Should Uber and Careem merge?

Each week I attempt to answer an intriguing question from the world of tech in typical countdown fashion (Top 3, Top 5… but in no particular order). I’ll usually tackle a question that is inspired by the news cycle, but I may go off the rails every now and then. It’s still early days and I would love your feedback.


Answer Me This: Should Uber and Careem merge?

Yes. This is a scenario that’s played out in South East Asia (S.E.A) when Grab gobbled up Uber, so why is the Middle East ripe for such industry consolidation?

Here’s my top 2 reasons why

#1 Unit economics do not support price discounts

There’s this common conception of the ride-hailing industry when it comes to competition. Investors and the media often refer to it as a “winner-take-all” industry. But, while that is true of some markets, not all markets were created equal. Certainly though, that narrative explains Uber’s withdrawal from several high-growth regions like(S.E.A) (Yielding its business to Grab) and China (selling off to Didi). Uber however is successfully navigating its way in the US and though its losing market share to its main rival, lyft, Uber is -dare I say it- profitable in the US? This brings me to my primary assumption; some markets are pure volume plays, operating on depressed prices. Compound that with the nature of ride hailing to dominate on the supply and demand fronts and you get a market unable of sustaining competition; a true winner-take-all.

The process of identifying which markets are low-margin is quite arbitrary in the absence of any detailed financials from any major ride hailing company, but a lot can still be inferred from what’s available in the public domain.

Ride hailing companies operate on the core premise that their services are cheaper than the local taxi service. Yes there are several other key features including higher quality and friction-less payments, but pricing has always been key for acquiring users. Looking to a market’s local taxi industry can provide limited insight into a market’s profitability structure.

Most Uber markets operate at a significant discount to local cab services

Cities in the US and Europe have Uber fares at more than 20% below cabs

Data as of 2018, Grab prices for Kuala Lumpur, Bangkok, Singapore and Manila and Uber prices for all other cities Source: Uber and Grab fare estimate tools, Numbeo

The basic foundation of a ride hailing company’s business model is this:

  1. Undercut a local market’s taxi service on pricing + spend heavily on customer acquisition (CAC) = -ve contribution margin
  2. Low pricing grows the demand-side of the ride hailing network (riders) and in turn, the supply-side grows (drivers)
  3. The network hits its liquidity threshold (minimal wait times)
  4. sustained low pricing + Lowered CAC = +ve contribution margin

Pressured pricing can however spoil that progression. In cities with cheap and accessible taxi services, a typical ride hailing company (let’s call it ABC) can’t sustainably compete on pricing, but can only use it as a gateway to customer acquisition and pray they stick around when it raises prices and pulls back on the discounts and free credit. Here’s how the business model plays out for ABC

  1. Discount pricing… check
  2. Network establishment and growth… check
  3. Liquidity threshold… yup
  4. Low pricing + high CAC = -ve contribution margin

Typically, ABC would be unable to raise prices, provided that the alternative being a taxi is already cheap. Instead, ABC would continue subsidizing its rides through offers and discounts to maintain its network liquidity, raising its CAC and burning cash in hopes it can drive out competition, but that doesn’t happen, at least not fast enough. Soon enough, ABC finds itself stuck in low-margin hell with no way out.

Data shows that markets with pressured pricing are typically large metropolitan cities in developing countries, with cheap and accessible taxi services. This is not only true of some key markets in S.E.A, but is also true of Cairo, one of the biggest ride hailing markets in the region and certainly a contested battle ground between Uber and Careem. Unit economics are however more favorable in the Gulf region, with room to undercut local taxi services and still get the contribution margin in the green.

#2 low motorization rate is a structural supply bottleneck

While unfavorable unit economics might be exclusive to Egypt, markets across the Middle East are capped with limited supply, not unlike S.E.A. with below average motorization rates. This in turn creates two major roadblocks:

  • Operating below the liquidity threshold: Less drivers raises a ridehailing company’s average wait time, rendering its network inefficient.
  • CAC inflation: Limited supply can take a further toll on CAC [ 2 sided-marketplace CAC = spending on user acquisition + spending on driver acquisition]. The scarcer the drivers, the higher the spending.

The Middle East and S.E.A share a lower motorization rate compared to Europe

Egypt, Saudi and Turkey are collectively 58% below the average global motorization rate

Data as of 2015 source: OICA, World Bank

There is no plug-and-play answer to why this merger should happen, given the disparity in market structures across the region, but with most countries coming short on pricing, supply, or both, the region is ripe for consolidation.