Remember, a few years ago, when you wanted to go from a place A to a place B, you had only a few choices. You could either go by public transportation, use your car, or take a taxi. In case you didn’t want to use your car, the fastest and most flexible way to go was to use a taxi. Taxi companies operated in a stable environment. Regulation, which shielded them from competition, determined how many taxis could operate in a city. Cab drivers would not get rich, but they could make a solid living.

Today, this market has changed. If you want to go from A to B, you have a large variety of choices. You can use a shared car which is provided by Zipcar, DriveNow and the likes. You might want to rent a public bike. Or you can order your personal driver at relatively low cost. This last kind of service is provided by companies like Lyft and Uber. Uber, which does not own a single car, is valued between $ 5.6 to 17 billion, depending on whom you ask. It has received wide media coverage for a number of reasons. But most importantly, it has been catching a lot of heat because it disrupts the once stable taxi market.

In this post, we will explore why Uber is able to disrupt the taxi market. Understanding this will provide us with valuable lessons that we can apply when conducting a market analysis.

Why are Taxis not able to compete with Uber?

Taxi drivers feel threatened by Uber. I haven’t seen much hard data about how much market shares Uber has taken from taxis yet. Yet, if you read the media it surely feels like Uber is taking market share from taxis like Amazon is taking market share from bookstores. Uber is able to offer transportation for as little as almost half the price of a taxi on certain routes. At the same time, Uber drivers are said to earn up to three times as much as a cab driver.

Legislators of various cities and countries are putting bans on Uber in order to protect taxi drivers. And to protect customers; as the claim. Most recently, a German court ruled, that Uber’s low cost UberPop service could no longer take on passengers due to a lack of public permission.

Now why do regulators step in, and why are taxis not as competitive as Uber? It is often cited in the media, that Uber is disruptive, but why exactly is the company able to disrupt the taxi market?

The superficial answer is that taxis are regulated. Yet, that doesn’t explain the full picture. What’s the sense of the regulation of taxis if makes them vulnerable to more efficient competitors? Imagine you have to explain to your frustrated cab driver why Uber is able to offer lower fees to customers while paying higher ‘salaries’ to drivers. More important, he might be puzzled why a company that doesn’t own a car is valued at up to 18bn.

 

One market? Not quite.

To understand Uber’s business model, we first need to understand that the taxi market is not single market. The taxi market actually consists of different market segments. Each market segment is characterized by different needs of customers and by different economics. A study by the Institute of Transport Economics describes the four segments of this market as street hail / cruising, rank-stand, pre-book and contracts. For illustration purposes we will look at two of them, street hail/cruising and pre-book.

The street hail / cruising segment includes those customers who flag a taxi at the street. Those customers need a taxi right now. In order for the transport system to function, it is necessary to ensure that a constant supply of ‘flaggable’ taxis is available at any time. As you can imagine, it is not trivial to match supply and demand perfectly in this market. If there is an undersupply of taxis, a taxi is likely to have a good bargaining power. Imagine a customer in a hurry, standing in the rain. He might be tempted to pay a good premium on the fare when a taxi driver takes advantage of him.

To ensure this constant supply for customers, there needs to be an oversupply of taxis in the market. Taxis will need to drive empty for a significant part of their time. Aircraft operators call these trips empty legs. Think how often you see an empty taxi waiting or cruising. These empty legs will result in a low capacity utilization for taxis. For any asset-heavy industry; for any industry that has to acquire or lease expensive assets, the utilization of those assets is a key driver of its profitability. If you own a restaurant, your monthly rent for the building will be a major cost factor. Having lots of traffic in your restaurant, will have a major impact on your profit margins. This, of course, applies to taxis in a similar fashion. Thus if taxis want to operate profitably, they need to charge higher prices to compensate for those empty legs.

There is another problem in this market. Customers cannot assess the reliability of drivers. Ensuring safety therefore is critical.

In order to solve both problems – to ensure a sufficient supply of taxis at constant rates, and to ensure the safety of passengers – this market is usually regulated. One must be licensed to operate a taxi.

[mks_pullquote align=”right” width=”300″ size=”24″ bg_color=”#ffffff” txt_color=”#1e73be”]Uber is not a taxi operator. It is a match-maker who helps operators increase capacity utilization. [/mks_pullquote]

However, this goes only for the taxis that are flagged on the streets. A different part of the market, which is also served by the regulated taxis, has different economics. There are customers who do not need a taxi right now. Think of customers who need to go to the airport. They are able to pre-book their ride. In addition, mobile phones have made pre-booking possible at even shorter notice today. We are speaking of 10-minutes pre-booking if you want to call an Uber. This pre-booking segment is a completely different animal than the street hail segment. The pre-booking provides the opportunity to increase the capacity utilization by matching supply and demand. This matching of supply and demand is a major part of the value, which Uber creates. Through this matchmaking, Uber enables drivers to increase their utilization rates, which in return enables them to operate more profitable. They can pass this higher profitability on to customers in the form of lower fares.

Think of aviation as an example. Private jets are expensive, because they fly only for a few hours, followed by a waiting time of several hours. Their capacity utilization is very low. Scheduled airlines on the other hand are able to maximize capacity utilization. This results in lower fares for customers. Simply put, taxis are the private jets, while Uber is the scheduled airline.

Since it is possible to balance supply and demand in Uber’s market, the pre-booked and mobile phone-supported market, no regulation is needed to make it efficient.

photo credits: Mikhail Starodubov, Pinkcandy / Shutterstock

photo credits: Mikhail Starodubov, Pinkcandy / Shutterstock

Legal requirements for taxis also try to ensure safety of passengers in the street hail segment of the market. Again, no regulation is needed in Uber’s market segment. Uber is able to ensure safety and quality standards by providing ratings of drivers. Why is this possible? Because Uber’s business model is built on return-customers. Uber can only operate profitably, if customers return frequently to Uber. Acquiring customers is expensive for Uber. In order to recoup that cost of customer acquisition, they need to ensure that the customer takes many rides with them. Uber therefore is incentivized to generate happy customers. They do this by ensuring quality standards for its drivers. If the driving style of an Uber driver is inspired by Nascar racers he won’t stick with Uber for long.

If you have ever been in a restaurant in a holiday destination, you know that you might have to expect lousy food for high prices. Why? Because the owner knows that no matter how good or bad the food, you will not come back once you have ended your holiday. This is the street hail segment, where a driver is very unlikely to meet you again. In contrast, if you go to your local restaurant in your home town, the owner will be motivated to keep you happy. Why? Because he knows you might come back for his excellent food and service.

 

Different segments = different economics

Now we have explored that Uber operates in a different segment of the market, 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 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.

photo credits: Jorg Hackemann / Shutterstock

photo credits: Jorg Hackemann / Shutterstock

 

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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 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.

photo credits: Brandon Bourdages, Goran Bogicevic, vesilvio, Gritsana P / Shutterstock

photo credits: Brandon Bourdages, Goran Bogicevic, vesilvio, Gritsana P / Shutterstock

 

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.

 

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photo credits cover photo: Corepics VOF / Shutterstock
photo reference Miami taxi: Jorg Hackemann / Shutterstock.com
photo reference TucTucs: Gritsana P / Shutterstock.com

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