The Business Of

Sharing | Uber | What Are Their Margins?

Morning All!

So, yesterday we dug into how Uber makes money. And we saw that Uber has 131 million active users, who on average book 36 trips each a year! The average booking value/trip is ~$11. And Uber’s take rate from their platform is ~27% - more than double the take rate we saw at Airbnb (13.3%)!

On Friday, we’ll look more into why Uber’s take rate is so much higher than Airbnb’s. But today, we’ll turn our attention to costs and margins. And look at what’s really necessary to operate a business model like Uber’s! Let’s start with a split of the company’s cost structure…

As we can see, a huuuuge proportion of Uber’s costs come in their ‘cost of revenue’ line, so we’ll spend a longer time in this section today. I learned a lot when I was researching Uber’s cost of revenues so I’m looking forward to this! Let’s dive in…

Ahhh So That’s Where All Their Revenue Goes!

Okay, I’ll start by looking at Uber’s gross margin and compare it to Airbnb’s. Last week we saw Airbnb had the highest gross margin of any company we’ve looked at so far on TBO! So will Uber’s gross margin also be as high?

Well, unfortunately for Uber, no! As we can see in the chart below, Uber’s gross margin of 38% is miles off Airbnb’s 82%. This begs the question - why is this?! What on Earth do Uber have in their cost of revenues?

Well, there’s 2 massive costs Uber has - that Airbnb doesn’t - which really drag their gross margins down. They are (i) driver incentives, and (ii) insurance costs. Let’s start with driver incentives!

Now, these driver incentives aren’t the normal payments drivers get for a trip. Remember, if we pay £10 for a ride, Uber takes £2.70 of that, and the remaining £7.30 goes to the driver. Driver incentives are additional payments that Uber make to drivers. But hold on - if drivers already take most of our trip fares - why do Uber make additional payments to them?

Well, the main reason Uber make these additional payments is because drivers aren’t tied to Uber! Drivers can drive for Uber, Bolt, normal cab companies, Deliveroo, Just Eat, etc... there are so many options! And one of the biggest factors that decides who they’ll drive for is how much money they’ll make. So Uber use these additional payments to continually incentivise drivers to drive for them.

So, how do these incentives work for drivers? Well, there are 2 types of incentives. One is extra money a driver can make for completing a certain number of trips. The screenshot below shows an example where Uber are offering a driver $155 extra (on top of their trip fares) if they complete 65 trips.

And the second form of incentives is guarantees. This is where Uber will say to a driver ‘we’ll pay you $2k per week if you drive 60 hours’. So even if a driver doesn’t make $2k in trip fares from their 60 hours of driving, Uber will top up their amount to $2k! Now, $2k per week was actually a real incentive Uber had, which sounds like a huge amount! But before you go off and sign up as an Uber driver, check this article out. Because there are a few costs that come out of that $2k for the driver unfortunately…

Okay, so we’ve talked about driver incentives. Let’s move onto insurance costs. And the first question to ask is - what are Uber paying insurance for? Don’t drivers already have their own personal driving insurance? And the answer is yes - every Uber driver will have the normal insurance to drive a car. But that insurance doesn’t cover them when they’re driving an Uber!

So, let’s say I’m driving my car and I get into an accident. The accident was my fault. What happens? Well, my insurance company pays the damages. But what about if I’m driving for Uber and get into an accident. Will my insurance company pay for damages? No - I need a different type of insurance! And this is what Uber provides. Now, these insurance payments cost Uber billions of dollar a year. And a question to ask is - do they really have to do this? Why don’t they get their drivers to arrange their own ridesharing insurance?

Well, it’s like we said earlier. Uber need drivers. And drivers have options. Making drivers pay for insurance only increases the obstacles for someone to sign up as a driver. So Uber pay for their drivers’ insurance! Now, although Uber don’t disclose exactly how much they spend on incentives and insurance every year, the key takeaway here is that nearly 62% of revenue is spent on these 2 items. Expensive!

13 Million Rides A Day = Lots Of Support Required!

Okay, so that’s cost of revenues, which make up the largest part of Uber’s cost structure. But the other big cost for Uber - like it was for Airbnb - is people. Software developers, marketing employees, operations employees, etc. And I was stunned by this - but Uber have over 32,000 employees! Miles more than what we saw at Airbnb. And a question is – if Airbnb and Uber have similar business models, why do Uber have so many more employees?

Well, one of the main differences between Uber and Airbnb is the level of support required for customers. In Uber’s IPO prospectus (a document companies publish when they’re about to IPO), they reveal that out of the ~22k employees they had in 2018, over 5,000 of them were support employees based in Uber’s 10 global support centers. 5,000 support staff! And these support centers are basically call centres in countries like India, dealing with Uber’s customer service.

