The Inconvenient Truth: How TNCs Like Uber Provide Rides So Cheap
“An Uber ride for $4? It can’t be the true cost of the ride. Somewhere in the process, somebody got screwed.” Kara Swisher said in one of her recent Pivot podcasts. She is correct.
Labor is expensive in the U.S. So, while you’re enjoying that $4 ride, have you wondered “how can Uber make this so much cheaper than a cab ride?”
Uber and Lyft or transportation network companies (TNCs) don’t reduce the overall cost of transportation services; they redistribute it. At minimum, it still takes a car, a driver, some gasoline, and insurance to provide a ride regardless of the dispatching technology.
How does Uber shuffle the cost? They employ a two-pronged approach.
First, Uber only pays for a fraction of the time that drivers are active on the platform. Uber segments the time drivers spend on its platform into three categories:
- P1 or idling time is the time that drivers are active on the platform waiting for a ride request,
- P2 or the en route time, is the time between when the driver accepts a request to when they arrive at the pickup location, and
- P3 or passenger time is the time between when the driver picks up the passenger and when they drop them off at the destination.
Uber only compensates drivers for P3 time when drivers are transporting passengers. Uber may cover a portion of P2 time in extreme cases such as a long pick-up where the driver must drive more than the average P2 to the pickup location.
So, if a driver is active on the Uber platform for five hours, but only spends one hour transporting passengers, they are only compensated for one hour. In this way, Uber reaps an 80% discount on the labor cost!
This keeps Uber’s cost and the passenger’s price low. However, drivers bear the cost of not only their time but also the fuel and vehicle wear and tear. Considering even the most well-managed fleets have less than 50% utilization, the cost of idling time is truly substantial for drivers.
To optimize their financials, drivers must reduce their idling time by driving only when the demand is high (such as during rush hours or in densely populated areas) or driving for multiple platforms at the same time (such as driving for Uber and Lyft as well as Doordash or Postmate). If drivers don’t optimize their time, they will quickly find they lose money by driving and subsequently leave the platform. More than 68% of Uber or TNC drivers leave the platform within six months (Wall Street Journal, May 12, 2019). This tactic of Uber’s wouldn’t hurt drivers if the drivers were able to control their own rate; but they can’t.
Control the Price of the Ride
Second, Uber controls costs by setting the price of the rides and the driver’s pay.
Uber claims they operate as a marketplace for drivers and riders to connect. However, a true marketplace, such as eBay or Upwork, doesn’t set the price for the goods or services being traded on its platform. In addition, a true marketplace simply presents available suppliers to a buyer. The marketplace doesn’t insert itself in the supplier and price selection process. Uber does both by setting the price and selecting the supplier. It does so for a good reason — to provide a good user experience to riders.
The average Uber ride is 6 miles and costs about $12 dollars in large cities. At this price, riders prefer a hassle-free solution to a time-consuming selection process. So, Uber’s no-hassle user experience works well for riders. Riders love Uber’s services. However, by deciding the price and supplier, Uber is no longer a marketplace. Uber is functioning as an operator. More accurately it is an unlicensed operator because transportation operators must be licensed in each of the 50 states. These actions call into question the claim of TNCs that drivers are contractors.
Information Opacity Arbitraging
By underpaying drivers and functioning as an unlicensed operator, Uber shifts the majority of the cost burden to the driver. Cost shifting doesn’t create overall economic gain. That also calls into question the sustainability of the TNC model.
This TNC business model should not be confused with the practice of outsourcing. Outsourcing reduces cost by arbitraging the labor costs of two countries with different living costs such as US labor cost is about three times of China’s. The workers are paid a fair wage in accordance with their local standard. Hence the cost reduction is real and there is no unfair labor practice. Economic value is created when the products made in China are sold in the U.S. for a fair market value. The arbitrage lasts until the labor cost of the other country rises to a certain level that is no longer justified by the price.
In the TNC model, the company is arbitraging the information opacity not the actual cost, i.e., drivers and public are not clear exactly how much the service costs. As the true cost of a Uber ride is similar to the cost of the same ride provided by a licensed operator, what is being arbitraged is the difference between driver’s perceived cost and their actual cost, i.e., information opacity. The issues of using the TNC model is that no real economic gain is created, and the information clarity can be achieved quickly. Once TNC drivers understand their true costs, they will leave the platform or urge the companies to pay a fair price to the drivers’ time. Once this happens, the TNC model can’t be sustained. This is exactly what’s happening in California and several other U.S. states.