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Tag: Platforms

Uber for X, Amazon for Y

It’s not that long ago when every startup in town had wanted to be the Uber for X, where X is a specific service such as Dog walking or Home cleaning. Here’s how Y Combinator described the phenomenon:

That idea – an app that lets consumers get a specific service when they need it, while giving service professionals (“pros”) immediate work – makes complete sense. It worked great for local transportation services, so why could it not be applicable across all types of industries?

Wired magazine had predicted that Uber, not any other startup, would be the Uber for X. So why then does Dara Khosrowshahi, Uber’s CEO, instead want Uber to be the Amazon for Y (urban mobility/transportation)? Here’s the relevant bits from his interview with Kara Swisher of Recode at the Code 2018 Conference [emphasis added].

Dara: A very, very important push for us is to innovate to lower costs, so the ride itself becomes much more efficient. And then, we are thinking about alternative forms of transport. If you look at Jump, the average length of a trip at Jump is 2.6 miles. That is, 30 to 40 percent of our trips in San Francisco are 2.6 miles or less. Jump is much, much cheaper than taking an UberX. To some extent it’s like, “Hey, let’s cannibalize ourselves.” Let’s create a cheaper form of transportation from A to B, and for you to come to Uber, and Uber not just being about cars, and Uber not being about what the best solution for us is, but really being about the best solution for here.

Kara: So bikes, scooters?

Dara: Bikes, perhaps scooters. I wanna get the bus network on. I wanna get the BART, or the Metro, etc., onto Uber. So, any way for you to get from point A to B.

Kara: Wait, you wanna start your own BART?

Dara: No, no, no. We’re not gonna go vertical. Just like Amazon sells third-party goods, we are going to also offer third-party transportation services. So, we wanna kinda be the Amazon for transportation, and we want to offer the BART as an alternative. There’s a company called Masabi that is connecting Metro, etc., into a payment system. So we want you to be able to say, “Should I take the BART? Should I take a bike? Should I take an Uber?” All of it to be real-time information, all of it to be optimized for you, and all of it to be done with the push of a button.

Kara: So, any transportation?

Dara: Any transportation, totally frictionless, real time.

Some, like Stratechery’s Ben Thompson, have claimed that this move is Uber’s bundle strategy.

This is very much a bundle, and like any bundle, what makes the economics work in the long run is earning a larger total spend from consumers even if they spend less on any particular item. To that end, as Khosrowshahi notes, the real enemy is the car in the garage; to the extent Uber can replace that the greater its opportunity is.

Bu whether Uber is a bundle or not depends on your definition of a bundle.

Here are some sample definitions: Investopedia defines it as “offering products or services together in order to sell them as a single combined unit. Bundling allows the convenient purchase of several products and/or services from one company.”, while researchers at Harvard Business School define a product or service bundle as “a set of goods or services at a lower price than the price charged if the customer bought all of them separately”.

If your definition is simply the convenience for customers to buy (à la carte) several products and/or services from one company (but not cheaper together than if those products or services are bought separately), then Uber is a bundle. But that’s like saying your neighborhood Walmart is a bundle because you can buy multiple types of products from a Walmart Store.

If your definition is that the combined product or service can be bought cheaper than if those products or services are bought separately (or if there’s no way to buy them separately at all)1, then Uber is not a bundle. At least, not quite yet.

Go back to that Chris Dixon blogpost referenced in Thompson’s Stratechery post.

What price should the cable companies charge to maximize revenues?

Note that optimal prices are always somewhere below the buyers’ willingness-to-pay. Otherwise the buyer wouldn’t benefit from the purchase. For simplicity, assume prices are set 10% lower than willingness-to-pay. If ESPN and the History Channel were sold individually, the revenue maximizing price would be $9 ($10 with a 10% discount). Sports lovers would buy ESPN and history lovers would buy the History Channel. The cable company would get $18 in revenue.

By bundling channels, the cable company can charge each customer $11.70 ($13 discounted 10%) for the bundle, yielding combined revenue of $23.40. The consumer surplus would be $2 in the non-bundle and $2.60 in the bundle. Thus both buyers and sellers benefit from bundling.

If the cable company offers ESPN and History Channel at $9 each à la carte, that offering is not a bundle. Offering both ESPN and History Channel at a discount ($11.70 instead of $18 it costs to buy individually) is the bundle that benefits both buyers and sellers.

