Why UBER will be a massively valuable Company

Last week, there was lots of groaning and moaning about the financials of Uber that were made public across media. UBER’s losses seemed unbelievable and many financial pundits sounded the death knell for the Company.

I have a very different view on UBER and actually believe it will be a very valuable Company. And that too very soon!

Here is why:

First the results:

To summarize the results in the words of Techcrunch

“Uber had gross bookings of $20 billion, according to information shared with Bloomberg. Of that $20 billion, Uber counted $6.5 billion as net (GAAP) revenue.

Uber lost 5 percent more in the fourth quarter of 2016 compared to the third. The firm lost $991 million in the final period of last year, according to Bloomberg, implying a loss of around $943 million in the third quarter.

The company lost an adjusted $2.8 billion in 2016. That figure rises to a $3.8 billion tally when losses related to Uber’s Chinese operation are included, according to a Bloomberg estimate. Both figures do not “account for employee stock compensation, certain real-estate investments, automobile purchases and other expenses,” according to Bloomberg.

So, on an adjusted basis, Uber lost around $3.8 billion in 2016. The real figure, using a full-GAAP reckoning, is likely higher. Merely employing the $3.8 billion figure, Uber had a -58.5 percent profit margin in 2016.”

Whoa! Did your heart skip a beat?

I wouldn’t be surprised if it did.

BUT (in Capital – please note) the missing picture in this financial mayhem is the Business Model of Uber – which is honestly STUNNING (Capitals again).

I would entirely credit my younger daughter (18) for pointing me to this article in the Wall Street Journal that forms the basis of my thesis on why Uber will be (actually is) a very valuable Company.

Headline : Uber’s Demand Curve is unbelievably INELASTIC

Let me take a minute to explain this term quickly:

We all know that Goods and Services needs consumers to sell to, who in turn are willing to buy (what is being sold) at a particular price.

Now, there are some goods whose demand is very sensitive to price. Meaning – a small change in price will immediately affect demand. Think of clothes, pizza etc. If your favorite clothing brand or pizza brand increases its prices astronomically, you will ditch that brand and look for alternatives. If there are no alternative pizza brands available, you may settle for other junk food things to eat 🙂

These products demonstrate what we call a highly ELASTIC demand curve. Minor changes in prices can either increase or decrease demand in the same or worse proportion.

Take a look at this graph that demonstrates this point and brings out the point of Elastic Demand. Note that the curve has a gentle slope

I guess you’ve got the point and also figured out the opposite of Elastic Demand? Yup, it’s Inelastic Demand.

Inelastic demand is best demonstrated by goods and services you just can’t do without, despite a change in their price. The price of Gasoline or Petrol is one perfect example. Since we can’t do anything about the price of gas, all we do is slightly adjust our driving patterns when prices go up astronomically and hope and pray that prices of gas will soon come down.

Note the inelastic demand curve of Gasoline and how steep the demand curve is.

Courtesy – https://www.econedlink.org/

Enter Uber’s Inelastic Demand Curve.

Famed Economist Steven Lewitt (of Frekanomics fame) in the Wall Street article says “Consumers’ demand curve for Uber rides is, in economists’ speak, quite inelastic–that is, not especially responsive to price.” 

My belief is that the genius of the Uber’s business model and its ability to ride its inelastic demand curve is its concept of Surge Pricing. If you don’t know what surge pricing is, look it up.

In the WSJ article, the father of microeconomics Alfred Marshall is quoted to say  “We cannot guess at all accurately how much of anything people would buy at prices very different from those which they are accustomed to pay for it.”

Well, that was until Uber and it’s famous  infamous “surge pricing” came along.

Now, when Uber ‘surges’ prices, Uber and the economists of the world know (and have captured) what people are actually ready to pay IN EXCESS of what they are used to paying.

I believe that via surge pricing, as and when it wants, Uber will be able to generate obscene amounts of money since it’s demand curve is inelastic.

This is the data set that is beyond stunning (See – https://www.nber.org/papers/w22627.pdf for a complete report)

Note that when surge goes up to between 1 and 2, purchase rate declines slightly from 62% to 53%

The authors state “We find that consumer demand is inelastic, despite the existence of what would seem to be reasonably close substitutes (competitors, taxis, public transportation, driving one’s self). “

There are several charts in the study quoted above that map the inelastic demand curve of Uber and I while I produce one below just visual presentattion, do check out the others also. (Ps – I am not an expert on the methodology described below).

Moving beyond the fact that Uber does enjoy inelastic demand, the moot question therefore is “What is the estimated value of this Inelastic demand curve that Uber seems to be enjoying”?

Marshall captured this very eloquently in his concept called ‘Consumer Surplus’ which he described was “the excess of the price which [a person] would be willing to pay rather than go without the thing, over that which he actually does pay.”

This is what Lewitt and Company found:

Uber riders enjoyed $1.57 in consumer surplus for every $1 they spent in 2015, the study said. That equates to $6.8 billion in consumer surplus across the U.S. last year, or $18 million a day.

Put it simply, Uber is actually leaving 6.8 Billion US$ on the table as a strategy to keep growing. The day it decides to take some more money home, the 3.8 Billion US$ it lost in 2016 will be recovered without a problem. All it needs to do is press ‘Surge’ !

image courtesy – nickarapkiles.com

Uber will become a massively valuable, disruptive new economy business. At least I am betting my money on it when it IPO’s in 2018 🙂

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