The Lyft IPO hit public markets this week, pricing the company at a $25 billion valuation. Much has already been written about Lyft’s potential, so I’m going to share a favourite story to illustrate the risks for ride-sharing platforms like Lyft and Uber.
The Rise of America’s Daily Newspapers
Throughout the 1800s, newspapers across America exploded in popularity. In the early 1800s, New York had a dozen or more competing newspapers for readers to pick from. By the late 1800s, New York City’s newspaper count had grown to almost 100, and that figure likely doubled again by the early 1900s.
New York City saw particularly fierce newspaper competition due to its size, but this phenomenon was happening in almost every major city across America. Thousands of newspapers fought tooth-and-nail for the attention of readers across the country.
The Decline of America’s Daily Newspapers
But as America’s newspaper market matured through the 1900s, many publishers folded under the weight of shrinking margins and rising costs. Newspapers covered most of the same stories, but each paper required a printing press, distribution network, and an editorial team. The costs of supporting many daily newspapers greatly outweighed the benefits.
Warren Buffett saw this transformation occuring, and developed a track record for buying up mis-priced newspaper publishers through the 1960s and 70s.
The main insight Warren had was that each city in America only required one newspaper, yet some still had two (or more). The same way each city only builds one set of power lines or plumbing pipes, once a newspaper gained traction in a city it was difficult to scale up a competitor.
The Two Newspaper Town
Almost all of America’s cities had become ‘one newspaper towns’ by the 1970s. A single publisher owned most of the news circulation within a city. But Buffalo in 1976 faced a different story. Two newspapers remained. The Buffalo Evening News had a lock on daily news during the week, and the Buffalo Courier-Express dominated circulation on Sunday.
Neither was making much money, but one was up for sale. Warren Buffett pounced, and purchased the Buffalo Evening News for $32.5 million on $1.7 million in pre-tax earnings. Buffett understood that the two papers were headed for a showdown, and only one paper could run Buffalo.
A profile from Roger Lowenstein’s book, ‘Buffett’ reads:
The Buffalo Evening News ended up pushing the Daily Courier into bankruptcy, but only after a long, drawn-out battle for market share. This multi-year battle led both papers to growing losses, until the Daily Courier ran out of money. It was a happy ending for Warren Buffett though, as his paper got free access to the Daily Courier’s former readers. The business instantly turned into a money-printing monopoly.
The Ride Sharing Showdown
I expect similar consolidation in the ride sharing business in the next decade. Today, Lyft and Uber are competing on prices (because they have no other meaningfully different features) and are quickly growing their ad spend to win market share. Neither have ever made a profit, and it doesn’t look like Lyft will for at least a few more years. Uber is probably in the same position, but we won’t know for sure until we see Pre-IPO financials.
As the ride sharing market matures, I think Lyft has limited upside to extract more fees from drivers, with their service fees already nearing 30% in Q4 2018. Again, I assume Uber is in a similar situation, but nobody knows for sure.
Amazon only takes 15% of third party sales, and Airbnb only takes 20% of home and experience sales. Lyft’s 28.7% cut is entering uncharted territory that only ad monopolies like Google and Facebook have explored. I just can’t imagine drivers accepting a 30-40% Lyft/Uber fee. Their meager earnings already get taxed 30-40% by the government as it is.
Growing The Ride Sharing Market
So if Lyft can’t extract more fees from each ride, how do they grow? Lucky for Lyft, the ride sharing market isn’t saturated. McKinsey estimated that 1% of all miles driven in 2016 were from ride sharing services, so growing the overall ride sharing market is the next best revenue driver for Lyft and Uber.
The ride sharing movement has momentum, and aggressive marketing is paying off right now. While Lyft’s marketing spend grew 37% in 2018, their revenue grew by 104%. However, marketing will become more expensive over time as Uber and Lyft converge on the same customers.
Lyft and Uber aren’t exactly direct competitors today, they’re competing against vehicle ownership - and winning. But the ride sharing market won’t grow forever, and once adoption stalls, Lyft and Uber will be forced to compete directly against each other for market share.
That can quickly turn into a ‘two newspaper town’ scenario, setting the stage for low investor returns and a money-losing battle for market dominance. But that’s not even the biggest threat to Lyft and Uber.
Tesla’s Autonomous Fleet
Tesla manages a fleet of 500,000+ almost-automated cars around the world. Their fleet is expected to approach 1 million cars by the end of this year, with full self-driving capacity soon to become reality.
This presents a major problem for Lyft and Uber, the obvious outcome is that Tesla could become a competitor. But it’s the second-order effects of Tesla’s autonomous fleet that would be truly devastating to Lyft (and Uber). Let’s do some quick math. In Q4 2018:
- Lyft supported 178.4 million rides
- Lyft’s revenue (service fees collected) was $669.5 million
- Lyft takes a 28.7% cut, so the average Lyft ride cost $13.08
- Therefore, Lyft earned $3.75 per ride
We already discussed how Lyft will struggle to grow their $3.75 cut of rides by squeezing profits out of drivers, but what happens when there are no drivers at all?
The Falling Costs of Ride Sharing
Tesla can step in and massively undercut Lyft, maybe cutting prices by a factor of 5 or 10. While full autonomy isn’t quite ready yet, one analyst has already put Tesla’s odds of launching an autonomous fleet by 2023 at over 50%. If this happens, Lyft and Uber service fees (and overall revenue) will implode.
Let’s assume the average Lyft ride is about 5 miles. That would cost an autonomous Tesla roughly $0.22 in charging fees. The owner of the autonomous Tesla will get a cut of the action, so maybe they earn $2-$3 per hosted ride (just a guess). But Tesla won’t need a cut themselves. Remember, Lyft’s average ride cost $13.08 in Q4 2018.
Tesla cars could instantly become the least expensive way to travel, even costing less than a public bus ride. With millions of Teslas driving on their own, Tesla customers could hail rides for less than Lyft’s service fee! At the same time, Tesla’s profitable manufacturing business gets a demand boost from prospective car-lords (like landlords, but for cars).
To compete, Lyft (and Uber) need to create entirely new fleets from scratch. No vehicles on the Lyft network will have autonomous capabilities. Even Lyft drivers using Teslas won’t be able to join Lyft’s autonomous fleet. Elon Musk said the cars in Tesla’s autonomous fleet will not be able to earn money on other ride sharing platforms.
Checkmate for Lyft and Uber
The logical move for Lyft and Uber is to buy from or partner with traditional OEMs not named Tesla. But since all other OEMs are years behind Tesla in autonomy and electrification, prospects appear bleak. Without both autonomy and electrification, it’s hard to compete against Tesla on pricing. It’s less expensive to fuel a car with electricity than gas, and less expensive to autonomously drive people around than to pay drivers.
Tesla is about to show a ‘two newspaper town’ how to publish on the internet.
PS. To read more about Warren Buffett’s Two Newspaper Town investing rationale, I highly recommend this book.