(Chinese Version)

In the second half of March this year Uber once again made a price cut and lowered its price by 30%. One week later after the cut, I happened to hail a cab on Uber after hanging out with my friends and it turned out to be extremely cheap, only 6 RMB after a 50% discount. If I took a taxi it would cost me 25 Yuan instead! Almost all my friends who still keep the Uber app on their phones after the subsidy war among cab-hailing apps agree that using Uber is so much cheaper than hailing a traditional taxi on the street.

When at war with local cab-hailing apps in China, besides offering vouchers for free to its passengers, Uber has also slashed the price of People’s Uber --- its cheapest service--- to the most affordable level, setting itself apart from the crowd. How did Uber pull this off? How could Uber lower its price drastically without compromising the drivers’ income? In this article, I will try to explore the mentality behind such pricing strategy and find out the secret sauce of Uber.

Uber drastically increases the success rate of hailing a cab

First we need to understand that what Uber does is all about increasing its efficiency. If you had used Uber before you would immediately understand what kind of efficiency that Uber has. Once you make your cab request on Uber, the nearest Uber driver would come pick you up as fast as possible, which would only take a few minutes, quicker than expected. And after delivering you to your destination, the driver would receive another request from a nearby would-be passenger very soon. That’s the efficiency I am talking about. No more wasting time driving around the city looking for a passenger for the drivers, and no more standing on the street waving in frustration for passengers.

The traditional taxi industry has an enormous driver and passenger base, and therefore by nature it enjoys a higher efficiency than private cab service industry does. In other words, they don’t have to worry about meeting the demand with supply or the other way around. Thus, in order to boost the efficiency, the first step for cab-hailing apps is to amass enough drivers(cars) and passengers(clients) and build up the user base. The subsidy war among ride-hailing apps is at its core also a competition for drivers and passengers.

First of all, let's have a look at Uber’s operation strategy.

Drivers and passengers, who should be the priority? This is a very tricky question to answer. To get more drivers, Uber adopts a very conventional strategy popular in the private cab service industry, which is to seek cooperation with car-rental companies and get cars from them. Ben is the general manager of Uber Beijing, an American Chinese born and raised in the US who later developed a career as an investor. After making a few investments, he decided to come back to China and join Uber. He first asked his friends at Uber to hand out flyers in bars. But he found out this approach was not efficient enough since only a few people would actually take the time to scan the QR code on the flyer with their phones and download Uber. Then he asked his friends to contact business school students through emails who were generally more open-minded and already had knowledge on Uber. It turned out to be an immediate success for Ben. The number of downloads and active users skyrocketed due to his efforts.

Before that, Uber’s cab fare was relatively high. But as the number of active drivers and passengers goes up and the service coverage becomes more intensive, the fare gradually goes down.

Apparently, Uber didn’t start cheap. During its early time in Beijing, Uber was only available in areas such as China World Towers and Sanlitun with relatively high fares. Even after price cut, the success rate of hailing a cab was still low sometimes and waiting for a cab for a long time was a also common experience to some passengers. Eventually, some passengers were lost.

However, the success rate of hailing a cab jumps amazingly in recent time. A new Uber driver told me that even after the subsidy war between Didi and Kuaidi, Uber still offers subsidy to its drivers. He added that Uber also removed its 20% commission on drivers. Thanks to these benefits, he made about 7000 RMB in just two weeks after joining Uber. Every morning and evening he would go out on the street and earn about 100 RMB before going home. But still, there are also drivers who had drove for a month and only to made about four or five thousand RMB.

Using subsidy to attract drivers and increase the efficiency and intensity would probably be the main reason why Uber could make the already low fare even 30% cheaper.

This is the strategy that every private cab service company that will try to use. But the reality is that Uber can do so much better than that. As a matter of fact, Uber has three approaches that really impress me.

No cab appointments

Uber doesn’t allow passengers to make cab appointments beforehand.

Making cab appointments decreases the efficiency in effect. For example, if you made an appointment with a driver to pick you up at 11 am to go to the airport, then after 10 am your driver would have to consider whether he could still pick up other passengers before the appointed time. If he went to the west side of the city to pick up a passenger and there’s no other passengers there that wanted to go to the east side, then it would mean no money to be made on his way to your house, and, wasting precious working time and fuel. In this case, making appointments could potentially disrupt the drivers’ schedule and decrease the chance of getting more passengers.

