Economics of Uber

An interesting article by Len Sherman in Forbes magazine argues that unregulated taxi services are characterised by bounded demand, abundant supply given low barriers to entry, relatively undifferentiated service quality, low customer switching costs, high variable costs and virtually no economies of scale. Historically, this led to regulation, for example the set fares and ‘Knowledge’ requirement for drivers of London’s black cabs, which allowed profitable operation and acceptable remuneration, at the expense of consumers who paid higher fares.

Uber’s buccaneering approach bypassed taxi regulation, and allowed rapid market penetration of a service that is superior in many respects to existing taxi and private hire services and hence very popular. The question is whether Uber can be profitable, which Sherman doubts.

The economics of ride hailing, or demand-responsive transport (amongst the variety of terms in use), is not straightforward. These businesses compete for both customers and drivers. Low fares attract customers but deter drivers who have other choices for getting clients. Reducing the commission taken (20-25% for Uber) could benefit drivers and customers but would reduce profitability and disappoint investors. Raising fares could benefit both drivers and profitability but would encourage competitors to enter the market.

Much depends on whether the market for ride hailing tends to monopoly, so that the dominant incumbent is able to deter new entrants by short-term fare reductions; or whether sufficient competition would naturally arise because barriers to entry are not high (digital platforms being replicable). Lyft, Uber’s main US competitor has been gaining market share, which suggests a competitive market may be possible.

For governments, there are a number of challenging questions about the future regulation of taxis and private hire vehicles:

• Create barriers to entry that result in effective monopoly supply, with improved driver remuneration but higher fares (the situation with regulated fares)?
• Or aim for a level playing field for competing suppliers, to encourage innovation and benefit consumers?
• Segment the market with distinct classes of providers, or allow new entrants with novel offerings, such as demand-responsive minibuses?
• Protect remuneration of drivers in a competitive market by application of the ‘minimum wage’ concept?
• Regulate overall numbers of ride hailing vehicles to mitigate congestion and to limit diversion of passengers from buses, or regard such services as helpful in reducing individual car ownership?

One approach to the problems experienced by Uber drivers in London is being developed by the New Economics Foundation – a driver-owned alternative that is just as convenient and competitive on price, but treats its passengers and drivers with respect. However, the question is whether the economics of ride hailing allow better rewards for drivers, over and above ‘respect’, particularly since a driver-owned cooperative would be constrained by limited capital in the face of competition from well-capitalised commercial enterprises able to sustain short-term losses while seeking market dominance.

Perhaps a better approach to improve the position of drivers would be to devise an app that allowed them to achieve improved outcomes while continuing to work for Uber and other ride hailing businesses. The key point is that transport services are very time sensitive and therefore vulnerable to interruption. It is noteworthy that Ryanair, which had long declined to recognise the pilot unions, has recently agreed to do so when faced with a strike in the run up to Christmas.

Organising collective action by drivers by means of an app might be one approach to securing better terms. But it might also be possible to take advantage of Uber’s surge pricing system in which prices rise when demand exceeds supply, thus deterring some customers and attracting additional drivers. An app that allowed drivers collectively to constrain additional supply could prolong the duration of surge pricing to their benefit.

The operation of such driver-organising apps in an already complex industry would need careful analysis, based on game theory concepts. It is possible that the outcomes for drivers would be better than head-on competition by a driver cooperative.

A kind of precedent is the Vegas Kickback app, which rewards drivers, over and above the fares earned, who take customers to commission-paying destinations in Las Vegas – nightclubs, massage parlors, gun ranges etc.