liquidity-network-effects

Uber’s Flywheel: Liquidity Network Effects To Spark Growth

One of the key elements of platform business models is their ability to create strong network effects.

One major issue when kicking off a platform from scratch is to create “liquidity.”

What is the business world is referred to as a “cold start problem.”

Indeed, network effects only become valuable after a certain threshold (which depends on the type of product and service offered).ย 

 

 

 

 

Understanding network liquidityย 

As pointed out on Uber Financial Prospectus:

Our network becomes smarter with every trip. In over 700 cities around the world, our network powers movement at the touch of a button for millions, and we hope eventually billions, of people. We have massive network scale and liquidity, with 1.5 billion Trips and an average wait time of five minutes for a rider to be picked up by a Driver in the quarter ended December 31, 2018.

In order to trigger network effects, Uber needs to think in terms of nodes of a graph, rather than just customers. Indeed:

Every node we add to our network increases liquidity, and we intend to continue to add more Drivers, consumers, restaurants, shippers, carriers, and docklesse-bikesand e-scooters.

Looking at the future Uber will be widely investing in other areas as well:

We also hope to add autonomous vehicles, delivery drones, and vertical takeoff and landing vehicles to our network, along with other future innovations.

This means the ability to generate enough supply, which improves the service. Thus it generates even more demand.

Network effects marketing as a flywheelย 

This flywheel effect is the key to triggering the network effects needed to unlock growth.

flywheel-marketing
Flywheel marketing was first introduced in 2001 by Good to Great author Jim Collins, who likened the strategy to a flywheel. For those unaware, a flywheel is a mechanical device designed to store rotational energy in an efficient way. It can be difficult to spin at first, but once momentum is built, the flywheel can perpetuate its own motion and spin by itself.ย Flywheel marketing has become a critical component of growth for platform business models.

As pointed out:

Our strategy is to create the largest network in each market so that we can have the greatest liquidity network effect, which we believe leads to a margin advantage.

Building a valuable network: beyond the cold start problem

Thus, Uber looks after a liquidity network, which allows it to create a competitive advantage, which over time becomes a margin advantage!

uber-flywheel-effect

Source: Uber Financial Prospectus

Uber leverages liquidity network effects, which starts by creating driver’s supply, which determines lower wait times and fares for riders.

In turn, this attracts more riders.

uber-business-model
Uber is a two-sided marketplace, a platform business model that connects drivers and riders, with an interface that has elements of gamification, that makes it easy for two sides to connect and transact. Uber makes money by collecting fees from the platform’s gross bookings.

Thus, with more riders per hour, there is a higher earning potential for drivers.

When this happens more drivers join the platform, thus making this network effect speed up.

That’s how Uber kicks off growth from its platform!

It’s important to notice, that initially, these network effects might take time to materialize.

Indeed, the hardest part, is the initial kick-off of network effects, valuable enough, to make a network liquid.ย 

As explained in its financial prospectus:

Increasing scale, creating category leadership and a margin advantage.We can choose to use incentives, such as promotions for Drivers and consumers, to attract platform users on both sides of our network, which can result in a negative margin until we reach sufficient scale to reduce incentives.

Therefore, to focus on growth, Uber kicks off a market by eating up its margins, which become negative, until sufficient scale is reached.

At that stage, incentives are reduced.

Build-in subsidies to kick off local markets

The thing with Uber is that it’s not just a digital player.ย 

It combines a digital platform and a strong physical presence, in a highly regulated industry.ย 

Thus, when kicking off operations in other countries or regions, the company can still leverage its playbook and user base, but it still has to create liquidity for that local network, almost from scratch.ย 

How does it do that?ย 

Uber subsidizes a market when it first enters it.

That is also why and how Uber has been able to build up a global presence:

uber-global-presence

Source: Uber Financial Prospectus

In certain markets, other operators may use incentives to attempt to mitigate the advantages of our more liquid network, and we will generally choose to match these incentives, even if it results in a negative margin, to compete effectively and grow our business.

Uber here clarifies even further how Uber eats up its margins, by making and prioritizing Growth.

Prioritizing on growth over profitabilityย 

For its first 12 years of life, Uber has been aggressively prioritizing growth.ย 

Caring little about profitability,ย 

This aggressive growth strategy, it’s described by LinkedIn’s founder Reid Hoffman, as Blitzscaling:

what-is-blitzscaling
At its core, the concept ofย Blitzscaling is about growing at a rate that is so much faster than your competitors that makes you feel uncomfortable. In short, Blitzscaling is prioritizing speed over efficiency in the face of uncertainty.

Generally, for a given geographic market, we believe that the operator with the larger network will have a higher margin than the operator with the smaller network.

In short, Uber prioritizes making its network larger, so that over time it can gain higher margins on its operations.

