A basic question facing company leaders is whether to grow by cutting your product's price below that of rivals--and losing money in the process--or whether to make your business profitable and then try to grow quickly.
Even though many startups skip the stage of making their business model profitable before sprinting to an IPO or acquisition, I believe that's a big mistake. And avoiding that mistake is one reason I wrote my latest book, Scaling Your Startup.
Did Uber make a mistake by growing quickly to a dominant position in the ride-sharing market? I think anyone who invests in Uber's stock after it goes public is taking a huge risk that most of the upside potential will be reflected in its $10 billion valuation. And that's because the ride-sharing industry in which Uber competes is inherently unprofitable and lacks a sustainable competitive advantage.
What Is a Sustainable Competitive Advantage?
Competitive advantage is measured by a company's share of an industry's profits. This definition means that a competitive advantage is impossible if an industry lacks profitability--which describes the ride-sharing industry. How so? In 2018, Uber lost $3 billion from operations, while Lyft lost $900 million.
The problem with ride-sharing--a so-called two-sided market--is that there are low barriers to entry and the switching costs are low on both the supply side (the drivers) and the demand side (consumers).
As a result, the industry features "numerous players offering virtually the same services. They are in a spending arms race to draw new drivers and consumers, bidding up ads on Facebook and Google and forking out hefty bonuses to new drivers," according to the Wall Street Journal.
Uber's market share lead is a pyrrhic victory, since the company is losing money. But it's worth studying where Uber falls short on three key elements of competitive advantage--and what you should do to avoid Uber's mistakes.
1. Give customers more bang for the buck.
When people buy things, they compare different suppliers on a ranked set of factors, also known as customer purchase criteria (CPC).
My experience suggests that ride-sharing CPC include how long riders must wait for a driver, whether the fare is competitive, and whether the driver is competent and unlikely to do something nasty.
Lyft's ability to increase its U.S. ride-sharing market substantially when Uber was suffering from its period of worst public attention in 2017 suggests that Uber has been losing out on that third factor.
Indeed, Uber's prospectus highlighted this problem, noting that "in 2017, the #DeleteUber campaign prompted hundreds of thousands of consumers to stop using our platform within days." Then there was the employee blog alleging that Uber had a toxic culture and hosted "certain sexual harassment and discriminatory practices."
To avoid making it easy for competitors to take your business, you must listen to, say, 100 potential customers, find out what CPC they use to choose between your product and those of your rivals, and make sure your product offers much more value for the money than theirs do.
2. Harness capabilities to win at scale.
Winning and keeping customers--especially when a company has millions of them--depends on doing certain things well.
Uber's prospectus documents what sounds like a brilliantly conceived collection of capabilities--which it dubs the Liquidity Network Effect (LNE).
The basic idea is that as the number of drivers increases in a new location, Uber's market coverage improves, which reduces average wait times and attracts more consumers. The boost in demand increases the volume of trips, which in turn increases driver utilization--attracting more drivers and cutting fares.
Uber's problem is that Lyft was able to copy its strategy. Indeed, since Uber burned through $1.5 billion in cash from operations, it really should be called a Negative LNE.
To keep rivals from copying your capabilities, create strengths that are arrayed against your competitors' weaknesses. For example, IBM urges customers to buy a bundle of products including all the products it has obtained through its acquisitions. Startups can win because they offer customers better individual products at a lower price than IBM can provide.
3. Sustain competitive superiority.
Uber has lost money and market share. As the Wall Street Journal noted, Lyft raised over $4 billion since the start of 2018--including more than $2 billion in its March 29 IPO--using fare discounts to take market share from Uber which it matched to stay competitive.
I see two takeaways for startups. First, try not to compete on price. Instead, anticipate how customers' needs will change and beat rivals to market with new products that meet their evolving needs. Second, only compete on price if you can keep your costs lower than your rivals do.