Mclowd Community Newsletter May 2019

Welcome to the Mclowd Community Newsletter.

There has been a growing chorus of questions and doubts about the unit economics and, really, about whether ride-sharing is a good business, period,” said Tom White, equity analyst at DA Davidson.Uber extends slide on second day of trading, ft.com May 13th 2019

Introduction

I was never a heavy user of Uber, mainly because I was never a heavy user of taxis.

But the 50% per unit price deflation that Uber represented was enough for me to change my behaviour.

However I had no sooner started using Uber than I stopped. Because I started using an identical app called Taxify (now Bolt).

When I say identical I mean identical. Bolt is exactly the same car, the same driver and the same user experience. (For anyone who uses ride-hailing regularly, you will know that the drivers keep multiple apps open concurrently, cherry-picking customers as required, which is why so much of the platforms’ efforts are now about throwing money at both drivers and customers in order to defend their flawed business models).

Identical except for the fact that Bolt charges 15% commission, whereas Uber charges 25%.

However the hypothesis that Bolt (or Ole or Didi) represent some sort of microeconomic end-point is not supported by any evidence.

Quite the opposite. By their very behaviour, what these companies are doing implies that the process of per-unit price deflation will continue ad infinitum, until some 15 year old builds an identical app (perhaps as part of a high-school STEM-project), puts it up on Google Play and the App Store, and simply gives it away for free.

Implications For SMSF Investors

I have chosen to focus this Newsletter on the economics of the ride-hailing industry because – as we are all about to witness – what is going on in the public capital markets will have considerable implications for:

  • The deployment of capital in the future
  • The SMSF sector (which is ultimately about the deployment / management of capital in order to support self-funded retirement)

In the context of the recent Lyft / Uber IPOs, it is important to understand that:

  • The globally-defined marginal cost of what these companies do is approaching zero
  • As a consequence of their capital-intensive governance structures, all of their efforts are now focused on sustaining price some distance from that marginal cost

I have some very bad news for the investors that have poured tens of billions of dollars into those efforts:

By creating a governance / capital structure that is inflexible to deflation, they have effectively signed their own microeconomic death certificate.

Uber will now spend the rest of its life fighting deflation, and will ultimately fail for the simple reason that it is now fighting capitalism itself – whose raison d’etre is to continually drive price towards marginal cost.

The lesson for SMSF investors is very simple:

Exercise extreme caution when deploying capital into entities which:

  • Assume that they can sustain prices that do not reflect globally-defined marginal cost
  • Have capital-intensive business models

The Changing Nature of Microeconomics

The microeconomic rationale behind the vast amounts of private equity that have been thrown at these companies is fairly straightforward:

Build up a two-sided network which is then difficult to replicate, thereby supporting a highly profitable gross margin model that will justify the capital structure in the long term.

But as my experience illustrates, that is simply not the world we live in any more.

We live in a hyper-connected world where:

  • Consumers are empowered by instantaneous access to information
  • Switching costs approach (if not equate to) zero

As a consequence elasticity of demand is off the charts (why would I pay 10% more to Uber when I can switch to Bolt in a couple of minutes while standing in the pick up zone at Sydney airport?).

Uber vs NBN Co

This is not some esoteric economic discussion.

The process I have described above is being mirrored in the case of Australia’s National Broadband Network, which ironically has now consumed almost exactly the same amount of capital (~A$50 billion) as Uber.

The unifying theme here is very simple:

Capital is being deployed in vast quantities, and no sooner has it left the building than it collides head on with deflationary reality.

And in almost every case it will be deflation that will prevail.

(In the case of NBN Co, the incoming Federal Government will shortly announce that they are writing off tens of billions in taxpayer funding – equivalent to around $1,000 for every man, woman and child in the country).

Conclusion

While I would agree that Uber and its peers have a role to play in the transformation of mobility, I don’t believe it will be that role for which they are ultimately remembered.

Instead – largely because of their sheer size – I believe that Uber, Lyft and NBN Co will ultimately be the trigger for a fundamental change in the way capital is deployed.

One in which the Zero Marginal Cost destination figures more prominently.

Postscript

The very DNA of the Mclowd Community was formed from an understanding of the above process, and its eventual outcome.

As a consequence of its governance / capital structure:

  • Mclowd is able to price its product / service adjacent to globally-defined marginal cost
  • Unlike incumbent vendors, the Community can now grow ad-infinitum, freed from the need to constantly throw incentives at users (which, like Uber, must be paid for from the monetisation model itself)

Regards

Ashley Porter

Managing Director
Mclowd Pty Ltd

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