… The Unit Economics of The Market Segment
Different segments = different unit economics
We have explored that Uber operates in a different market segment, which shows different customer requirements.
The question that follows from this finding is, why don’t taxis just compete with Uber? Some might argue that regulation keeps them from competing with Uber. Regulation is one factor, however it is not the key factor. The different market segments do not only have different customer requirements, they also show different unit economics. Accordingly they require a different skill set.
In Uber’s market, there are two forms of value creation. One is the actual service and the other one is the match making that maximizes capacity utilization. To increase the drivers’ capacity utilization by matching supply and demand, a critical mass of customers and drivers is necessary. Building that critical mass of supply and demand is not trivial. If it were easy, then more Uber’s would be around. Uber invests heavily in acquiring customers. And they do this in every city in which they operate. It will take quite a few rides from a newly acquired customer until Uber will earn back its marketing investment. Next to investing in marketing, Uber also needs to build a base of reliable drivers. When Uber wants to generate happy and long-term customers it needs to ensure that customers can get a ride within a few minutes and that the drivers are reliable.
Now if we look at this, it becomes clearer, why taxis are passive to the threat of Uber. They are not only limited by regulation but taxi unions don’t have the skill set that Uber benefits from. Uber’s business is built on capacity maximization and on return customers. The capacity utilization is enabled by customer acquisition skills. This expensive customer acquisition is only profitable, because Uber’s customers stick with the company for a long time due to quality control. In the core taxi segment, the street hail segment, this model obviously does not work. Plus taxi unions do not have the skills to acquire customers in large formats. Compare the size of customer database of taxi companies with Uber. Or have a look at the job board of Uber and compare it with the job board of a taxi organization.
Lessons learned: dive deep into the segments
What do we learn from this? When analyzing a market it is necessary to dig into the details of each market segment. Often the customer requirements as well as the required skill sets of companies differ widely by segment. To understand a business, you need to understand these differences.
And once you think that you have understood them, you might still have to dig a little bit deeper. If we return to Uber, now that we have understood the differences between the street hail and pre-booked segments, we should be in a position to make an assessment on the size of each segment? Well not quite yet. We still run the risk of comparing apples to oranges. Why? Because the share of pre-scheduled rides as part of the total market varies widely city-by-city. As the above-mentioned study explains, in New York more than 90% of taxis are flagged on the street, while in Stockholm; the majority is pre-booked on the phone. Also on an overall basis, Taxis are used more frequently in Dublin and New York, than in Paris and Amsterdam. Looking at overall market figures will therefore always have to include broad assumptions. In order to really understand this market, one would need to have a look at this market locally. What we are looking at is not one global market, but a market that consists of many different local markets.
It’s tempting to work with broad generalizations when analyzing a market. Going into details seems to be a hurdle for many people. In particular analysts, who are covering 30 or more stocks don’t have the time to do this. A helicopter perspective may look great on paper. But don’t let this fool you. The challenge is to understand the specifics of each segment and each customer type. For each segment we need to understand what drives the profits. This is where the rubber hits the road. These specifics determine where growth opportunities or threats exist, as we can see from the Uber example.
This article was part of our free series Business Thinking 3.0