willingness to engage in predatory competition funded by Silicon Valley billionaires pursuing industry dominance. But this financial evidence, while highly suggestive, cannot completely answer the question of how an Uber-dominated industry would impact overall economic welfare.
The next articles in this series will examine the critical questions of cost competitiveness and industry dynamics. Could Uber ever produce urban car services as efficiently as the incumbent operators it has been driving out of business? Is Uber’s business model is based on the types of major product/technological/process breakthroughs that could provide sustainable competitive advantages large enough to justify the losses its investors have been subsidizing to date? Has Uber transformed urban car services into a “winner-take-all” market? Do the billions that the capital markets have invested in Uber and similar companies reflect a reallocation of resources from less productive to more productive uses? Is Uber’s pursuit of returns on the $13 billion its investors have provided consistent with the normal workings of competitive markets?
 Newcomer, Eric, Uber Bonds Term Sheet Reveals $470 Million in Operating Losses, Bloomberg, 29 Jun 2015; see also Biddle, Sam, Here Are the Internal Documents that Prove Uber Is a Money Loser, Gawker, 15 Aug 2015; Griffith, Erin, For high-risk start-ups like Uber, big ambitions don’t make losses any less unsettling, Los Angeles Times, 11 Aug 2015;
 Efrati, Amir, Uber’s Losses Grow, The Information, 11 Jan 2016; Salomon, Brian, Leaked: Uber’s Financials Show Huge Growth, Even Bigger Losses, Forbes, 11 Jan 2016. ;Newcomer, Eric & Huet, Ellen, Facing a Price War, Uber Bets on Volume, Bloomberg, 21 Jan 2016
 Newcomer, Eric, Uber Loses at Least $1.2 Billion in First Half of 2016, Bloomberg, 25 Aug 2016; Issac, Mike, How Uber Lost More Than $1 Billion in the First Half of 2016, New York Times, 25 Aug 2016 The bottom line in the first set of reports was labeled as either “Net Loss” or EBIT (earnings with only interest and taxes excluded) but is presumed to be EBITAR the second set of reports shows that 40% of total GAAP expenses were excluded from EBIT numbers, and the third set was explicitly labeled as EBITAR.
 Hansell, Saul, Amazon, Facing Slowdown, Cuts 1,300 Jobs, The New York Times, 31 Jan 2001
 Griffith, Erin, The problem with ‘Uber for X’, Fortune, Aug 2015
 Uber began implementing driver compensation cutbacks in the second half of 2015. Huet, Ellen, Uber Tests Taking Even More From Its Drivers With 30% Commission, Forbes, 18 May 2015.
 Uber China was valued at $8.2 billion based on an investment base of $1.2 billion. Bensinger, Greg & Winkler, Rolfe, Uber-Didi Tie-Up Threatens Lyft in U.S., Wall Street Journal, 2 Aug 2016. Hook, Leslie, Uber’s battle for China, Financial Times Magazine, Jun 2016.
 Newcomer supra note 1
 Efrati supra note 2