Theoretically, Uber could become a mixed bundle if you could pay a flat fee (say $99 per month), and ride a limited number (say 100) of Uber+Jump+Bus+Metro rides (that may also limited in distance or dollar value, say sub $5 rides, so that you don’t uber from Seattle to Miami haha!). Individually these would have cost much more (let’s say $200). That’s definitely a bundle strategy, but Uber isn’t there yet. Simply offering a ridesharing subscription is not a bundle, and is unlikely to work because, like some other subscription businesses, it is simply a money-losing incentive for a subset of customers.

So if Uber isn’t a bundle, how does Uber’s Amazon for Y strategy work? It may be easier to analyze using a version of Amazon’s famous flywheel applied to Uber.

In essence, 1P providers are Uber’s own services such as Uber X, Uber Pool, Jump Bikes, Jump Scooters, Uber Eats etc. that are owned and controlled by Uber. Uber controls the pricing and a large part of the customer experience of the end customer. In addition to these 1P services, Uber would, for a percentage of revenue, allow any third party transportation provider to plug into Uber’s platform and offer their transport services. The 3P providers such as public buses, metros, or car rental companies would set their own prices but Uber would take a cut for the customer referral. And unlike a listing of links of the provider, I would imagine Uber would allow the customer to complete the entire transaction without leaving the Uber app. Perhaps even a curb-to-curb package delivery service that doesn’t involve bike couriers and simply uses existing Uber driver network?

The benefits of such a platform isn’t difficult to grasp. The more transport options (1P & 3P) that Uber can provide, the less downtime there is for drivers, the better the end customer experience and the more customers (and customer segments) Uber can attract. The more customers Uber attracts, the better it can distribute its fixed costs, leading to lower cost structure, lower prices, faster transport options, and eventually improved profitability.

Is there really a path to improved profitability when Uber has lost more money than any American tech firm of its age in history? As The Economist notes:

The intensely competitive nature of the ride-hailing business will continue to hit profitability. Though Mr Kalanick had hoped that Uber would quickly dominate ride-hailing around the world and enjoy fat profit margins close to those of Google, Mr Khosrowshahi is less sanguine. “Physical transport comes with lower margins,” he says, predicting that Uber will never claim fat “software margins”. So far, Uber has lost more money than any American tech firm of its age in history. In the second quarter of this year it reported $2.8bn of revenue, but lost $891m.

The truth is a bit more nuanced than “Uber is unprofitable”. To understand the nuances, let’s get a quick overview of Uber’s business model based on their unaudited income statement (here’s an Excel version to play with).

For most rides, Uber keeps ~25% (some say effective rake is 40%) of the fare to themselves. The fare is their Gross Booking, and the fee from the rake is their Gross Revenue. According to Uber, their cost of revenue (COGS) is approximately 10% of Gross Bookings, the cost primarily related to insurance. Since Uber charges around $1.5/mile, and the mean insurance and maintenance costs are about $0.15/mile, 10% seems right. At 25% rake, this is about 40% of revenue, implying gross margins of about 60%. From this gross margin, Uber incurs variable costs such as payment processing/credit card fees, payment fraud costs, refunds, promotions and incentives, customer service, dispute resolution, any driver service costs and local regulatory fees.2

There are five factors to consider in Uber’s path to profitability:

(1) Think of the first decade of Amazon – it was characterized by high spending (and several unprofitable years) in order: (1) to buy physical assets to build the physical infrastructure of its fulfilment network (this spend is capitalized and depreciated over time, so doesn’t show up as a one-time massive loss in the P&L statement), (2) to develop software to build the digital infrastructure (this spend is expensed in the year it was incurred, so shows up as massive losses in the P&L statement), and (3) to attract customers by price promotions, free shipping etc.

Well guess what, like Amazon, Uber will continue to spend heavily on both #2 and #3 in its early years. But just like Amazon, Uber’s software scales infinitely for all customers using the app. The marginal cost of serving one additional customer order is limited to their variable cost and software KTLO (and a small portion of fixed costs – primarily in Sales & Marketing – to fire up each new geographical location). To be profitable, Uber’s 25% rake on an annual basis simply needs to cover their variable costs and an estimated annual allocation of their fixed costs (as if they were depreciated over time instead of expensing them). Uber can do this by decreasing driver and rider incentives (perhaps even increasing its prices even if it means lower number of riders), better third-party transport provider utilization of their software (see #3 below), and better control over G&A expenses (currently growing 75% YoY). In other words, being GAAP unprofitable in the short-term doesn’t mean they’re losing money.