So how did Uber handle this problem and satisfy the need? Uber’s concept is simple, it makes sure you can get into your cab after making a request in 5 minutes. For instance, Uber drivers in London, Los Angeles and San Francisco can get to their clients in just 3 minutes after receiving a request. In Beijing, the case will be 5 minutes. Whenever Uber passengers request a ride, their cabs will arrive at their location and pick them up within 5 minutes on average. It’s fast and effective, and it satisfies the need of car appointment.

Dynamic pricing (“surge pricing”)

Another secret sauce of Uber is its dynamic pricing algorithm that’s used to balance demand and supply.

Uber drivers and passengers will always be the center of this algorithm. For example, right on the day Uber announced the price cut, the real-time fare jumped 130% due to the lack of available cabs on the street. The next day the fare went even higher to 180%. The math is quite simple here, the fare skyrocketed due to the lack of supply while demand was increasing.

 “Every week and everyday there will always be Uber drivers on the street picking up passengers. Sometimes they make 10 RMB for a 10 minutes’ driving, sometimes they can make 15 RMB, 20 RMB, or even 25 RMB for the same amount of driving time. The real-time fare is adjusted by our surge pricing algorithm. When the efficiency increases according to the demand, and that’s the time the fare will go down.” Ben explained.

This is a very interesting mechanism. When Uber lowers the fare, more passengers will emerge on the platform, and drivers will get more requests. It works like a pyramid. The lower the fare gets, the more passengers there will be on the street, and obviously reaching the bottom will get the largest amount of passengers. The price gap between Uber cabs and traditional taxis is very delicate, and the balance can be broken very easily. The cheaper Uber becomes, the more popular it will be. That’s where the snowball effect comes into play.

Compared to traditional taxi industry, Uber is a marketplace and its drivers are all independent agents. Thereby drivers don’t need to pay any fee for driving as Uber drivers. Uber uses this advantage to lower the fare for passengers. However, once the fare is lowered to a certain level, Uber would need to find ways to keep Uber drivers’ income level higher than that of taxi drivers. Failing to do so would result in the loss of drivers. It’s natural, when Uber drivers realize the price cut would mean working longer hours to make up the gap, it would cause them to leave the platform to find a replacement elsewhere. Eventually, there won’t be enough cabs to meet the demand. In the end, the price goes up, attracting drivers to use Uber again.

It’s really difficult to find the equilibrium point in price cut. Companies often times have to choose between drivers and passengers. It’s like ying and yang that are constantly fighting each other while trying to reach a balance. Even just one side grows too strong the whole will perish. Uber’s dynamic pricing algorithm makes instant adjustment to the actual fare, real-time, in order to reach that balance and meet demand with supply, and meet supply with demand.

It is Uber that distributes the cabs

Uber’s final secret sauce is its cab distribution management.

Allowing drivers to choose their passengers will lead to the situation where drivers compete with each other for the passengers that seem easier to get to, which will set them into a very intense working environment. Uber is known for its high efficiency and it developed an algorithm to distribute Uber cabs to suitable requests.

Let's try to imagine what it would be like if Uber let its drivers decide their passengers. When drivers open Uber, the system will display nearby passengers that have sent out their requests. And then, drivers will pick their passengers based on their destinations while passengers will pick their cabs based on the car models or other preferences. In this case, both drivers and passengers make their optimal decisions. But Uber does the opposite. It doesn’t allow drivers or passengers to choose, it makes optimal decision through its algorithm and distributes the nearest cabs to the passengers.

However, local optimum doesn’t always make the global optimum.

Traditional economics believe people tend to be rational, and therefore they will always make the optimal decision for themselves. Now we apply this theory to Uber and see what exactly is going on. In a situation where both the drivers and passengers of Uber have access to the symmetrical information, the only way to maximize efficiency is build a central system that can monitor the supply and demand and make independent and optimal decisions after processing the data.

Kevin Kelly once proposed the tendency of decentralized Internet and described a case concerning the bee hive in his book Out of Control. Every swarm of bees is given a certain degree of latitude that allows them to work on specific tasks and cooperate with other groups. It’s a mechanism in which random crowds elect a random leader. It sounds like a bad thing, right? Not necessarily. In fact, the outcome is astonishing and it tends to be beneficial to the bee hive. An unorganized hive can select a queen and act as a whole under the queen’s leadership. The concept of decentralizing brings forward distribute management. When adopting this mechanism, the queen will lead the hive and distribute a certain degree of latitude to different small groups. It’s similar to what Uber is doing.

