Ubernomics: The Questionable Business Model of a Unicorn

Uber is the most valuable startup in the world today. It is valued at $51 billion which is more than what Facebook was valued when it was a private limited company. The company has done so well that it has become a sort of an adjective. A really innovative solution is now being referred to as an Uber. The Uber of healthcare or the Uber of packaging industry etc. are common phrases being used to describe newer companies. In this article, we will understand why Uber is not nearly as brilliant as it claims to be.

Uber’s business model is based on some very questionable business practices. In fact, some insiders call Uber half a technology company and half a company that was created to avoid regulation. Let’s understand some more details in this article.

Avoiding the following three key pieces of legislation has given a simple technology like Uber the edge it needs to become the most valuable startup in the world!

Regulation #1: Jumping the Licenses

The business of taxis and cabs has always been tightly regulated throughout the world. There were only a few cabs in existence in cities like New York because the number of permits being given out was restricted. There were only so many permits to go around and hence there was a cartel which was created by the government and derived its powers from the government as well. Cab fares were set relatively high because there were only a few cabs in existence and hence the supply was severely constrained.

Uber jumped the gun on this regulation. It came into the market as a ride sharing app. As such it was not necessary for Uber to have any permits. However, it could still perform pretty much the same services that cab drivers could. Uber had therefore successfully broken the cartel which can be viewed as a positive thing since it provides customers with more choices and hence a more rational fare structure. However, Uber has also jeopardized the livelihoods of several thousand cab drivers all over the world. The first stroke of genius was in avoiding all the possible regulation and costs associated with it and passing the savings on to the customers.

Regulation #2: Employing Drivers as Contractors

All over the world, Uber now employs millions of people. However, it does not call them employees. They are not officially on the payrolls of Uber Inc. but instead, they are independent contractors. So, legally Uber is subcontracting the cab service to a third party i.e. a different legal entity. Uber claims that this model allows the contractors to work freely and independently. The spokesperson often claims that drivers can choose their working hours and times. While this is true to some extent, the real reason that Uber does not want employees on its payroll is because of the regulation that is associated with it. Hiring people in the western nations is an expensive affair, and Uber wants to avoid expenses at all costs. Hiring people means providing money for their retirement, providing them healthcare and other benefits, paying for social security, unemployment insurance, etc.

These expenses are not trivial by any means. Uber is a private limited company and does not disclose its finances. However, it has been estimated that if Uber had to provide these benefits to their workforce, it would cost them an additional $4 billion per year.

$4 billion is a huge amount to be paid on an annual basis, and it would leave a huge hole in the current $49 billion valuation that the company has. Also, it would have an enormous negative impact on the cash flow.

As of now, Uber has about $1.5 billion in cash in its vaults and is not generating any profits. Hence, if Uber has to pay benefits to employees, it would run out of cash very soon. The huge valuation that Uber regularly gets from investors is partly because of its ability to undercut employees and government and spend less money on regulatory hurdles.

Regulation #3: Bait and Switch

Uber helps its contractors join the company by paying a small amount upfront. It has agreements with financing partners that will lease the car to Uber’s contractors or hypothecate the car.

Initially, when Uber enters a market, they offer lots of money to the drivers. Since the money being made is huge, a lot of small businessmen stop doing other businesses and start driving for Uber. However, once a certain threshold is reached, Uber starts cutting down the payouts. This means that Uber is enticing small entrepreneurs to join its business. Then it is cutting out the exit options. This essentially leaves the associates trapped with Uber.

A lot of drivers are struggling to make even close to the same amount of money that they once made despite putting in almost double the efforts. Using the carrot and stick model, Uber has established its dominance in almost every market it has entered.

To sum it up, there is nothing inherently path-breaking about a ride-sharing app! The technology is pretty simple and can be easily copied by several competitors. However, what those competitors would not be able to emulate is circumventing of regulations that Uber does with absolute precision.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.

Managerial Economics