Question

You have been hired to advise the Uber top management team on their non-market strategy (circa 2015).

1) Describe Uber's historical non-market strategy by utilizing any relevant non-market categories shown in the "Nonmarket Environment of Business" figure on p. 45 of the "What Every CEO Needs to Know About Nonmarket Strategy" background reading. Would Uber have been able to achieve its staggering success without raising the associated nonmarket controversy?

Answer 1

Disruptive technologies face the challenge of gaining and sustaining success in the marketplace. Some disruptive technologies create new markets, whereas others disrupt existing markets with incumbent firms and workers. Incumbents adapt to the new competition or perish, and some fight back less in the marketplace and more in the institutional environment in which they operate. This paper considers the disruption of the taxi industry by ride-hailing with a focus on the market and institutional strategies used by Uber to address the challenges from the taxi industry and other interests including some Uber drivers, labor advocates, safety advocates, and opponents of the independent contractor model of platform organization.

Although the focus is on Uber, the approach to analyzing the competition in the disrupted market and in the institutional environment is applicable to other technologies that disrupt established industries. The markets themselves can differ considerably as can the technologies, but the incentives for incumbents to fight in both the market and the institutional environments can be quite similar. Uber enters local transportation markets with incumbent taxi industries that are subject to regulation; Airbnb enters local housing rental markets with an array of incumbent housing accommodations including hotels that are both regulated and taxed. The incumbents attempt to use the institutional environment to restrict entry, raise entrants’ costs, and reduce their competitive advantage.

Uber’s business model is to provide a peer-to-peer platform that matches travelers with drivers who are independent contractors and choose whether, when, and how long to drive.1 Unlike some other platforms network externalities are quickly exploited.2 Value is created through ride-hailing—the use of otherwise idle personal vehicles of drivers who voluntarily participate. The innovation provided by Uber is the direct matching of travelers and drivers through an app rather than hailing from the street or calling to have a taxi dispatched. In operating as a platform, Uber seeks to avoid the regulatory system that governs taxis and limousines. Uber’s basic strategy for entering a market is to enter first and deal with institutional issues as they arise.3 Uber often enters a market first with UberBLACK as a means of building market recognition and then introduces UberX with lower fares and a larger network of drivers. It is UberX that generates opposition.

Uber’s business strategy has four basic phases.4 One is a strategy for entering and penetrating markets with the objective of quickly winning the market and emerging as the dominant firm. Uber typically enters markets without obtaining regulatory approval. The second phase is maintaining and strengthening its market position in the face of market challenges by its rivals without sacrificing its core platform and challenges from the institutional environment, such as the possibility of having its drivers classified as employees rather than as independent contractors. Uber’s most important resource is the capacity of its network to carry passengers. The third is extending its platform to accommodate complementary activities such as UberEATS and other delivery services. The fourth phase is to transition to autonomous vehicles, which generates a host of challenging issues. The focus here is on the second phase involving maintaining Uber’s market position and its business model to position itself to execute the third and fourth phases of its strategy.

Uber enters markets where there is an established taxi industry whose market organization can range from an effective cartel to competitive with easy entry. A cartelized industry with a captured regulator provides the most attractive market opportunities for Uber, but the incumbent industry then has the strongest incentives to oppose ride-hailing. The nature of the opposition depends on the shares of the rents obtained by taxi companies and by their drivers. In Las Vegas, where the taxi industry is concentrated and the taxi companies own the medallions, the incumbent firms have strong incentives to develop relationships with local government and taxi regulators. Two days after UberX was launched in Las Vegas, the taxi industry succeeded in obtaining an injunction that forced UberX to shut down. In Toronto, drivers own the medallions and taxi companies provide dispatching, so drivers as well as the taxi companies have strong incentives to oppose Uber. Their strategy is to influence the city council to treat Uber as a transportation service that should be regulated under the same framework applied to taxis. In Calgary, drivers hold 55% of the taxi plates (medallions) with taxi brokerages holding the rest. The principal opposition is the taxi drivers, and they succeeded in keeping Uber out of Calgary until December 2016, when the city council approved regulatory changes to accommodate ride-hailing.

