Will Driverless Cars Ever Yield Profits for Uber and Lyft?

Uber has suffered a series of troubles early this year, from sexual harassment claims by a former staff engineer to an intellectual property theft lawsuit by Google unit Waymo. But Uber’s most longstanding, recurrent, and core problem stems from its relationship with its contract drivers.

It’s not surprising that Uber is seeking an escape from that relationship with an ambitious plan: to dial drivers out of its business model altogether by replacing them with self-driving cars. Among the pressures the company has been facing: Cities have demanded background checks on drivers to protect passengers, while drivers have sued for the right to be recognized and compensated as employees. That conflict got personal recently for CEO Travis Kalanick in a confrontation recorded during one of his own Uber trips, when the contract driver reproached him for lowering Uber fares, thus slashing the driver’s income.

Like Uber, top competitor Lyft is also making a bet that self-driving cars will provide a long-term path forward for ride-hailing companies. Innovative car manufacturers and startups have jumped on board, with plans for taxi or ride-hailing businesses based on fleets of autonomous vehicles.

But are they all chasing a mirage?

The question bubbling up now is not whether self-driving cars can be made to work. It’s whether anyone could make much money in the long run by deploying them as ultra-high tech taxis. Pilot vehicles studded with sensors, lasers, and cameras are already cruising the streets on test runs in various cities. What isn’t clear is how Uber, Lyft, and the carmakers are going to engineer the business model of a driverless taxi service of the future so they all—or, indeed, anyone—can make a profit. Business analysts and investors are starting to raise these questions as self-driving technology comes closer to commercial reality.

Gartner senior automotive analyst Michael Ramsey says believers in the potential of driverless taxi companies focus on the cost savings in getting rid of drivers—but they ignore the new costs that would arise once they’re gone. Could a trip in a high-tech car, sophisticated enough to drive itself, possibly cost the same as, or less than, a conventional taxi ride? It’s been that kind of competitive pricing that allowed Uber and Lyft to become mass transportation providers.

A traditional taxicab company with its own fleet and drivers is no high-margin business. Still, the ride-hailing companies have been able to compete with taxis on the price of a trip—in large part because they own no cars at all, and define their drivers as independent contractors. Yet even with the immense advantage of acting as virtual transportation companies, Uber and Lyft aren’t profitable—their operations are still subsidized by billions of investor dollars.

“Existing ride-hailing companies with human drivers don’t make money,” Ramsey says.

But if a ride-hailing company like Uber says goodbye to its drivers, it will also be saying sayonara to its virtual fleet—the drivers’ personal cars.

Uber can only forego the use of those cars by replacing them with much more expensive driverless vehicles, which are bristling with cutting-edge technologies such as laser guidance systems, artificial-intelligence software, sensor networks, and robotics. Either a ride-hailing company, or its business partner, would need billions of dollars to buy or manufacture such high-tech fleets. Someone involved in the endeavor would also have to bear the manifold expense of operating the pricey cars—a long list of costs, from maintenance to DMV fees, that would likely be higher than Uber and Lyft drivers now pay for their relatively modest vehicles.

Moreover, the financial rewards in store might only be a share of any profits from the commodity fares that consumers have come to expect after years of price wars between the two top ride-hailing companies.

“It doesn’t make sense,” Ramsey says. “The autonomous fleet idea has so many holes in it.”

(We reached out to Uber, Lyft, and several automakers for their views, but they weren’t able to comment by the time this story was published. We look forward to updating the story if they weigh in.)

Billions in investment to reap grocery store margins?

Might Uber and Lyft be able to outsource their self-driving fleet ownership entirely, the way they have avoided operating physical fleets so far by contracting with individual drivers?

Last year, Mercedes-Benz manufacturer Daimler agreed to own and operate driverless vehicles at some point in a partnership with Uber. GM has formed an alliance with Lyft to combine ride-hailing with autonomous cars. It remains to be seen how Uber and Lyft would divvy up responsibilities with the carmakers, split the expenses, and share the revenue if these pilot ventures ever reach a commercial scale.

