Ask an economist about a company’s prospects, and they will pose three questions.

  1. Do the company’s products offer value that customers will pay for?
  2. Can the company provide that value at a profit?
  3. How easy or difficult is it for a competitor to do the same thing?

Unfortunately, many investors neglect to ask economists about newfangled technology companies on the verge of an initial public offering (IPO).

That’s a pity … because lumping all tech IPOs into one bullish basket is as dangerous as ignoring them altogether.

Underneath the flashy CEO presentations, the adoring headlines and the marketing buzz, all tech companies are businesses trying to make a profit.

But only some of them will.

I happen to be an economist. So before I invest in one of this year’s IPOs, I’m going to explore those three questions above.

And to help you increase your chances for profit, today I’m going to report my results on the buzziest IPO of all…

The Amazon of Transportation?

The spinmeisters at Uber want you to associate the company with Amazon so you will buy it at its IPO.

“Cars are to us what books were to Amazon,” Dara Khosrowshahi, Uber’s CEO, said last July. “Just like Amazon was able to build this extraordinary infrastructure on the back of books and go into additional categories, you are going to see the same from Uber.”

I don’t believe that for one second, and neither should you.

It all comes down to market structure … specifically, the markets for books and car trips.

Amazon’s Path to Profit

Jeff Bezos founded Amazon in 1994 as an online bookseller.

Bezos knew that a book is a book, whether it’s in Atlanta or Seattle. Customers don’t care where they come from.

If they can get it shipped from Seattle at a lower price than at a local bookstore, they’ll order it from Seattle.

In other words, the market for books is national.

Amazon went public in 1997. It didn’t report a quarterly profit until 2009. It didn’t begin to report consistently significant profits until the last quarter of 2015.

Amazon Profit Margins 2012-2017


That’s because for the first 20 years of its existence, Amazon focused on adding more products to its initial national marketplace for books. It spent billions of dollars of investor money and operating revenue to expand its market share for those goods.

All the products Amazon added to its website were like books. It didn’t matter where they were when a customer bought them, as long as they could be delivered at a competitive price.

They were all national markets.

Many people accused Amazon of “selling dollar bills for 90 cents” just to grow market share and revenue. They claimed Amazon would never be profitable.

But Bezos knew it would. “It’s a fixed-cost business, so what I could see from the internal metrics is at a certain volume level we would cover our fixed costs, and we would be profitable,” he said.

He was right. Once Amazon had gained enough market share and volume, it could undercut local retailers on price and earn a profit at the same time. All those years of losses were simply the cost of getting there.

And now that Amazon is there, no other company can challenge it. No investors are prepared to spend billions of dollars subsidizing a competitor’s attempt to grab market share and volume from Amazon.

Uber Has No Path to Profit

Uber has never turned a profit. It has reportedly burned through $20 billion so far.

Uber says this is because it is following the Amazon model. It’s focused on growing revenue and market share so that one day it can become profitable.

Unfortunately, that day will never arrive.

First, unlike Amazon, Uber’s costs aren’t fixed. Because it must pay individual drivers to provide rides, its costs go up as it expands.

And Uber has no scope to reduce those costs. A two-year study of Uber drivers in Washington, D.C., found many drivers already earn as little as $5 an hour.

Second, unlike Amazon’s single national market, Uber’s market is a patchwork of local markets. People want rides within those markets. They don’t care who provides them or whether that company operates in other places.

Third, it’s easy to develop and launch a local ride-sharing app. So, in each of its local markets, in addition to taxis and Lyft, Uber faces intense competition from city-based ride-sharing startups like Juno, Via, Gett and Arro. And because those smaller competitors have low costs, they are profitable.

Lastly, its drivers can easily switch to one of Uber’s competitors. To keep them working for Uber, the company subsidizes them heavily. It must do this because given all the competition it faces, Uber cannot raise its prices.

The bottom line is best expressed in a recent article from The Economist:

Look through history, though, and taxi monopolies look anything but impregnable. That is because the ride-hailing business, which will remain Uber’s bread and butter for the foreseeable future, is local, not global. And as long as competition is unregulated, entering local markets is relatively easy. As competition increases, ride-hailing becomes a commodity business. Customers care little whether they ride with Uber or Lyft, as long as it gets them from A to B. That means neither firm can easily increase profits by raising fares, but may instead have to offer discounts. Likewise, the ride-hailing firms do not own their cars: their drivers do, and so have no reason to be loyal. That forces the firms to pile on incentives to stop drivers from deserting, kicking profits even further down the road.

Uber Is a Losing Prospect

Let’s return to the questions I posed at the beginning:

  1. Do Uber’s products offer value that customers will pay for? Yes.
  2. Can the company provide that value at a profit? No.
  3. How easy or difficult is it for a competitor to do the same thing? Extremely easy.

Uber shares may provide some short-term gains for savvy speculators.

But whatever you do, don’t buy and hold.

Kind regards,

Ted Bauman

Editor, The Bauman Letter