But such mechanism only works in a world of information asymmetry. Whether to distribute drivers to requests via a central system or allow drivers to pick the requests they want is a complex question. And it’s apparent that information symmetry is shaping the market and leading the distribute system to a new place. In the case of information symmetry, a central system can reduce the operation process and make optimal distributions, thus reaching the optimum efficiency.

When I was in discussion with Zhou Hang, the founder of Yidaoyongche, he pointed out that drivers’ first demand wasn’t money but respect. It’s a refreshing idea. He chose an approach that appeared to be more comfortable to the drivers and gave them the respect and recognition they wanted. Uber is more like a college student that studies science and worships rationality and thinks to maximize efficiency and profit. Uber lets machines and algorithm regulate the market with the principle of maximum efficiency.

The centrism thinking of the system in which drivers pick their requests can be optimized and applied in the subsidy war. The central system knows the demand and supply condition in different areas. When the demand and supply condition is imbalanced, the central system needs to mobilize available cabs from supply-intensive areas to areas that have greater demand. But driving to different areas means extra expenses and wasting working hours, this is where subsidy comes into play. The system can use the least subsidy to guide drivers to areas that have lots of passengers. In this case, maximum efficiency is reached and lowest cost is spent.

If we took this matter to the level of social formation, the false production report wouldn’t be accepted by the mass in the Great Leap Forward Movement in the 60s and 70s if transparency and information symmetry were established. It occurs to me that a sophisticated and centralized system could be more efficient.

Almost every cab service platform wants to cut down the fare by increasing efficiency. Uber’s advance and efficient algorithm contributes to the low fare that’s being offered on the platform, but it’s not the sole reason.

 “Price-sensitive demand is not our priority since cheap fare is the only motivating force for them.” An industry leader of cab-hailing service said in an interview.

After hearing this idea I suddenly realized that it’s a matter of business concept that enables Uber to lower its fare. Some companies’ business concept is offer high quality services while some focus on efficiency and lowering the fare, and Uber belongs to the latter group. Uber’s concept is increase the efficiency by utilizing the edgy that sharing economy has to offer. Once the efficiency is increased the fare will drop as a result. This is the instant benefit that ordinary people can get from sharing economy, and it’s what they mainly care about. Sharing economy is no doubt penetrating every aspect of everyday life and Uber has been a successful case so far.

Uber has been planning its pricing strategy for a long time. A small detail on its official website can confirm it indirectly. When you open uber.com, you will find a sequence that shows Uber X-Taxi-Black-SUV-LUX in order. Apparently, Uber X, a service that offers cabs cheaper than traditional taxis, is a long-planned strategy.

Therefore, from Uber’s perspective, pricing is a business concept at its core.

When innovation meets regulation

In general, pricing is one of the crucial areas that government supervises and regulates. In the early stage, cab service companies didn’t lower their fares at all. It's probably due to the negotiation outcome after discussing with the authorities besides being influenced by demand and supply, efficiency, and business concept. In this case, these companies must find ways to convince the regulators and work their ways around.

This is not happening only in China. Uber has been facing obstacles created by local policies and traditional cabbies all around the globe as anti-Uber activities continue to intensify. That’s why I think the most admirable quality that Uber possesses is the bravery to play against the rules with its disruptive innovation.

Now, let’s see what the founder of Uber, Travis Kalanick, did to fight back.

In 2010, just four months after Uber’s launching, Kalanick received a letter from the municipal government of San Francisco, ordering him to shut down his business. That’s the very moment he realized he had indeed made something special. Kalanick’s reaction to the letter was astonishing, he ignored the government and reached out to the netizens and asked them to sign a petition that was sent to the mayor’s office subsequently.

It’s reported that in Los Angeles the total passengers of traditional taxi industry dropped two third in just two years after the launching of Uber and it’s just in one city. Uber’s methods to counterattack the authorities are also very bold. When threatened by the local governments and police departments, Uber would sent out messages to its users, asking them to talk to local politicians for support. Uber even hired high-profile lobbyists such as President Obama’s former campaign advisor David Plouffeuber to fight the battle alongside.

And of course, Uber’s efforts did work. After lobbying the governor’s assistant of Virginia after being shut down, the DMV soon announced publicly that Uber could operate once again, which only took Uber less than 48 hours to achieve.