To the extent that competing ridesharing category participants choose to shift their strategy towards shorter-term profitability by reducing their incentives or employing other means of increasing their take rate, we believe that we would not be required to invest as heavily in incentives given the impact of price and Driver earnings on consumer and Driver behavior, respectively.

Therefore, according to Uber, those players that prioritize “short-term profitability” make it easier for Uber to be competitive.

In addition to competing against ridesharing category participants, we also expect to continue to use Driver incentives and consumer discounts and promotions to grow our business relative to lower-priced alternatives, such as personal vehicle ownership, and to maintain balance between Driver supply and consumer demand.

Leverage network liquidity to scale in adjacent markets

The interesting part is that once a network becomes liquid, you can potentially build other networks on top of it.ย 

An example is how Uber expanded its service, with Uber Eats, which now has grown as another company within Uber.

uber-eats-business-model
Uber Eats is a three-sided marketplace connecting a driver, a restaurant owner, and a customer with the Uber Eats platform at the center. The three-sided marketplace moves around three players: Restaurants pay commission on the orders to Uber Eats; Customers pay the small delivery charges, and at times, cancellation fees; Drivers earn through making reliable deliveries on time.

In short, Uber can borrow the liquidity of its core network, to kick off adjacent networks (in this case delivery services).

This is how the company can scale quickly.ย 

Changing playbook: from growth at all costs, to profitabilityย ย 

As the market conditions, by the end of 2021, and the beginning of 2022, have tightened, also companies like Uber that have been prioritizing growth their all life, are now turning back to profitability.ย 

As Uber’s CEO, Dara Khosrowshahi explained:ย 

Itโ€™s clear that the market is experiencing a seismic shift and we need to react accordingly.

We have to make sure our unit economics work before we go big,

The least efficient marketing and incentive spend will be pulled back.

We will treat hiring as a privilege and be deliberate about when and where we add headcount,

We will be even more hardcore about costs across the board.โ€

For the first time, in its history, Uber changed its focus from growth to profitability.ย 

Uber as Amazon’s cash machine?

cash-conversion-cycle-amazon

This isn’t that far from Amazon’s cash machine strategy, where Amazon voluntarily reduced its margins to prioritize aggressive growth and acquisition of market shares.

It is important to remark that Amazon has been profitable for many of its years of operations.

This business strategy used by Uber is a clear example of how platform business models can gain long-term competitive advantage by tapping into larger and larger networks.

Key takeaways

Yet, in this specific case,

  • Network effects take time before they become valuable, and actually making them valuable in the first place is one of the most difficult challenges for platform business models.
  • Uber focused for most of its life on generating as much liquidity for its network. As the network works on a local basis, Uber has to leverage its existing playbook, but adapt it to the local market, to thrive
  • Once the network is liquid Uber leveraged it to move to adjacent industries. Like Uber Eats, which has become a company within Uber.
  • Uber has been prioritizing growth for most of its life. And from 2022 going forward is looking at profitability, first.ย 

Key Highlights:

  • Platform Business Models and Network Effects:
    • Platform business models leverage network effects to create strong value for users. Network effects become valuable after reaching a certain threshold, which is crucial for platform success.
    • Network effects refer to the phenomenon where the value of a product or service increases as more people use it.
  • Creating Network Liquidity:
    • One major challenge for platforms is creating “liquidity” or network activity. This is especially important at the initial stage to overcome the “cold start problem.”
    • Liquidity is essential for triggering network effects and enhancing user experience.
  • Flywheel Marketing and Network Effects:
    • The concept of flywheel marketing, likened to a mechanical device, is essential for platforms to achieve network effects. Once momentum is built, the platform becomes self-sustaining.
    • Network effects are key to triggering growth and gaining a competitive advantage.
  • Uber’s Network Liquidity Strategy:
    • Uber leverages liquidity to build a strong network of drivers and riders, improving service quality and attracting more users.
    • Uber’s network effect creates a cycle of more riders leading to more drivers, accelerating growth.
  • Initial Challenges and Subsidies:
    • The initial challenge is to kick-start network effects valuable enough to create liquidity. To achieve this, Uber sometimes operates at negative margins until reaching sufficient scale.
    • Uber often subsidizes new markets to build network liquidity and overcome challenges unique to each market.
  • Growth vs. Profitability:
    • Uber prioritized growth over profitability in its early years. It focused on building a large network for long-term advantage.
    • As market conditions change, Uber has shifted its focus to profitability, similar to Amazon’s strategy.
  • Expanding into Adjacent Markets:
    • Once a network becomes liquid, platforms can leverage their existing network to enter adjacent markets. Uber’s success with Uber Eats is an example of this strategy.
  • Changing Strategies:
    • While growth was a priority for years, market shifts have prompted Uber to shift its focus to profitability. This change marks a significant shift in its strategy.

