Why cities should promote robust competition in ride sharing markets

We’re in the midst of an unfolding revolution in transportation technology, thanks to the advent of transportation network companies. By harnessing cheap and ubiquitous communication technology, Uber and other firms organizing what they call “ride sharing” services have not only disrupted the taxi business, but are starting to change the way we think about transportation.  While we think of disruption here as being primarily driven by new technology, the kinds of institutional arrangements–laws and regulations–that govern transportation will profoundly determine what gains are realized, and who wins or loses.

Right now, Uber has an estimated market value (judging by what recent investors have paid for their stake in the company) of nearly $70 billion. That’s a whopping number, larger in fact than say, carmakers like Ford and GM.  It’s an especially high valuation for a company that has neither turned a profit nor gone public, thus subjecting its financial results to more outside scrutiny.  Uber’s generous valuation has to be based on the expectation that it’s going to be a very, very large and profitable firm, and that it will be as dominant in its market as other famous tech firms–like Microsoft or Google–have been.

The importance of competition

For a moment, it’s worth thinking about the critical role of competition in shaping technology adoption and maximizing consumer value. Take the rapidly changing cell phone industry, which has increasingly replaced the old wire-line telephony of the pre-digital era. Back in the day, phone service—especially local phone service—was a regulated monopoly. It barely changed for decades—the two biggest innovations were princess phones (don’t ask) and touch-tone dialing.

But when the Federal Communications Commission auctioned off wireless radio spectrum for cellular communications it did so in a way that assured that there would be multiple, competing operators in each market. Though there’s been some industry consolidation, critical antitrust decisions made in the past few years have kept four major players (AT&T, Verizon, Sprint, and T-Mobile) very much in the game. T-Mobile has acted as the wildcard, disrupting industry pricing and service practices and prompting steady declines in consumer voice and data costs. In the absence of multiple competitors, it’s unlikely that a cozy duopoly or even triopoly would have driven costs down.

Or consider the case of Intel, which because of a quirk of US Defense Department requirements was obligated to “second source” licenses for some of its key microprocessor technologies to rival Advanced Micro Devices (AMD). Second-sourcing required Intel to share some of its intellectual property with a rival firm so that the military would have multiple and redundant sources of essential technologies. This kept AMD in the market as a “fast follower” and prompted Intel to continuously improve the speed and capability of its microprocessors.

How much does being first count for?

Uber’s first-mover advantages and market share arguably give it a market edge; drivers want to work for Uber because it has the largest customer base and customers prefer Uber because it has more drivers. More cars mean shorter waits for customers, which attracts more customers to Uber and therefore generates more income for its drivers. This positive feedback loop can help drive up market share for Uber at the expense of its competitors. Whether this happens depends two things: how powerful are these network effects and whether effective competitors emerge.

Some economists think that these network externalities tend inevitably to lead to winner-take-all markets, and that once established, dominant market positions are difficult or impossible to overcome. That’s a major factor behind Uber’s high valuation: investors think the company will continue to have a dominant position in the industry and will eventually reap high profits as a result.

Antitrust is a live issue with Uber. The company has famously disclaimed that Uber drivers are its employees—asserting, instead, that they are “independent contractors”—businesses separate from Uber. But this has led some to argue that Uber is collaborating with its drivers to fix prices, which may constitute a violation of antitrust laws. The argument is that the Uber app —which presents all customers with the same rate and gives supposedly independent drivers no opportunity to offer different prices (and no opportunity for customers to bargain) — represents technology-enabled price fixing. This may especially be a problem for “surge pricing,” when every driver effectively raises her price at the same time (something that would be impossible to accomplish absent the technology).

But others question whether the market power afforded by these network externalities extend beyond local markets. Bloomberg View’s Justin Fox argues that the scope of network effects probably doesn’t exceed metropolitan markets. Except possibly for business travelers or tourists, Uber’s market share in some far away city is of little importance to travelers in Peoria. This may increasingly become true as these services become more widespread—it’s still the case that 85 percent of Americans have never used Uber or Lyft, and the 15 percent who have used the services are wealthier, better educated, and probably less price sensitive than those who haven’t used these services yet.

A policy shock in Austin

The big news in the ride sharing business this year was a referendum in Austin on the city’s proposed requirement that all contract drivers be fingerprinted. Uber and Lyft went to the political mat, spending $8.4 million on a campaign to defeat the requirement (the most expensive local political campaign in Austin history by far). The centerpiece of their campaign was a threat to pull out of Austin if the requirement took effect. They lost 56 to 44 percent, and both have followed through on their threat. But in their wake, a number of smaller companies and startups have stepped into the gap. (It’s hard to think of a place that is more entrepreneurial and tech savvy; other communities might not have seen such a response.) According to the Texas Tribune, there are now half dozen companies offering ride sharing services, with a range of pricing, technology, and business models. The lucrative New York market has also attracted a new entrant, Juno. It aims to attract Uber and Lyft’s highest rated drivers by offering them a chance to own equity in the firm. Nothing guarantees that any of these competitors will survive. Already, Uber’s largest domestic rival, Lyft, has put itself up for sale.

In the long run, the social benefits of a new technology will depend, in large part, on whether the technology is controlled by a monopolist, or is subject to dynamic competition. New evidence suggests that the economic harm of monopolies may be much larger than previously recognized, and that a key method monopolists use to earn high profits (or “economic rents”) is to try to shape the rules of the game to their advantage. In a recent research paper published by the Federal Reserve Bank of Minneapolis, James Schmitz writes:

. . . monopolists typically increase prices by using political machinery to limit the output of competing products—usually by blocking low-cost substitutes. By limiting supply of these competing products, the monopolist drives up demand for its own.

There’s nothing foreordained about what shape the marketplace for transportation network companies or ride sharing will look like. There could be one dominant firm—Uber—or many competing firms. It’s actually very much in the interests of cities to encourage a large number of rivals. Economically, competition is likely to be good for consumers and for innovation. Having lots of different firms offer service—and also compete for drivers—is likely to drive down the share of revenue that goes to these digital intermediaries. And as the experience of Austin shows, having just one or two principal providers of ride sharing services means that they can credibly threaten to pull out of a market, and thereby shape public policy. With more competitors, such threats are less credible and effective, as pulling out would usually just mean conceding the market to those who remain.

As municipal governments (and in some cases, states) look to re-think the institutional and regulatory framework that guides transportation network companies and taxis, they should put a premium on rules and conditions that are competition-friendly, and that make it particularly easy for new entrants to emerge. An open, competitive marketplace for these services is more likely to promote experimentation, provide better deals and services for customers, and give communities an equal voice to that of companies in shaping what our future transportation systems look like.