(2) Unlike Amazon though, Uber’s flywheel is limited by geographic limitations. In Amazon’s case, a seller acquired in one part of the country could sell to customers in other parts of the country, and continue the virtuous cycle of the flywheel. However, in Uber’s case, a driver or a transportation provider acquired in one city will not be able to service customers outside that city. Thus, while Amazon could quickly (ahem!) utilize their physical assets and digital infrastructure to service customers acquired in any part of the country to turn profitable, Uber will need to turn profitable city by city. And as they turn profitable in one city, they will need to continue to spend on customer and rider acquisition in each new city expansion, eroding overall short-term profitability, but marching towards long-term market leadership and long-term positive free cash flow.3

(3) Demand for the variety of third-party transport services such as bus transit that Uber envisions customers of its app will be interested in. Given how much each city spends on transit upkeep (as an example, San Francisco just approved a one-time $194M, and a 10-year $266M operating cost overhaul of its smart-card technology), one could argue whether they are better off partnering with someone like Uber rather than EACH city developing their own technology and spending several hundred millions EACH on their upkeep. If (and that’s a big if) Uber can develop a plug & play model for cities around the world, they could get a better utilization of their fixed costs in developing this tech, and offer it to cities at a much lower cost that it would take for each city to develop it themselves.

There are two other factors – (4) regulatory scrutiny, and (5) building its own autonomous-car capabilities – both fleetingly mentioned in The Economist article referenced above, that will ultimately decide how profitable Uber can eventually become.

Dara is a diplomatic deal maker who knows how to push the right buttons to get partners on board, and this bodes well for Uber and its Amazon for Transport strategy. They need all the partners they can get on this platform in order to build the Uber Transport Platform (pun intended).

  1. aka Pure bundling, which refers to the practice of selling two or more discrete products only as part of a bundle. Mixed bundling refers to the practice of selling a bundle of the products as well as the individual products themselves.

  2. I’m not sure why insurance costs are not included below the line (in operating expenses), or why promotions and incentives are above revenue (below Gross Bookings). In my view, all of these are variable costs that should be below the line.

  3. Uber expanding to new markets is akin to how physical retailers start new stores, where there are short-term costs in getting the store up and running

Platforms – The Pricing View

In construction, a platform is something that lifts you up and on which others can stand. The same is true in business. By building a digital platform, other businesses can easily connect their business with yours, build products and services on top of it, and co-create value.

-Harvard Business Review, Three Elements of a Successful Platform

Two-sided Markets, Platforms, Marketplaces, or Aggregators – whatever you call them, they are all the rage. Facebook, Uber, AirBnB, Yelp and other breakout platform companies of the last decade have popularized this business model for entrepreneurs and VCs alike. First identified and analyzed in pioneering work by Nobel Laureate Prof. Tirole and research partner Prof. Rochet, “two-sided markets” or “two-sided platforms” refer to businesses that cater to two interdependent groups of customers.1

Outside academia, VC Bill Gurley is perhaps the most famous proponent of marketplaces and its potential.2 His 10 factors to evaluate a new marketplace and optimal marketplace pricing strategy blogposts are required reading for anyone interested in platforms/marketplaces. Recently, Stratechery author and blogger Ben Thompson has garnered significant praise for rightly explaining this business model through his  “Aggregation Theory”. In this post, I am going to expand on Bill’s pricing blogpost to classify platform businesses from a pricing perspective and then elucidate why it is important to do so.

When viewed through a pricing lens, there are four kinds of platforms:

Paid Cross-side Platforms – These platforms create value primarily by enabling direct exchanges between its consumers and producers, and benefit from cross-side network effects, i.e. the volume and nature of merchants attract users, and more users attract more merchants (more sellers -> more customers, more customers -> more sellers). Interaction is cross-directional, from sellers to customers and customers to sellers. Customers don’t necessarily interact with other customers (and merchants do not necessarily interact with other merchants), and even if they do (Uber Pool etc.), that communication is not the primary goal for the platform. Examples are eBay, Amazon Marketplace, Alibaba’s Tmall, Uber, Lyft etc. They are called “paid” platforms because merchants are charged a rake (or revenue share) when they sell to customers. These platforms are price elastic with respect to the rake that they can charge merchants because higher rakes are passed on to the end-customer as higher prices.3

Hardware Cross-side Platforms Cross-side platforms or marketplaces built on top of a hardware or physical layer is unique because these platforms do not attract users primarily by the volume and nature of the merchants on their platforms; rather the hardware attracts users, and the users then attract merchants. As a result, these platforms are more price inelastic (compared to other platforms) with respect to the revenue share they charge merchants. Examples include Apple Appstore, Xbox Gamestore, Google Playstore. In my view, even a physical marketplace in a unique location that allows merchants to sell their wares and charges them on a revenue share model falls in this category.

Free Cross-side Platforms – These platforms enable exchanges between its consumers and producers almost always for free, and use an ad-based model (free for users, producers pay for ads) for monetization. They benefit from cross-side network effects. Google, Yelp are examples.

