IT IS said that Travis Kalanick, who resigned as Uber’s boss last month, has been reading Shakespeare’s “Henry V”. Prince Hal’s transformation, from wastrel prince to sober monarch, is doubtless one he would like to emulate. But as a guide to the ride-hailing firm’s financial dilemma, “Macbeth” is the best play. This line especially resonates: “I am in blood stepp’d in so far that, should I wade no more, returning were as tedious as go o’er.”

Uber has bled money for years in an attempt to become the absolute ruler of its industry. Once Mr Kalanick’s replacement is found, voices will whisper that the firm, like Macbeth himself, is in too deep to alter course. But the new boss must change Uber from a company that sacrifices anything for its ambitions, to one which has a realistic valuation and uses resources efficiently.

Its product is elegantly simple. Uber makes a market between drivers and passengers and takes a cut of about a fifth of the fare. The more people use its service, the better it functions, with lower waiting periods for passengers, and better use of drivers’ time. Some 55m people in 574 cities use it every month. Underlying sales were $4bn in 2016, over double what they were the year before (all figures exclude Uber’s Chinese arm, which it sold to a local rival, Didi Chuxing, last year). Uber’s main trouble is high expectations. Its supporters think it will become the next Alphabet or Facebook. At its last funding round in 2016 (it is private), investors valued it at a whopping $68bn.

But the next boss will have to deal with an income statement that is scarier than the Thane of Cawdor. Underlying pre-tax losses were $3bn-3.5bn last year and about $800m in the most recent quarter. Some $1bn-2bn of last year’s red ink was because of subsidies that Uber paid to drivers and passengers to draw them to its platform. At least another $1bn went on overheads and on developing driverless cars; money is also being splashed on a new food-delivery venture and a plan to build flying cars.

To put its 2016 loss in perspective, that number was larger than the cumulative loss made by Silicon Valley’s least profit-conscious big company—Amazon—in 1995-2002. Measured by sales, Uber is the world’s 1,158th-biggest firm. Judged by cash losses, it ranks in the top 20. It is now eight years old, but still probably years away from being stable enough to make an initial public offering of shares. In contrast, Amazon went public at the age of three, Alphabet at six and Facebook at eight.

Investors rationalise its valuation by assuming that in the long run it will be highly profitable, with a dominant share of a large market. In 2014 Bill Gurley, a well-known tech investor who was then an Uber director, estimated that the pool of consumer spending that it could try and capture might be over $1trn, with ride-hailing and ride-sharing replacing car ownership. Today many Silicon Valley types think that estimate is too conservative.

But a discounted cashflow model gives a sense of the leap of faith that Uber’s valuation requires. After adjusting for its net cash of $5bn and for its stake in Didi, worth $6bn, you have to believe that its sales will increase tenfold by 2026. Operating margins would have to rise to 25%, from about -80% today.

That is a huge stretch. Admittedly, Amazon and Alphabet, two of history’s most successful firms, both grew their sales at least that quickly in the decade after they reached Uber’s level, and Facebook is likely to as well. But over the same periods these firms’ operating margins show an total average rise of only one percentage point. Put simply, Uber finds it desperately hard to make money. It is not clear that it breaks even reliably across the group of cities where it has been active for longest.

So the new chief executive will have to deliver a bleak message; that ride-hailing is locked in a vicious circle. Low prices and high subsidies lead to losses, so firms must raise capital continually, requiring them to exhibit rising valuations. To justify these they must frequently enter new cities and dream up new products. Even more speculative capital is then drawn in by the paper gains seemingly on offer. In the past year, ten of Uber’s competitors, such as Lyft in America and Grab in South-East Asia, have together raised or are raising, roughly $11bn. That will be used to finance still more price wars to win market share.

Double, double toil and trouble

Uber is on course to use up its existing cash and credit lines in three years. Its next boss must break the cycle before then by cutting subsidies and talking down its valuation. It could lose market share and may need to exit scores of cities. On July 13th it said that it will merge its operations in Russia with a competitor. Similar deals need to follow. Although Uber should continue to invest in driverless cars, some of its more experimental “moon shot” projects will probably be for the chop. Its investors, including Goldman Sachs, Saudi Arabia’s government and Jay-Z, a rapper, could face paper losses. Staff paid in stock will be furious.

Yet over time the aim should be a firm with a lower market share of a more stable industry. Successful, dominant firms, such as Google and AT&T, don’t seek absolute monopolies by killing off weaker rivals. They allow them enough space to plod on. That lowers the risk of antitrust problems and deters new entrants. By signalling that Uber’s valuation is too high its new boss would knock valuations across the ride-hailing industry and slow the flood of speculative capital—in the end, a good thing.

Once the losses abate, the priority should be to create a more “capital light” model. Perhaps Uber could license its brand and technology to local partners in some markets. It could concentrate subsidies on customers who sign up to long-term contracts. The biggest impediment may be Mr Kalanick. With allies, he still controls a significant share, probably a majority, of the company’s voting rights. Anyone taking on tech’s toughest job must have the inner steel to confront him. They should remember another quote from the bard; “I must be cruel only to be kind.”

Source: economist
An action plan for Uber’s next chief executive