“Uber and Lyft, what they really want is to not own any of these cars,” Ramsey says. “They’re hoping a fleet operator will come along with $10 billion and buy them.” By his rough estimate, Uber would need about 60,000 self-driving cars to duplicate its current U.S. network of conventional vehicles and drivers.

But what financial upside would exist for a carmaker or other fleet operator to maintain thousands of self-driving vehicles on call for Uber or Lyft?

The cost of running such an autonomous fleet could be enormous, starting with a fat sticker price for each vehicle, or the expense of manufacturing it. Add to that costs such as vigilant cybersecurity to shield the cars and their passengers from being hacked or hijacked, and the duty of meticulous maintenance by highly trained technicians to avoid malfunctions and accidents that could discredit the whole idea of vehicle autonomy. (With supercomputers, sensor arrays, and LIDAR range finders on board, ordinary garage mechanics wouldn’t do, Ramsey says.) Not to mention more mundane costs such as fuel, tires, repair garages, parts, parking, and property taxes on the fleet, equipment, and buildings. The dollar amounts of some of the expenses, such as insurance bills and state vehicle licensing fees, would likely climb upwards based on the high asset values of the cars alone.

“There may not be much financial upside,” Lux Capital partner Shahin Farshchi says. Self-driving taxi services would be operating on extremely slim margins, he says. “I’m talking grocery store margins.” (Lux Capital has a stake in the autonomous car future through its investment in Zoox, a startup developing self-driving vehicles.)

On top of that, Uber and Lyft would be negotiating for a share of any profits with powerful auto industry partners—not with individual drivers who have much less leverage against a big tech company.

“It’s all going to come down to bargaining power,” Farshchi says.

The ride-hailing companies might have a choice among many carmakers to partner with, judging from the global ranks of manufacturers eagerly working on autonomous vehicles, he says.

On the other hand, new startups can, and have, created their own apps to compete wth Uber and Lyft in certain regions. For example, Via competes with them in New York, and both Fare and the non-profit RideAustin are among their competitors in Austin, TX. Carmakers might also work with many ride-hailing partners—and possibly create or acquire such apps of their own.

“Anybody can make an app for hailing cars,” Farshchi says.

Ramsey carried out a thought experiment to illustrate the financial challenges of driverless taxi fleets, compared with conventional cab companies. Such legacy taxi outfits typically buy used rental cars a year or two old, costing about $10,000 or $11,000 each, he says. They run these cars for perhaps 300,000 miles over four or five years’ time, while the cars depreciate by about $2,500 a year.

But a self-driving car might cost as much as ten times the price of a conventional taxicab—perhaps $100,000, Ramsey says. “Your depreciation is enormous,” Ramsey says. “Now it’s $25,000 a year.”

It’s not clear what would happen to the earliest self-driving cars once they’d racked up four or five years of constant commercial use as taxis. Conceivably, a Web-connected autonomous car might reach the end of its useful life faster than a conventional car, because the swift pace of innovation among competitors might make it outdated. Would those used cars be scrapped entirely, or could they be sold to other fleets, or to individuals?

Farshchi raises another key question about the car markets of the future. Will self-driving cars end up being marketed to individual consumers? Or will fleets of autonomous cars lead to the dominance of “mobility as a service” —the sale of on-demand trips that make car ownership unnecessary and obsolete?

“The idea is, people will give up their cars to have car usage, like seeing a video on Netflix,” Ramsey says.

To swing the future in that direction, ride-hailing might have to remain about as affordable for most people as owning a car, or using other options such as traditional taxicabs and public transit. A hybrid system that included both car ownership and mobility services—as well as transit—-could continue to put downward pressure on the price of a ride in one of those costly autonomous cars—-squeezing the margins for high-tech fleet operators. At the same time, carmakers might be under constant pressure to spend on R&D and keep improving their vehicles to maintain a competitive edge.

“The only players who will capture margin are the innovators,” Farshchi says.

The hidden costs of autonomy

Uber and Lyft are now virtual transportation companies that have measured their successes by achieving scale—a classic pattern among Silicon Valley startups. As they attempt to take ride-hailing into a higher realm of technology with self-driving cars, they’re also trying to follow another Silicon Valley business model—software as a service—that creates an alternative to individual ownership.

