In his excellent book Hot Seat, Dan Shapiro writes that taxi companies are not the kind of companies that a VC would invest in (Chapter 15). A VC, Dan writes, wants a company that can grow explosively and deliver crazy returns.

Facebook is one such example. In a relatively short time Facebook has grown into a company with over a billion users. The cost of adding users for Facebook is very low. With each user Facebook adds, their advertising revenue increases incrementally.

Then there’s this taxi company that built cloud based dispatch. They have convinced people to use their personal cars to drive for the taxi company. Every driver installs the taxi company’s mobile app so that they can get riders through the taxi company’s dispatch. The whole thing is a con, since the drivers pay for their cars, gas, maintenance and insurance while the taxi company sets the fare level. The taxi company just rakes off something like 20% of the fare for providing dispatch.

This sounds like a pretty good business. Maybe Dan is wrong. Raking off 20% with no capital investment and no costs beyond the cloud dispatch software sounds pretty good.

Except for one obvious fact. Every dollar the taxi company makes requires a car, a driver and a fare. The only way that the taxi company can expand is by adding more drivers. Explosive growth requires explosive growth in a labor force that provides their own cars.

Maybe I am completely underestimating what a great business model this taxi company has. What does it take for a well funded competitor to enter the market for taxi dispatch of drivers who drive their own cars?

You would have assemble a small team of experienced software engineers and deploy your taxi dispatch application on the Amazon cloud. Any competent team should be able to do this for under $10 million. Probably much less than $10 million.

There is a dimension in this taxi business that I have not mentioned yet. There is actually a high barrier to competing against this taxi company. The taxi company controls the fare charged for a ride and can adjust the amount of money paid to the driver. This taxi company is subsidizing taxi rides so that they can undercut the existing market. The taxi company is losing billions of dollars a year. Any company that wants to compete against the taxi company also has to have the resources to subsidize rides and lose money.

The taxi company’s growth is limited by the availability of drivers. The barrier to entry is the ability to lose money on a vast scale. What VC firm would invest in this taxi company?

The answer is that many of the top VC firms in the United States and a collection of other investors like sovereign wealth funds. All these funds have invested in a taxi company called Uber and another a smaller one called Lyft.

This is not too much money chasing a good deal, but too much money blindly chasing a bad deal.

Uber’s losses cannot continue indefinitely. This is not like Amazon losing money in return for world domination.

The actual costs that the Uber drivers incur will have to be factored into the fares, or Uber will not be able to get the drivers required to sustain Uber, much less grow. At some point, Uber will become become just another taxi company. Uber has done nothing to fundamentally change the costs of the taxi business.

Uber users love the convenience of Uber and low cost of the subsidized Uber rides (subsidized by Uber and by the driver). They love the fact that Uber drivers treat them better than taxi drivers (in most cases). Well, enjoy the ride while it is available.