The interesting part is that every time Uber meets great obstacles such as taxicab strike and policy resistance, its number of downloads always surges. Often times the strikes would become free advertising campaign for Uber in some level. They exposed the potential users to a convenient ride-hailing app that provides better service with lower fare, and the outcome is obvious.

As the voice of anti-Uber movement grows louder, Uber’s corporate valuation also goes sky high. Its corporate valuation reaches US$40 billion after receiving another US$1 billion in funding.

Uber never backs down in any wave of opposition and fights back with passion through lobbying. According to Washington Post, Uber has at least 161 lobbyists that are working to lobby the law makers in different states and has hired many senior political consultants to fight against traditional taxi companies at political price. It’s said that Uber had spent US$475 thousand on lobbying the law makers in Sacramento of California alone.

As a matter of fact, for Silicon Valley companies it’s quite common to hire political lobbyist groups. Google alone spends around US$14 million on lobbying the US government annually.

Some people might say it would be a different story in China if Uber adopted the same method. It’s quite true, and Uber China’s smart about its operation. Recently, the Minister of Transport even made a public statement announcing that private cars are prohibited to be used for providing private cab service. Before the announcement, the Ministry of Transport of China had introduced policies that encouraged ride sharing which could potentially solve traffic issues.

Uber adopts a relatively mild approach to handle the resistance it faces in China. Currently there are two kinds of cabs on Uber China, one is Uber X (Uber Black), cabs that are provided by the private cab service companies Uber’s cooperating with and are not considered as private cars.

The other kind is People’s Uber, a localized version of Uber service in China. The model People’s Uber adopts is ride-share. It encourages all drivers to pick up passengers that go the same way and earn some extra money by doing so. It's also expected to alleviate traffic jams and potentially solve traffic problems.

Uber China reported to the headquarter in the US that People’s Uber is a ride-share platform, and therefore the 20% commission should be removed. Uber China’s proposal brought up great stir in the headquarter for the fact that changing the business concept would mean extra technological support and algorithm framework adjustment, in short, more cost. That said, a proportion of revenues would be lost as a result. Another important thing is that drivers on this platform don’t have a minimum request number to meet, and they can use the app whenever they are available.

At present, using People’s Uber feels no different from hailing a traditional taxi. Just think about it, when the drivers can take 2 or up to 3 ride-share requests on one trip, the fare can go even lower.

From the information I have provided above you can easily tell in capitalism countries Uber usually fights back resistance by asking its users to write letters to influential figures and signing a petition. On the mayor election day of Ottawa, Uber even offered free cabs to passengers who needed a ride to go to the voting canter. In China, Uber works it ways around the policies and goes for the direction that the government encourages. All innovations are disruptive and they will wreck the existing industries very easily, changing the balance of interests as a result. At the end of the day, the game-changer is the bravery and wisdom to continue on after breaking the rules.

As for the authorities, which usually are the governments, they need to take the mass’s opinions into consideration. They need to address traditional taxi drivers, ensure passengers’ safety, and solve traffic problems as well. This game is far from over yet, after all, in Beijing, the traffic demand has outgrown the supply that traditional public transportation and taxis can provide.

One of the most frequently used accusations against Uber is its safety issue. For instance, in Paris and India, allegedly there have been cases where Uber drivers raped their passengers. People use these cases to attack Uber quite often. However, the interesting thing is that Uber is currently collaborating with the United Nations to help provide jobs for women globally. The logic behind it is quite the opposite of what those accusations are indicating: the drivers will be safer since Uber has the information of every passenger they pick up.

In this case, start-up companies and newly emerged industry forces like Uber need adequate regulation and supervision, not policies that are simply there to ban them. For instance, when private cars have in fact become the mainstream of the cab service, the cab-hailing platforms can put investment in increasing passengers’ safety by collecting fingerprints, verifying identity and keeping tracks of records. It requires self-discipline of the companies and authorities’ intervention when the standard is over relaxed. When that time comes, it would mean the government had accepted this industry and it's no longer a grey area in law.

From the long run, this is a tendency that can not be stopped. Tesla is currently developing driverless cars, which can lead to a future where drivers are no longer necessary. Once driverless technology becomes matured and is applied for private use, I would totally lend me car to Uber and let it drive for money after arriving at my office. When this becomes a reality, the government might want to think about establishing relevant tax system rather than dwelling on Uber’s problem.

[The article is published and edited with authorization from the author @Liu Hongjun, please note source and hyperlink when reproduce.]

Translated by Garrett Lee (Senior Translator at ECHO), working for TMTpost.