This paper focuses on three issues that pose serious threats to Uber and its business model. The first is whether Uber is a platform that matches travelers and drivers or is a transportation service that falls under the jurisdiction of existing regulatory frameworks. As a transportation service, drivers can be required to obtain commercial licenses and insurance, pay fees and taxes on their commercial activity, and undergo regular inspections. Also, Uber could be subject to price regulation and controls on where and how it operates. The second issue is the classification of Uber drivers as independent contractors. Unions, labor advocates, and some Uber drivers argue that ride-hailing drivers should be reclassified as employees, which would entitle them to the protection of labor laws and eligibility for overtime pay, vacations, unemployment compensation, and workers compensation. Drivers reclassified as employees would also be easier to unionize. The third issue is passenger safety and security and particularly driver qualifications. Safety advocates and the taxi industry argue that Uber drivers should be fingerprinted as part of their background checks, have commercial licenses, and have their vehicles inspected on a regular basis. Fingerprinting, commercial licenses, and vehicle inspections are typically required of taxi drivers in the United States. Uber relies heavily on part-time drivers, and fingerprinting, commercial licenses and the associated fees, and vehicle inspections would place substantial burdens on many of them; with fewer drivers the capacity of Uber’s network would be reduced. Uber (and Lyft) withdrew from the Austin, Texas, market because the city imposed a fingerprinting requirement.

These issues are addressed in institutional settings that vary from market to market. In the United States the issue of whether Uber is a transportation service falls under the jurisdiction of city councils and state legislatures, whereas in countries such as France and Germany national law is governing. The issue of whether Uber drivers should be classified as employees falls under the jurisdiction of courts and departments of labor, and on some specific issues such as eligibility for unemployment compensation under the jurisdiction of federal labor law. Driver qualifications and vehicle inspections are largely a matter for city councils and regulatory agencies, but state legislatures can limit the discretion of city councils.

An issue can be addressed in more than one institutional venue. One strategy used by Uber is institutional venue shifting to take an issue from the jurisdiction of city councils, and particularly city councils with strong connections to the taxi industry, to state jurisdiction, where the influence of taxi interests is diluted. Uber has had a degree of success in obtaining state legislation that limits the ability of city councils and taxi regulators to restrict its operations. Uber was successful in obtaining state legislation in Nevada that allowed it to reenter the Las Vegas market. Uber was unsuccessful, however, in obtaining provincial legislation in Alberta.

The disruption of local transportation markets by ride-hailing also disrupts the institutions governing those markets and can result in changes in the rules of the game. Existing regulations and laws can prove to be inadequate, leading to substantial changes in the regulatory framework, as in the case of Toronto which has attempted to create a more level playing field for ride-hailing and taxis. The changes include revised regulations by city councils, new state laws restricting the authority of local governments to regulate ride-hailing, a new interpretation of the standard for classification of workers as independent contractors, and new interpretations of existing laws and regulations by the courts. The perspective taken here is that the institutions, laws, and regulations are endogenous and shaped by the influence of interests including ride-hailing companies and their drivers and passengers, taxi companies and their drivers, and other interests in addition to the institutional officeholders who choose the rules of the game.

In addressing issues, Uber uses both single-purpose and dual-purpose strategies. A single-purpose strategy is intended to benefit Uber in either its market environment or its institutional environment. For example, defending against a lawsuit claiming that Uber drivers are misclassified as independent contractors is a single-purpose strategy. A dual-purpose strategy provides benefits in both the market and institutional environments. For example, a work enhancement strategy can both attract additional drivers, thereby increasing the capacity of Uber’s network, and can reduce the incentives of drivers to participate in a lawsuit on the driver classification issue. Dual-purpose strategies are not necessarily better than single-purpose strategies but instead provide benefits in both the marketplace and the institutional environment, and both sets of benefits should be taken into account in choosing strategies.

Three dual-purpose strategies, corresponding to the three issues, are considered—market engagement, work enhancement, and accommodation. A market engagement strategy can focus on the demand or supply side of Uber’s platform. On the demand side, Uber engages local communities through special promotions and partnering with local organizations, which both build market demand for ride-hailing and broaden the potential for mobilizing public support for ride-hailing in opposition to restrictions under consideration by a city council. On the supply side, Uber works to build a deeper pool of potential drivers, which increases the capacity of its network and broadens its base for mobilizing drivers in opposition to restrictions on ride-hailing. A work enhancement strategy also increases capacity and can reduce the likelihood that a trial lawyer can find drivers to build a class action lawsuit on driver classification. Accommodation involves bargaining and compromise, and Uber’s bargaining strength is due to the benefits its platform provides to passengers, drivers, and communities, and to its credible threat to withdraw from the market. It may accept restrictions on some aspects of its operations to avoid restrictions on other aspects. For example, to avoid required fingerprinting, Uber strengthens its background checks on drivers. The market engagement and accommodation strategies are typically specific to a local market, whereas the driver classification issue could affect all markets in which Uber operates.

