Uber’s Achilles’ Heel

Most people accept the popular view that the arrival of self driving cars will be a blessing for Uber, delivering increased profits, lower prices, and larger scale. In reality, self driving cars will put the entire company at risk.

Uber is winning today because of the powerful network effects associated with a two sided marketplace for transportation. They spend the majority of their resources on attracting, screening, hiring, training, engaging, and retaining drivers. It is their core competency as a company. Having the most drivers online makes Uber the best place to get a ride with the fastest arrival time at the best price. Having the fastest arrival time and best price attracts the most users to Uber. Having the most users makes the drivers stay with Uber, because they can make the most money there. This is a powerful virtuous cycle once you are at scale. Legendary investor / operator David Sacks drew this cycle on a napkin:

On the other hand, there is very little loyalty to transportation companies like Uber. Arrival time and price are really the only 2 meaningful factors consumers make decisions based on. Customers are happy to use other competitive services when Uber isn’t the cheapest or doesn’t have the best arrival time. When Uber initiates surge pricing, users flock to competitors. Uber maintains a strong defensible lead mostly because they have locked down the supply of drivers in many different regions. This is why they’ve aggressively raised the most capital to go after every market as quickly as possible. This is their only key advantage over other companies, and it’s about to disappear.

As self driving cars become a reality, this type of service is no longer a two- sided marketplace, but instead a commodity rental business. There will no longer be a constrained supply of drivers, so the network effects evaporate. This will give car manufacturing companies the advantage to enter and win the market. The company that can create cars for the cheapest will have the lowest prices. Having a low arrival time will simply be a matter of manufacturing enough cars to put on the road in a given area. Companies who have the ability to produce cars the most cheaply will be the best suited to compete. A car company like Toyota can compete in San Francisco simply by manufacturing a few hundred cars to get to arrival time parity with Uber. With an investment as low as just a million dollars for a hundred cars, any car company could challenge Uber in their most important markets where they have remained untouchable for years. It has cost Uber tens, if not hundreds of millions of dollars, to win a market like San Francisco and that market will be vulnerable to any car manufacturer willing to invest just a million dollars.

Car companies will focus on the on-demand self-driving car market because it will be much more profitable than selling cars. If Toyota can either sell a new Camry for $20,000 or rent it on demand for 200,000 miles at $.25 a mile and make $50,000 instead, they will pivot the business to on-demand rides. $.25 a mile is almost 5 times cheaper than the current rate Uber charges in San Francisco. Is there any doubt that everyone in San Francisco will switch to the Toyota app when they can get around town for 5 times cheaper? This opportunity will compel the car companies to release their own apps. You will be able to use the Tesla, BMW, or Ford app to get a ride on demand. The dispatch software is simple to build, and there are many failed Uber competitors for the car companies to acquire this technology from. They can even have all of it built for them $20k by Gigster, a software-on-demand service.

Given these risks, Uber could also consider becoming more of a car manufacturer themselves. Last year, Netflix CEO Reed Hastings said Netflix had to become HBO before HBO became Netflix. Creating content has become as critical as streaming it. Similarly, Uber must become GM before GM becomes Uber. Creating cars will soon become as important as providing them. Offering the lowest cost rides will only be possible by manufacturing the cheapest self-driving vehicles. There are many failing auto companies Uber can afford to acquire and double down on making the cheapest, best self-driving cars in the world.

Google is the farthest along in developing autonomous vehicles. Google should license out their self driving technology to car companies like they did with Android to smartphone manufacturers. Google Maps could operate as a marketplace platform for all of the car companies to offer on demand rides. With dozens of car companies competing on price and arrival time, there is simply no way Uber would be able to win. Google can solve the distribution and technology problem for the car companies, and the car companies can focus on making the cheapest, most energy efficient cars. Amazon was smart and humble enough to realize the power of third party merchants in their marketplace, and they are quickly becoming the majority of products sold on their platform. Uber could fight this by becoming a platform for the auto manufacturers before Google does, but it would require a major change in the company’s structure, culture, and humility.

I’m not saying that Uber isn’t going to be a huge, valuable company. I am suggesting that the path to it becoming more valuable is much less certain than most people think. Navigating this shift will be as difficult and risky for Uber as the transition to mobile was for most consumer internet companies. With great execution, they can come out on the other side even more valuable. A few missteps, and they could just as easily end up as the defining example of the most overvalued company during the second internet bubble. The only certain winner of this race to the bottom will be consumers. Transportation will be cheap and plentiful in a post self-driving world.

Uber is just one example. Many marketplace companies that seem invincible right now will lose their network effects. Not only will automation put many types of jobs at risk, but also the companies that operate as labor marketplaces themselves.

The ultimate irony is that Uber is in such a hurry to replace their drivers with self-driving cars- all without realizing that the drivers are the only thing that keeps the company safe from competition.