Smith Brain Trust / April 15, 2019

How Uber and Lyft Could Find Profit

Study Finds Two Counterintuitive Keys to Ride-Hailing Success

How Uber and Lyft Could Find Profit

SMITH BRAIN TRUST  It’s got 91 million users, but ride-hailing giant Uber still hasn’t been able to turn a profit, according to its IPO filing. New research from the University of Maryland’s Robert H. Smith School of Business may hold the keys to doing so.

The research comes as Uber and North American rival Lyft make much-anticipated debuts on the New York Stock Exchange. In an IPO filing last week, Uber revealed that it foresees significantly higher operating expenses in the near future, but doesn’t foresee profits. The financial picture for Lyft wasn’t much brighter, and that company has seen its shares mostly slide lower since its public-trading debut a few weeks ago.

For Uber and Lyft, the best hope for profitability is to actually share more with riders and drivers – and keep less for themselves per transaction. That means paying drivers more and charging passengers less during non-peak hours, the researchers say. It might seem counterintuitive, but the researchers show that the strategy can pay for itself, by delivering volume, according to research from Maryland Smith professors Tunay Tunca and Yi Xu, Smith PhD alumnus Weiming Zhu, now at the University of Navarra in Spain, and Liu Ming from the Chinese University of Hong Kong, Shenzhen.

Both strategies would tighten margins for companies like Uber and Lyft, which already struggle with deficits. But an analysis of more than 350,000 transactions on Chinese platform Didi Chuxing points to increased volume and higher revenue overall when companies give more to connect drivers and passengers on their smartphones.

The study offers insights for the taxi industry and transportation regulators as well.

Unlike Uber and Lyft, the Didi platform allows traditional taxi companies to register in a separate category on the app — so customers can compare prices and wait times side by side and make choices in real time.

Less revenue for ride-hailing services sometimes means more for taxi companies, but not always. The authors are able to measure the interplay as they explore the impact of three financial factors: revenue sharing, surge pricing and government regulation.

Revenue Sharing

Ride-hailing apps typically keep 20 percent to 25 percent of each fare for themselves, plus added fees that raise the actual rates.

Giving drivers a bigger cut would seem to leave less for shareholders in the case of Lyft, which went public on March 29, 2019, and less for private investors in the cases of Uber and Didi, which have their own IPOs on the horizon. But something counterintuitive happens instead.

“Increased revenue sharing incentivizes drivers to be more active and boosts supply, which in turn increases customer demand and transaction volume,” the authors write.

Less is more, but the effect diminishes beyond a certain point.

“The platform can improve its revenue nearly 10 percent by reducing its revenue share by about 25 percent,” the authors write. “At the same time, the platform can raise the expected number of available drivers and customers that use the service by approximately 40 percent and 30 percent respectively, further generating significant additional economic value.”

Surge Pricing

Another business strategy that produces surprise results is surge pricing, the practice of raising fares to attract more drivers during periods of excessive demand.

Customers may resent paying higher prices precisely when they need ride-hailing services the most, such as during a blizzard. But maintaining equilibrium is key in a two-way market that brings drivers and passengers together as free agents on the same platform.

A shortage on the supply side means longer wait times for passengers, while a shortage on the demand side means fewer fares for drivers. Overall, the study shows benefits for everyone when platforms adjust rates based on supply-and-demand imbalances.

The authors estimate that customer welfare drops by almost 18 percent without surge pricing, and platform revenue drops by more than 22 percent. However, the strategy can become counterproductive during nonpeak hours.

“Reduced prices due to the elimination of surge pricing during nonpeak hours attract more customers, which in turn improves incentives for drivers to be available,” the authors write. “Our results suggest that restricting surge pricing to peak hours only, and eliminating it from nonpeak hours could be the best course of action.”

Government Regulation

As ride-hailing services approach optimal levels for revenue sharing and surge pricing, taxi companies may get left behind.

“Many ride-hailing platforms such as Didi offer fares consistently lower than traditional taxi fares,” the authors write. “Consequently, taxi companies around the world have been claiming unfair competition and asking for regulation."

Many jurisdictions have responded with price controls and other measures that raise operational costs for rideshare companies. Examples include mandatory certification courses for drivers in Montreal, and "congestion charges" that add an additional cost per trip in central London, in addition to a number of local governments that have considered enforced price hikes to ride-hailing services.

Some jurisdictions, such as Las Vegas, London and Austin, and some countries like South Korea have banned ride-hailing services altogether or attempted to do so. Taxi companies might welcome the protectionism, but analysis of the Didi data shows significant economic risks of such broad regulation.

“Our model predicts that a regulatory intervention that would increase prices to taxi levels would significantly decrease consumer and driver welfare,” the authors write. Further, using their model, the authors estimated the economic value generated by Didi’s platform and calculated that the ride-hailing services created consumer value equivalent to more than $32 billion in China in 2017.

The authors caution that when deciding on regulation to harvest the great economic potential of these innovative services, governments should try to balance the interests of all parties including consumers, ride-hail drivers, platforms, as well as those of the existing taxi drivers and companies.



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