Visual Stories Connected To Uber

Uber

uber-business-model
Uber is a two-sided marketplace, a platform business model that connects drivers and riders, with an interface with gamification elements that make it easy for two sides to connect and transact. Uber makes money by collecting fees from the platform’s gross bookings.

Uber Revenue

uber-revenue

Is Uber Profitable?

is-uber-profitable
As of 2022, on net revenues of $31.87 billion, Uber posted a net loss of $9.14 billion. In 2021, Uber posted a lower net loss ($496 million), primary thanks to the business divestitures of various assets. Throughout its history, on an annual basis, Uber has never made a profit. Yet, it has also shown incredible business growth, over the years, with its revenue at $3.8 billion in 2016, to almost $32 billion in 2022.

Uber Eats

uber-eats-business-model
Uber Eats is a three-sided marketplace connecting a driver, a restaurant owner, and a customer with the Uber Eats platform at the center. The three-sided marketplace moves around three players: Restaurants pay commission on the orders to Uber Eats; Customers pay small delivery charges, and at times, cancellation fees; Drivers earn through making reliable deliveries on time.

Uber Eats Revenue

uber-eats-revenue
In 2022 Uber Eats reached almost $11 billion in revenue, compared to over $8.3 billion in revenue in 2021 and $3.9 billion in revenue in 2020.

Is Uber Eats Profitable?

is-uber-eats-profitable
For the first time since its inception, Uber Eats’ EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) – which measures a company’s operational efficiency – was positive for $551 million, compared to negative $348 million in 2021; negative $870 million in negative EBIDTA in 2020; and over $1.3 billion negative EBIDTA in 2019.

Uber Freight

uber-freight-revenue
Uber Freight has grown from a $1 billion segment in 2020 to almost $7 billion in revenue in 2022, representing nearly 22% of Uber’s total revenue in the same year.

Uber Revenue Breakdown

uber-revenues-breakdown
In 2022, Uber generated $14 billion from its core platform (mobility), followed by $10.9 billion from the delivery platform (Uber Eats) and $6.95 billion from the freight platform. The company generates most of its revenue in North America.

Uber Advertising

uber-advertising
In 2022 Uber launched its advertising segment, which comprises revenue from sponsored listing fees paid by merchants and brands in exchange for advertising on the platform. By the end of the year, Uber advertising had generated $500 million in revenue from 315K merchants.

Food Delivery Business Models

food-delivery-business-model
In the food delivery business model companies leverage technology to build platforms that enable users to have the food delivered at home. This business model usually is set up as a platform and multi-sided marketplace, where the food delivery company makes money by charging commissions to the restaurant and to the customer.

DoorDash

how-does-doordash-make-money
DoorDash is a platform business model that enables restaurants to set up no-cost delivery operations. At the same time, customers get their food at home, and dashers (delivery people) earn some extra money. DoorDash makes money by markup prices through delivery fees, memberships, and advertising for restaurants on the marketplace.

Glovo

glovo-business-model
Glovo is a Spanish on-demand courier service that purchases and delivers products ordered through a mobile app. Founded in 2015 by Oscar Pierre and Sacha Michaud as a way to โ€œuberizeโ€ local services. Glovo makes money via delivery fees, mini-supermarkets (fulfillment centers that Glovo operates in partnership with grocery store chains), and dark kitchens (enabling restaurants to increase their capacity).

Instacart Business Model

how-does-instacart-make-money
Instacart’s business model relies on enabling an easy set up for grocery stores, the comfort for customers to get their shopping delivered at home, and an additional income stream for personal shoppers. Instacart makes money by charging service fees, via memberships, and by running performance advertising on its platform.

Grubhub Business Model

grubhub-business-model
Grubhub is an online and mobile platform for restaurant pick-up and delivery orders. In 2018 the company connected 95,000 takeout restaurants in over 1,700 U.S. cities and London. The Grubhub portfolio of brands like Seamless, LevelUp, Eat24, AllMenus, MenuPages, andTapingo. The company makes money primarily by charging restaurants a pre-order commission and it generates revenues when diners place an order on its platform. Also, it charges restaurants that use Grubhub delivery services and when diners pay for those services. 

Shipt Business Model

how-does-shipt-make-money
Shipt is a North American integrated delivery service for groceries, home products, and electronics initially funded by Bill Smith, a highly experienced entrepreneur with a history of creating successful start-ups; in 2014, Smith used $3 million of his own money to create the first iteration of Shipt, the company was acquired by Target in 2017 in a cash deal worth $550 million. Membership fees predominantly drive Shipt revenue generation.

About The Author

Leave a Reply

Scroll to Top
FourWeekMBA