Some thoughts on Lyft’s IPO

My recent experience with taxis

On my way into Manhattan from LaGuardia Airport on Monday night, I noticed an app symbol for Curb on the payment box in my taxi. The box said I could pay for the ride with this app. So while I was in transit, I downloaded the app, registered on the site, and linked to the number on the taxi’s payment box, which was its unique Curb ID. When the taxi ride ended, I simply got out of the taxi and went on my merry way.

Taxis have upped their game. The ride experience, the courtesy of drivers, the cleanliness of taxis, everything about the rides, is improved. And I have noticed this right across cities in the US, where shared-ride apps like Uber, Lyft and Via are active. After my experience with Curb on Monday, I saw a bunch of taxis idling on 8th Avenue in Manhattan. And each had the app symbol for Arro on them. So, I downloaded that app too, seeing that it was another payment network that would make NYC taxi rides a bit more frictionless when it comes to payment.

Taxis as a cartel

As Lyft moves toward IPO in March, these recent experiences are what’s on my mind. I have no doubt that competition from companies like Lyft spurred the innovation and improvement in service quality I have seen. And I am hoping to see more of this going forward. And so, it got me to thinking about why taxi service was so bad before Lyft and Uber came along.

The industry model I have in my head is of a cartel, where the industry artificially restricts capacity by creating barriers to entry that allow existing companies to operate with limited competition.

In New York, the artificial restriction is the Medallion. At the beginning of the Great Depression, there were more than 30,000 taxicabs roaming the streets of New York City. But today, there are fewer than half that many. That’s because there are only 14,000 NYC taxicab medallion licenses. And without a medallion, you can’t drive a taxi. That’s been the law since 1937.  Think of it as a right of entry that restricts competition. And, of course, since New York didn’t sell any new medallions until 1996, it meant that by 2014, there was such a huge shortage of taxis that medallions were selling for more than $1 million each.

In New York, taxicab drivers were always famous for their lack of knowledge of the streets. It was the medallions that created the lack of competition. But, in London it was “The Knowledge” which limited competition. To even be a black cab driver in London, in the old days you had to have “The Knowledge”. That’s familiarity with the byzantine London street map containing 25,000 different streets and the 320 standard ‘runs’ through central London within a six-mile radius of Charing Cross — as well as the major arteries running through the rest of London.  It can take two or three years’ training to know all those routes. That sort of ‘guild’ restricts drivers, reduces competition and raises prices.

The mobile internet changes all of that, of course. For one, you don’t need The Knowledge in London. Google Maps or Waze will get it done. Both companies are owned by Google, by the way. But, fast mobile Internet connections also make apps like Lyft possible. In the old days, when I lived in Brooklyn or uptown in Manhattan, or I was visiting friends south of the Thames in London, I could never find a cab. And if I hired a taxi to take me to Brooklyn, half of the time, they would ask me to get out because they didn’t want to go, due to the lack of return fares. Gypsy or jitney cabs, operated by non-Medallion companies or individuals without the Knowledge, filled the void. With Lyft, Uber and Via, that problem has gone away.

That means competition. The taxi cartel is over. Prices and wages are now lower.

Lyft as a business

But what about Lyft’s business model? Like Uber, it relies heavily on regulatory dodges, meaning it can operate as a virtual taxi company without the same regulations that real taxi companies are subject to. It’s like a giant gypsy cab company, scaled up by the network effects of its mobile app, operating on the periphery of the legal regulatory environment. Some cities have banned Lyft and Uber for that reason. So, Lyft can only operate like this as long as cities and states allow it to do so.

There’s another regulatory dodge that Lyft and Uber benefit from too. Unlike taxi companies that have drivers who are real employees, Lyft claims its drivers are private contractors. They aren’t actually employees of the service, according to the companies. And as such, Lyft doesn’t have to provide them any benefits that employees receive at other companies – healthcare, vacation, overtime, retirement, maternity leave. That means they can keep costs down. Without that regulatory dodge, labor costs would be some 30-50% higher.

But Lyft and Uber’s real innovation beyond the much improved user experience is the expansion of the applicable market. In San Francisco, for example, the taxicab business was a $100 million business in 2010. By 2017, Uber was doing $500 million of turnover in San Francisco alone. So these companies expanded the for-hire transport services in San Francisco by a factor of 5 or 10. That’s huge. And, because of network effects, all of the benefits of that expansion have accrued to the newcomers. In fact, until the taxi businesses started to up their game and better their service offering, they lost business to Lyft and Uber.

Let’s remember that Lyft and Uber are operating using a predatory model here. And by that I mean that they are using VC money – and soon, IPO money – to finance huge losses as they gain scale. Normal companies would go bankrupt if they sustained losses like that. But, these companies have buckets of VC money.  The losses aren’t just due to start-up and marketing costs, as the companies gain customers and scale. They are also due to predatory pricing, where the cost of the service is below what is sustainable for the business over the long-term. How? That’s because Lyft and Uber operate without a significant level of overhead. This is part of their appeal to investors, because it means they have operating leverage, where costs scale at a much lower pace than revenue. So, they have fewer variable costs. But, that also means that were Uber or Lyft forced to retrench, they couldn’t rely on cost cuts. They would also have to raise prices. And that would make them much less attractive for paying customers vis-a-vis taxis.

Lyft’s IPO

So, an IPO makes a lot of sense for Lyft and Uber. We are likely very near the end of this business cycle. Funding is likely to dwindle for companies like them. Now is the time to sell shares to the public, cash in on the investment you have made so far, scale the business further, and raise more money to safeguard against leaner times to come.

As a business, Lyft is fine as far as things go. I see it as a perfectly viable long-term business. The question with Lyft’s IPO is price. And for me that’s not just because of the potentially ephemeral nature of the regulatory dodges and the predatory pricing. It’s also because there are no real barriers to entry in this business. There is no secret sauce here; anyone could set up a competing business, with enough computer engineering know-how. The only question is scale because network effects are important. And switching costs are almost zero. My example at the outset of this post tells you that. I was able to switch to a different platform on the fly, en route from the airport. And now, if I want, I can use this app all the time. It’s that easy.

The same is true for all the other ancillary services that these companies can provide like delivery; there are no barriers to entry – zero. Case in point is former Uber CEO Travis Kalanick’s entry into the delivery business with CloudKitchens. He has raided Uber Eats’ staff and begun operation in the US, with an aggressive expansion into Europe and Asia planned.

Longer-term, all Lyft and Uber have is brand, name recognition and scale. Otherwise, they are completely exposed. They need to scale to create network effects that are their biggest barrier to entry before a downturn forces them to raise prices and lose business to traditional taxi services. And that makes them a risky investment. Personally, I like Lyft. As far as brands go, that’s the one for me. I deleted my Uber account early in 2017 when Uber was busy showing us it wasn’t a trustworthy company. They have since partially rehabilitated themselves. But, for me, the damage, is done. I am a Lyft guy now. Nevertheless, on their IPO, I say “caveat emptor”.