The cost structure of any urban car service company has four components: vehicle costs (typically 18 percent of total, including acquisition, financing, maintenance, and licensing), corporate costs (15 percent, including dispatching, advertising, overhead functions such as IT and legal, and returns to shareholders), fuel (9 percent), and driver compensation (58 percent, including benefits).5
Uber’s business model shifts the vehicle costs (ownership, maintenance, insurance) that traditional companies used to incur to its “independent contractor” drivers. Passenger fares need to cover total (Uber plus driver) costs. But shifting the burden of vehicle costs and financing onto drivers makes those costs higher, since hundreds of thousands of drivers with limited capital and business experience cannot possibly manage these costs as well as even a typical traditional cab company. Traditional cab companies also have much lower corporate costs, as they avoid Uber’s huge expenditures in areas like political lobbying, global branding, IT development, big corporate headquarters, etc.
Uber should also have higher driver costs than traditional operators, because the huge increase in the demand for drivers should have improved wages, benefits, and working conditions. As will be discussed below, however, Uber initially offered incentives that increased its driver costs, but since 2015 has suppressed take-home pay to minimum wage levels. This exercise of artificial market power cannot be considered an Uber efficiency or productivity advantage.
===== On Structural Problems:
Far from revolutionizing the future of transportation, Uber has not solved any of the industry’s long-standing structural problems.
Most taxi demand is low-income; higher fares would shrink traffic and reduce utilization. Taxi demand is sociologically bipolar: 55 percent of demand comes from people earning less than $40,000 per year while 35 percent comes from people earning more than $100,000.10 Demand from lower-income people is driven by access to jobs in areas (or at times of day) when transit service is poor or nonexistent. Given the current income distribution of riders, any attempt to balance supply and demand will either drive lower-income passengers out of the market or result in wealthy customers being charged less than they might be willing to pay. Uber does not have the lower cost structure needed to improve service while keeping fares low, and apparently realizes that only a small portion of the market is willing to pay fares that would cover the true cost of its service. Higher prices would also reduce vehicle utilization and destroy any notion that Uber’s business has exceptional growth potential.
Uneven geographic demand creates unavoidable empty backhaul costs. Taxi demand, as with demand for every other form of urban transport, has extreme temporal and geographic peaks. Most cities have a dense core area where taxi demand is highest, and taxis operating within that zone can maintain reasonably high daily utilization. But the true cost of trips to neighborhoods outside that zone can be as much as twice normal trip costs since they will have an empty backhaul. Low-income neighborhoods receive poor taxi service because drivers rationally avoid trips where they won’t find a return fare. Uber does nothing to create new demand that can fill those empty seats, and has no way to vary fares based on backhaul utilization. People expect that the fare to the airport should be roughly the same at 6 a.m. (when the cab will return empty) as at 4 p.m. (when return fares are queued up).
Extremely high cost of peak capacity. Peak taxi demand occurs during the late evening, especially on Friday and Saturday nights. As with rush-hour transit and expressway peaks, the cost of the capacity needed to serve peak demand is four to five times the cost of serving demand on Tuesday morning. Cab companies cannot afford to provide all the expensive capacity demanded, creating conflict as wealthier people headed to restaurants and clubs fight over the limited supply of cabs with late-shift workers at hospitals and warehouses. Uber has done nothing to reduce the high cost of peak service or find paying passengers anxious to travel at off hours. Uber’s core business proposition (“push a button, get a car!”) by definition requires far more capacity and much lower utilization rates than traditional operators.
Overcapacity risk. Taxi businesses in unregulated markets have no natural barriers to entry, and thus face the risk of ruinous overcapacity that reduces utilization and precludes a workable balance of supply and demand. As both Uber and past cases of unlimited market entry have demonstrated, new entrants don’t charge fares high enough to cover full operating costs, ensuring major losses for everyone.
Uber did not suddenly discover ways to dramatically improve productivity and service quality that everyone else in the industry had been too stupid to recognize for the past hundred years.11 In fact, nothing in Uber’s business model solves any of the major problems that have long frustrated users.