Now, the reason for having so many employees in support functions is because the level of customer support Uber need is higher than it is at Airbnb. I’m not saying there’s more to complain about in an Uber ride than at an Airbnb stay by the way! What I’m saying is that the number of opportunities to complain is higher with Uber! What do I mean? Well, it’s all about volume. In 2022, Airbnb had 96 million trips booked on its platform. But Uber had 4.7 billion rides booked on its platform. That’s nearly 50x as much booking volume going through Uber! So even if 10% of Uber and Airbnb’s customers had complaints and needed support, you’d have ~50x more complaints at Uber!

Now, whilst support functions make up a huge part of Uber’s employee base. The other big role in Uber is of course the software developers. Back in 2020, the company employed ~2,000 software developers. And like at Airbnb, these guys and girls will be getting paid considerably more than most other employees at the firm. This link gives you a breakdown of what the software developers make at Uber vs Lyft!

$1,500 For Referring A Friend… Sign Me Up!

Okay, so the final cost line we’ll look at today is marketing. In The Business Of Airbnb, we looked at how the company was able to make staying in a stranger’s home not seem weird. Well, getting into a stranger’s car also doesn’t seem the most appealing proposition. But again, Uber knew what would be an appealing proposition – money! More specifically, free money! If you thought Airbnb’s referral scheme was lucrative, check this out.

When Uber got going, in a bid to get people to refer their friends to download Uber and become passengers, the company gave people a $10 dual-sided referral credit. Meaning if I referred you and you booked a trip, we’d both get $10. This quickly rose to as high as $30 per person as Uber raised more and more money.

The crazy thing though is that the rewards were much, much higher for drivers. And it’s like what we saw with Airbnb - both companies prioritising the supply side of their platforms.

If I was a driver on Uber in the early days and I referred a friend to become a driver, I’d receive anything between $250 to $1,500! That is extraordinary. $1,500 just for referring a friend to drive! But Uber was so intent on winning drivers and increasing the supply of drivers that they spent a huge amount on referral credits. They even gave out specific referral credits to drivers who convinced their friends who were driving with Lyft to switch to Uber!

Lyft came up with plenty of their own marketing tactics by the way - including having pink moustaches on the front of their drivers’ cars! And this intense marketing battle between Uber and Lyft was a result of both companies realising the importance of scale and winning market share. Most people might have 1 or 2 ridesharing apps on their phone. But they don’t need 3, 4, 5! So you had to become forefront of people’s minds when they thought ‘I need a cab’.

To illustrate this, below is a chart on how the US ridesharing market is structured. As we can see, there are only 2 companies in this entire market… Uber and Lyft! All other US competitors have been vanquished! And so, like we saw with Nvidia and semiconductors, Uber operates in a duopolistic market in the US.

Globally, the ridesharing market isn’t quite as concentrated. Below we can see that whilst Uber is still the #1 player worldwide, Didi (the Chinese version of Uber) is a close second. DiDi actually bought Uber China from Uber back in 2016. And to read more about why Uber could never crack the Chinese market, give this article a read!

Okay, so the game plan so far for Uber has been to invest a lot in marketing (free rides, credits, advertising, etc.) to establish their leading market position. But now they are #1, do they need to continue growing their marketing expenditure at the same high rate? Probably not! And the chart below shows us this.

Whilst sales and marketing spend for Uber has grown from $3.15bn in 2018 to $4.76bn in 2022, a growth of ~11% CAGR, this figure has fallen massively from being 30% of Uber’s revenues to just 15%. This means Uber’s revenues have been growing faster than their marketing spend! Which is great, as this brings about margin expansion - just like we saw at Airbnb.

Will Uber Ever Turn A Profit?

Okay, so let’s wrap up. I mentioned on Monday, that Uber had lost a cumulative $25 billion since its founding. Well, 2022 was a landmark year because Uber’s Adjusted EBITDA margin turned positive for the first time!

To clarify, 2022 was the first time Uber as an overall company become margin positive. As the chart below shows, Uber’s Mobility business already had positive Adjusted EBITDA margins for several years!

Now, for all the Uber enthusiasts out there, I’m unfortunately about to burst your bubble. Because the chart above was for the Adjusted EBITDA margin. Of course, it’s great news for Uber that their Adjusted EBITDA margin is growing. But to consider ALL of the company’s costs and know whether the company is still losing money we need to look at the EBIT margin. For a refresher on Adjusted EBITDA margin vs EBIT margin, check out this previous newsletter!

So, looking at all the company’s costs, the chart below paints a slightly less positive picture. Because in 2022, Uber still had a negative EBIT margin! 14 years after the company was founded and still no profit!

So, the question is - will Uber ever turn a profit?! Will the company be able to benefit from economies of scale like Airbnb has done? Or will the driver incentives, insurance payments and marketing continue to hurt the company’s profitability?

Well, it’s a massive question… which we don’t have time for now! But on Friday, we’ll dig into what Uber’s CEO has planned for the company’s future profitability. And we’ll look at why economies of scale appears to be a less of a benefit for Uber vs Airbnb.

11th Oct 2023

Nigel Jacob CFA