The recent news about Uber's huge funding round ($1.2B at a $17B pre-money valuation) has had the effect you would expect: a lot of stories trying to make sense of the valuation, with most just concluding that Uber has the potential to be a very big company.
This post is not about whether or not such a valuation is warranted. Clearly the company is growing very quickly, has executed well so far and is targeting a very large market. If they execute flawlessly over the next few years, I think the company will be worth much more. However, that is the key -- whether they will be able to execute and fulfill their very ambitious vision. And that is where I think it is instructive to look at a recent and very relevant example: Groupon.
At first pass Groupon and Uber may not seem similar -- they are in very different markets with very different dynamics. But in fact, they face many of the same key challenges:
- A huge market in aggregate, but one that is composed of many small "local" markets
- A race to get big as quickly as possible with very well-funded competitors
- Building a two-sided platform (merchants/consumers, drivers/riders) where:
- The "buyer" side (consumers, riders) generally only cares about getting the best price
- The "seller" side (merchants, drivers) can fairly easily also use competitors' services
Let me delve into each of these in turn and explore what it means for Uber.
(The post is a bit long - you can jump to the final "Summing up" section for the conclusion.)
1. Market characteristics
Both companies have the exact same "problem" here: their markets are conceptually enormous, but they are fragmented and lack overall network effects.
For Groupon it was all local commerce, while for Uber it is all local transportation (with logistics optionally thrown in). In aggregate, both these markets are in the hundreds of billions, or perhaps trillions, in size. The problem is that each new city is a brand new battle. And having won in one city (assuming that can be done, per point 3 below) means little for who will win any other city. You can argue their brand will carry over, or that their tech infrastructure will give them certain advantages, or that their new-city operational rollouts will become more efficient - but the truth is that each new city presents new challenges. This is even more true in Uber's case, where local regulations and labor practices play a big role.
This is their reality and there isn't much they can do about it. But it does mean that it is important to scale up quickly and be aggressive about entering new markets. So far they have been doing this very well, which leads us to the next point.
2. Get huge fast
Given that these companies carry a limited competitive advantage from city to city and that we now live in a world where ideas are now copied in a flash, it is very important to scale up as quickly as possible. Groupon and competitors did it back in 2010-2012, and Uber, and competitors, are doing it now.
In 2010, Groupon went from operating in just Chicago (its only city for over a year since founding), to growing at a pace of around 10 new cities per week. It was a blazingly fast and impressive pace. In addition, they acquired a European copycat that had actually managed to scale up even more quickly in the previous six months. To fund this growth, they raised a lot of money: $30M at the end of 2009 to start ramping up aggressively, followed by $135M in April 2010 and culminating with a record $950M in January 2011. At the same time, LivingSocial, Groupon's main competitor, raised well over $600M and was expanding at a very similar pace. The third place company at the time, BuyWithMe, raised over $30M in the same time frame.
Over the last year Uber has raised more than $1.4B (on top of a previous large round) and Lyft, its key competitor has raised more than $300M (with more probably coming soon). The current third place, Sidecar, has raised about $20M. I'm not very familiar with how quickly Uber is expanding to new markets, but it looks like it's a pretty fast pace and Lyft is right there with them.
As you can see, the competitive dynamics are strikingly similar. What can we learn from this point?
First, these dynamics are just the nature of the beast. It's a race to get big and you expect management and investors to pursue the opportunity aggressively. However, this is where the first flag comes up: this frenzied expansion can lead to very real problems down the road. In two ways:
- Growing this quickly inevitably leads to flawed operational/tactical decisions. Groupon ran into this by late 2012 and had to lay off people and restructure some of its markets soon after.
- More worryingly, growing this quickly can also lead to strategic missteps. I'll explore some aspects of this point in more detail in the next point.
Before closing off this section, I'll make two notes that have caught my attention and that may bode well for Uber in this context:
- Uber has grown completely organically (as far as I know). This is in comparison to Groupon, which grew internationally (and also technology-wise) through a super-aggressive acquisition spree and which arguably led directly to the sub-standard operations and eventual restructuring. Uber seems more insulated from this risk.
- Uber's management has apparently sold very little stock, while Groupon management used the funding rounds to cash out hundreds of millions. This is a second-order point, but I would put a bit more stock in a team that is still fully vested in the long term success of their company.
3. Platform strategy
Finally, I get to the the most important part of this post and what will determine true long term value creation. As mentioned above, both companies are two-sided networks, so let's look at each side in turn.
