Uber recently released its second-quarter financial results, reporting revenue of $9.2 billion, which fell short of analysts’ expectations. Despite this, the company’s management provided optimistic guidance, and Uber achieved its first-ever operating profit. While the stock has seen a 77% increase this year (as of August 11), investors should exercise caution before adding Uber to their portfolios. This article discusses one compelling reason to consider investing in Uber stock and another important factor to consider before purchasing shares in this transportation-as-a-service business.
Reason to Buy: Harnessing Network Effects
Uber operates as a two-sided platform through its Mobility service, connecting riders with drivers. This structure allows the company to benefit from powerful network effects. With more active drivers, the service becomes more valuable to riders, as it ensures quicker matching with available cars. Similarly, an abundance of riders seeking transportation is advantageous for drivers, as it increases their earning potential.
In the Delivery segment, Uber employs a three-sided platform that involves consumers, drivers, and restaurants. This model creates a mutually beneficial ecosystem, where consumers have access to a wider range of food options, restaurants can expand their customer base, and drivers can generate more income through increased orders.
Network effects contribute to Uber’s economic moat, enabling the company to fend off competition and discourage new entrants from entering the market. As Uber’s user base grows, the service becomes more efficient for all parties involved. A larger user base means faster and more convenient matches between riders and drivers, driving substantial growth. Additionally, as the service becomes more valuable, it becomes easier and more cost-effective to attract new customers.
Uber’s scale and network effects have also led to positive profitability. In the latest quarter, the company completed nearly 2.3 billion trips, generating gross booking values of $16.7 billion for Mobility and $15.6 billion for Delivery. This impressive performance allowed Uber to achieve an operating profit of $326 million and free cash flow of $1.1 billion.
Reason to Hold Off: Absence of Switching Costs
Switching costs are a key component of a company’s economic moat, creating barriers that make it challenging for customers to switch to a competitor. However, Uber does not possess significant switching costs. Drivers have the flexibility to work for Uber, Lyft, DoorDash, or other platforms based on their immediate business prospects. Similarly, riders can choose the platform offering the lowest fares or the shortest wait times. They can also explore alternative transportation options, such as walking, biking, or using public transit.
The absence of switching costs places pressure on Uber to continually offer discounts and promotions to attract and retain both riders and drivers. Although sales and marketing expenses remained at $1.2 billion in the latest quarter compared to the previous year, Uber experienced its slowest revenue growth in nine quarters. This situation might necessitate increased spending to drive top-line growth.
Furthermore, all stakeholders may not always be fully satisfied. Riders may find fares high during peak demand hours, while drivers seek better benefits and higher pay. Restaurants, despite benefiting from increased sales, may express concerns about Uber’s fees.
Conclusion
Investors considering Uber stock should weigh the benefits of network effects against the challenges posed by the absence of switching costs. While network effects enhance Uber’s competitive advantage and profitability potential, the lack of switching costs necessitates continuous investment in promotions and discounts. By carefully evaluating these factors, investors can make informed decisions about including Uber in their investment portfolios.
