Why the taxi industry is the way it is and how this is a problem for Uber

An easy market to take

When the court ruled in favor of Uber on July 3rd allowing it to continue unregulated operations in Toronto, many saw it as a personal victory against traditional taxi drivers. This settled the debate about the legality of Uber’s operations, for now.

Public reaction to the court decision on twitter

Here in Toronto, a perception exists that some taxi drivers are lazy and unfair. Lazy because there’s a good chance the cab won’t show up on time even after calling it in advance; unfair because you won’t even get picked up unless your destination is at least, say, 5 km away. So when Uber came along, they didn’t exactly have to do much to win the public over. As a bonus, Uber rides were also cheaper.

But how did the industry become that way in the first place? And would Uber succumb to the same pitfalls one day?

The early beginnings

First, let’s consider how the taxi industry came to be. Everything starts with an idea, so let’s look through the eyes of our fictional entrepreneur, Billy. Billy would have realized that there are quite a few people who needed to get places, but not everyone had access to a vehicle. Maybe he could get one, he thought, and use it to take people to their destinations and charge them a fee.

And so, Billy would have gone and bought himself a horse and buggy and become the first “taxi” operator. Once people saw Billy earning profits, they would also have jumped in and operate their own “taxis”.

Taken from https://horsesandhistory.wordpress.com/2011/05/02/transport-and-carriages-in-the-victorian-era-1837-1901/

The birth of an industry

This is the point where one individual idea is now evolving into an entire industry.

The problem is that as the number of independent operators increase, the likelihood of someone getting harmed also increases. Here’s why: in the beginning, early founders are passionate about creating a product to improve their community. Once it’s validated and other people start jumping in, new entrants are primarily motivated by profits. As the industry gets larger, one might get by with mediocre or even unscrupulous behavior by believing their identity may be covered by a veil of anonymity.

And this is what actually happened. By the late 1800s, the taxi industry was still in its early stages in the United States and the cabs, called “hacks”, earned a poor reputation. During the night, some drivers would prey on passengers by taking them to out-of-the-way locations and force them to pay higher fares to get to their destinations by threatening to leave them stranded there. There were no rules that specified the customer service standards that had to be met.

Because of the inherent conflict of interest, it’s difficult to say if industries can truly self-regulate without any government intervention.

The impact of regulation

Let’s jump back to recent times. To address the safety and quality concerns of the public, the City of Toronto regulated the industry by issuing a fixed quantity of taxi licenses and creating rules to standardize the upkeep and maintenance of cars. The purpose was to benefit consumers and instill trust in the industry.

The problem is that this also created economic inefficiencies in the marketplace. A recent piece by the Globe and Mail does a fantastic job of showing how some wealthy investors gamed Toronto’s medallion system by buying them up and renting them out to the drivers doing the work. At one point drivers were paying as much as $80 a day to rent the car and license, resulting in a net profit of only $20–50 a day.

These factors contribute to the reason why some taxi drivers operate on a cash only basis and/or refuse rides.

The cycle of regulation

Ultimately the behavior of industries appears to be cyclical and can be summarized as follows:

If we look at the growth of Uber, it is apparent that they are following this same cycle:

  1. Uber shocked the public by successfully and rapidly disintermediating the industry.
  2. Drivers on the platform are earning abnormally higher profits due to lower operating costs, low barriers to entry and low competition.
  3. There are significant pricing inconsistencies in the industry overall since UberX can be either cheaper than a regular taxi during regular hours or more expensive during surge hours (and note — the surge algorithm doesn’t appear to have too much transparency).
  4. The number of crimes committed during Uber rides is increasing and media coverage of these incidents is also increasing.
  5. Uber is being scrutinized for regulation in many cities around the world.

It seems that the taxi industry is currently in the fourth stage of the cycle due to what’s happening with Uber, which suggests that regulation is inevitably next.

What the future looks like

Competition will continue to increase and more drivers will convert to Uber (and various other derivatives that will inevitably spring up in the future). As a result, pricing and service quality will become harder to standardize. Eventually, regulation will be necessary to control the industry once again.

As a byproduct, higher operating costs and lower margins will cause price increases for consumers or declines in service quality. It’s possible that people will find other ways to game the system, which can ultimately hurt consumers even more.

At this point, the industry will be ripe to be disrupted once again by a new idea, potentially causing the whole cycle to repeat again.

So let’s not be so quick to fight against our taxi drivers, Toronto, because there’s a lot more to it than what we see on the surface. If we take a page out of history, it might be possible that the whole cycle is set to repeat itself for Uber as well.