While software as a service is easy to scale, things can get a bit messier when companies take that model into the realm of physical things. For one thing, each additional driverless car may cost a lot more to provide than access to software for one more customer’s staff, say.

Unexpected things also happen in the physical world. Ramsey gives an example: What if a passenger throws up en route in a driverless taxi?

Or, say the autonomous car gets plastered with mud by a passing construction truck? Who’s going to stand by to clean the car—-and where will they stand with mop and bucket—-so the car can get back out on the road and keep making money?

These are the kinds of new costs that some observers don’t take into account when they enthuse about eliminating drivers, Ramsey says. “There are just a host of things nobody’s talked about,” he says.

The tasks that ride-hailing drivers now carry out, in addition to transporting passengers across town, include keeping their vehicles clean inside and out to attract good reviews and more fares. Drivers can also help an elderly person step into their cars; or take a call if a panicky passenger has left an indispensable cell phone in the backseat, Ramsey says. How would that work out with a driverless car that speeds off to pick up the next rider, he wonders.

These are what Farshchi calls “second order problems” in the development of the driverless taxi as a technology business. But they’re not insignificant challenges, he says.

“These are the tough problems,” Farshchi says.

Ironically, the adoption of driverless cars may make operating autonomous fleets a much more high-touch business, rather than a hands-off endeavor handled remotely by tech engineers. Farshchi says the consumer-facing components of the autonomous taxi business, such as a ride-hailing company controlling a fleet, may have a chance at reaping a higher share of the profit margin than the car manufacturers themselves—-even though the total potential profit may still be small. Returns for the consumer-facing brand could hinge on the quality of the experience provided, he says.

This might create an opening for small-scale, value-added taxi services that can charge higher rates, such as self-driving, limousine-like cars that ferry CEOs or prom dates.

Uber and Lyft, however may be locked into keeping prices low if they want to please a huge ridership. It’s worth asking if they can ever be profitable if they don’t charge more, whether they switch to driverless fleets or stick with contract drivers.

Why carmakers are betting on driverless taxis

Ramsey says the automakers who are exploring future business lines such as self-driving taxis are following a familiar pattern. They’ve long been criticized for operating cyclical, low-margin businesses.

“They attempt to delve into other businesses with higher margins,” Ramsey says. Car makers see tech companies disrupting other businesses, and they don’t want to become the next Kodak or Nokia, he says.

But past investments into service businesses didn’t work out well for car manufacturers. “Car companies all bought rental car companies, but it didn’t make sense. Then they sold them off,” Ramsey says.

He predicts that the same thing will happen with self-driving taxis, and even with the by-the-hour spot car rental service Maven, which GM is operating with its own conventional cars. Maven is spreading across the country, but Ramsey says GM hasn’t revealed how much the initiative is costing. (GM has not yet responded to Xconomy’s interview request.)

“These car companies will try all these models, then either close them off or sell them to someone else,” Ramsey predicts.

This is not to say that Ramsey is bearish on self-driving cars in general, or the advanced driver assistance features being pioneered by car companies. He just thinks that innovative car makers will free themselves from high-cost taxi services that bring in low fares.

There could be commercial niches where a self-driving car service makes sense, such as shuttles that circle a downtown area, stopping at known pickup and drop-off points, Ramsey says.

Automakers could also appeal to wealthy customers by selling them self-driving cars, or traditional cars with highway autopilot features that relieve them from miserable back-and-forth driving in heavy traffic—say, between Palo Alto and San Francisco, Ramsey says.

The most profitable use of the early generations of driverless cars may not be taxicab fleets. Instead, it might be something like a jaunty SUV sold to an active family who could keep all the kids’ school and soccer gear stowed inside, and program the complex schedule of after-school activities and best routes into the vehicle.

Creating a luxury market for rich early adopters could pave the way for these expensive, high-end features to become available later to a wider population, Ramsey says.

Carmakers have already developed extremely valuable technologies that save lives, such as electronic stability control and automated emergency braking, Ramsey says. As yet, the life-saving braking feature now exists in fewer than 10 percent of new vehicles sold, he says.

“My view is that autonomy will be built in slowly over time,” Ramsey says.

Photo credit: Depositphotos

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