First, the buy-side (consumers/riders). Both companies have a buy-side constituency made up of "standard consumers". While any company in this situation will try to differentiate itself and build up some barriers to entry, the reality is that most consumers just care about getting the lowest possible price. In the case of Groupon, consumers could easily subscribe to both Groupon and LivingSocial emails and very often did so, buying whatever offers caught their attention from either company. In the case of Uber, it is completely feasible for someone to have both the Uber and Lyft apps installed on their phone, and use one or the other depending on who offers the cheapest rates.
Is it possible to improve on a situation like this and build some actual consumer differentiaton and loyalty? It is, but it's not easy. Uber especially will have a hard time with this since transportation is a complete commodity (while a meal at a restaurant is arguably less so). Clearly, Uber will do all it can to have the best app, the best customer service, the best-known brand, etc. But in the end, it is trivial to have two different apps on my phone and to launch the one that gives me the best rates - and this is what most smart consumers will do.
This leads us to the crucial sell-side (merchants/drivers). It is here where the strongest differentiation and barriers to entry can be put into place. This is where, I believe, Groupon failed to create huge and long term value. And, as far as I can see, Uber is not yet fulfilling its potential. Let me explain.
Back in 2010/11, local merchants everywhere were hearing about this brand new marketing ploy called a "Groupon" and were intrigued by it. It promised to bring them lots of new customers for no up-front cost. So a lot of them, including many very high quality ones, tried it. The problem was that the long-term economics weren't great, and that there was another company (LivingSocial) quickly calling them up and offering to do the same thing but with a slightly lower share of revenue. So what did merchants do? First, they tried Groupon. If they liked the results (or thought they liked the results since the economics did not always become apparent until months later), then many would just try LivingSocial and play them off each other. If they didn't like the results, they were out of the market for these types of deals. And Groupon did absolutely nothing to either improve the long term economics for merchants, or to actually add enough differentiated value that a merchant would choose to stick with only Groupon long term.
Why was it key to differentiate/add value to the sell-side? Because merchants are busy and have limited bandwidth (especially when overloaded with a bunch of Groupon-carrying customers). If Groupon had offered the merchants a set of valuable ongoing services to complement (and improve) the "daily deal", merchants could have been long-term Groupon customers, without the need or ability to go to LivingSocial. This is different from the consumer side, where it is trivial to receive two email newsletters. A merchant, in contrast, can only have one provider of loyalty, CRM, payment processing or [fill in your preferred ongoing service]. Groupon was in a tremendous position to offer some of these services at cost (or even free), as long as a merchant stuck with them long term and did a periodic Groupon deal to bring in new customers. But they didn't - they were too busy growing like crazy. Eventually the craze cooled off: merchants saw the economics of daily deals were not favorable, LivingSocial forced margins down and the company ended up semi-pivoting to selling overstock/discount goods. While it's still a valuable company ($4B market cap in early June 2014), it is worth just a fraction of what investors/management were expecting when they invested $1B and rejected a $6B acquisition offer from Google in early 2011. I could write much more about this, but this post is primarily about Uber, not Groupon.
So how does this concern Uber? Well, every single time I have used Uber (or even just taken a taxi) here in San Francisco, I see that the driver has 2-3 different phones on his dashboard - one from Uber and one from a competitor. Understandably, the driver will take riders from either service and will probably favor the service that gives him the better economics (and, by the way, Lyft is said to be taking 0% share at the moment). But a driver is busy, wants to use his/her time as effectively as possible and would prefer to stick with a single service if it fulfills all his needs. And presumably a driver also needs additional complementary services (e.g., holistic routing, car leasing, car servicing, accounting/tax services, etc.) where it doesn't make sense to have more than one provider. Uber, sooner rather than later, needs to start giving drivers these additional services (at cost or even free) and making their lives as easy as possible. The "uber-goal" should be to make a driver decide to just stick with a single service and not play them against each other since it's not worth his time to do so. Is this possible? I think it is, although it seems less straightforward for Uber than it would have been for Groupon. After all, it's pretty easy to have two phones on your dashboard, but it was a very bad idea to run simultaneous (or even overlapping) Groupon and LivingSocial deals.
So where does this leave us? I think Groupon offers Uber a very relevant and recent cautionary tale. Uber seems to be doing many things right, especially around city-to-city scaling and fund-raising -- just like Groupon did in 2010/11. But Uber runs the very clear risk of focusing too much on growth and not on building long-term defensibility/differentiation. And the only way to build this defensibility is by locking in their drivers by whatever means possible and offering them long term, sustained value. Not just a higher revenue share - rather highly complementary services that make their lives easier and businesses better.
If they execute well on this, I can see Uber being worth hundreds of billions in a few years. If they don't, then they may end up like Groupon - worth "just" a few billion dollars. While that is nothing to sneeze at (how many people build billion dollar businesses?), it is very, very far from what it could have been.