Same-side Platforms – These platforms create value by enabling direct exchange amongst its users, and are monetized either by charging the users directly (rarely), or by charging advertisers to sell services to users (most often). They benefit from both same-side effects (more users -> more users) and one-way cross-side effects (more users -> more advertisers). Note that more advertisers do not directly mean more customers. In fact, more ads -> bad customer experience -> less customers. WhatsApp, Facebook, WeChat, Skype are examples.

So why is a pricing view of these platforms4 important? Because the rake that a company (rather a product) can charge depends on where it falls in this spectrum. Paid Cross-side Platforms are more price elastic with respect to the rake that they can charge merchants because a competing platform with lower rake can attract users with lower eventual consumer prices. Hardware Platforms get away with higher rake because of their hardware differentiation. In other words, Apple’s Appstore can get away (and they have for the past 10 years) with charging developers a high rake (30% revenue sharing) because a competing platform with lower rake for merchants is unlikely to cause users to shift (as long as Apple’s hardware continues to attract users). In Free Platforms, prices charged to advertisers don’t (directly) affect the prices on customers, so theoretically new platforms cannot undercut the price (charged to advertisers) of the dominant platform and capture more users. Similar to Free Platforms, prices charged to advertisers in Same-side Platforms don’t (directly) affect the prices on customers, so theoretically new platforms cannot undercut the price of the dominant platform and capture more users. The way to capture marketshare is to offer differentiated service (Facebook vs. Myspace, Snapchat vs. Facebook).

From a cost point of view, there are three costs at play in any business. An upfront capital expense (in case of platforms, this is incurred in developing the platform and is primarily in software development and in some cases physical assets and hardware costs), and variable costs that vary with each unit of output (i.e. costs that vary with the number of sellers and customers serviced such as platform maintenance costs, customer service, payment processing etc.).

So in cross-side platforms (other than hardware), your pricing/rake strategy can take two approaches:

  1. In the absence of sufficient funding, you charge sufficiently high enough to account for your variable costs and capital expense as a percentage of revenue. While this rake is likely to provide sufficient cash flow to keep you in business, it will also mean slower seller (and thus customer) acquisition for your platform. The less the rake, the faster your seller acquisition. As you grow, though, you should continue to reduce your rake to build a moat around your business and make it harder for new entrants. That is, as you reduce your rake, other startups like yourself will not be able to enter the market since they will have to charge a higher rake than you to generate sufficient cash flow to stay in business. Think about it this way: if you had to charge the high rake in the beginning, arguably new startups would have to do the same, unless they have deep pocketed investors willing to fund the lower rake.
  2. The second (and, in my view, better strategy) is to charge a rake that is only slightly higher than your variable costs. This way, you will acquire sellers (and thus customers) faster, and with each seller and customer acquired you will discourage other new entrants from competing. Your high initial capital expenses (fixed costs) will be depreciated completely anyway, and with more customers and orders, you can distribute your fixed costs over more customers. With a lower long-term capital expenses as a percentage of revenue, you can charge a rake that is slightly higher than both your capital expense and marginal cost combined, that others Such a low rake will not only attract sellers and provide low prices for customers, it will also make it cost prohibitive for any new entrant platform trying to enter the market. This second strategy requires patient investors willing to fund the initial capital expenses.

Fig 1: Rake, MC & CapEx is expressed as a % of Revenue. # of Sellers is absolute.

In both strategies though, in the long-term, if your marginal cost of serving an order is 5% of revenue, then unless you are a hardware cross-side platform (like Apple’s Appstore) you should not be charging sellers a rake of 20% giving you an operating margin of 75% ($20 rake, $5 marginal cost, $15 operating profit on a sale of $100), because someone else could charge lower rake and capture both sellers and customers.

So the next time you are deciding on the pricing strategy for your Uber for X startup, remember – some rakes are more hazardous than others.

PS: In traditional software parlance, platforms are those where other developers can build applications and software on top of your application (platform). I take a more broader view of platforms, one that includes marketplaces for sellers and buyers to connect, or advertisers and customers to interact.

  1. Think sellers and buyers at Amazon, riders and drivers of uber, and so on.

  2. With winning bets on several marketplace successes such as eBay and Uber.

  3. That said, Uber, Lyft and other “price setting” Cross-side Platforms are less price elastic because they set the final price to the customer irrespective of the rake, while a managed platform can charge higher rake if customers or merchants value the platform’s “management”.

  4. Some companies sit across multiple models but products typically pertain to one model. For example, Google is a Free Cross-side Platform for search, but Gmail is a Same-side Platform.

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