Dual-purpose strategies require implementation in the institutional environment, and the principal implementation strategies used by Uber are stakeholder mobilization, lobbying, and venue shifting. Because of variation in the organization of the local transportation markets and in the institutions with jurisdiction over the markets, Uber typically addresses issues on a market-by-market basis. This requires Uber to supplement its base capability with local professionals, including local lobbyists, and to partner with local groups such as MADD to build both market strength and public support for ride-hailing.

This paper presents a model of Uber’s market competition with taxis, and uses the model to structure the analysis of dual-purpose and implementation strategies in the context of the three issues. To illustrate strategy choice and competition, the paper draws upon detailed studies conducted by Holburn and Raiha (2016) of the Calgary, Las Vegas, and Toronto markets. Specifics about those three markets and the competition therein are to be understood as drawn from their studies and will not be individually cited.

The role of the model is several-fold. One is to understand the interaction among strategy choices. This requires a model that represents the market environment and the competition with the taxi industry and identifies incentives for market participants to act in the institutional environment. A second is to provide a framework for evaluating strategies that integrate market and institutional actions, as in the case of dual purpose strategies. A third is to conduct counterfactual analysis, such as allowing tipping and operating with drivers classified as employees.

The approach taken combines quantitative and qualitative frameworks. The quantitative framework involves a formal model of a local transportation market. A micro-model of the market is used to identify the incentives to participate in stakeholder mobilization campaigns and lobbying. Individual drivers and travelers are modeled, which allows distinctions between part- and full-time drivers, frequent and infrequent travelers, and taxi drivers who own and do not own medallions.

Incorporating institutional strategy choice in a formal model is challenging because outcomes are typically determined in the context of institutions that can differ considerably across issues and jurisdictions. For Uber the relevant institutions include legislatures, ranging from city councils to state legislatures to national legislatures, regulatory agencies with varying degrees of authority and potential for capture, courts at the state and national levels, and executives ranging from mayors to governors to presidents and prime ministers. Instead of attempting to include this array of institutions in a formal model, qualitative analysis is used. The qualitative analysis uses the “nonmarket” frameworks in Baron (2013) to analyze these issues and evaluate strategies, and it uses the model as a framework for tracing the effects of strategy alternatives on incentives for nonmarket action to affect institutional choices. This includes both Uber’s market competition with the taxi industry and that industry’s nonmarket strategy to restrict Uber’s operations and increase its costs.

The next section considers Uber’s integrated strategy, and Section 3 introduces the basic model of competition between Uber and taxis. Section 4 expands on the three issues challenging Uber, and Section 5 introduces dual-purpose strategies and uses them in analyzing the three issues. Section 6 offers conclusions, including speculation on the effects on Uber’s business model if the outcomes of the three issues are unfavorable for Uber.

2. Integrated Strategy and Uber

An integrated strategy as introduced in Baron (1995) is composed of a market strategy for engaging customers, suppliers, and competitors and a nonmarket strategy for engaging governments and individual and collective action. Uber’s market strategy for winning a market and sustaining its position is to move first and quickly in entering a local transportation market, and its success is determined by its ability to match travelers with drivers. Uber’s business model is built on flexibility and responsiveness. Flexibility is possible because as a platform Uber is unregulated and drivers are independent contractors who choose their driving. Uber taps a large pent-up demand for local transportation and matches demand with capacity provided by drivers seeking to supplement their income. Demand for local travel varies considerably by location and within and across days of the week, and Uber uses surge pricing to elicit additional capacity to respond to periods of high demand. The key to market success is relatively short wait times for travelers and relatively short idle periods for drivers before their next passenger. Surge pricing reduces traveler wait times, and the high demand assures drivers of relatively short idle times.

Uber enters a market maintaining that it does not require regulatory permission because it provides a platform that matches travelers with drivers and hence is not subject to regulation as a transportation service. Once Uber has entered a local transportation market, it frequently faces challenges from local regulators, city councils, and state legislatures and from taxi companies, their drivers, and unions. Uber’s nonmarket strategy is to anticipate and respond to the challenges, including withdrawing from a market if harmful regulation is imposed.5 Uber uses standard nonmarket implementation strategies such as lobbying and grassroots campaigns, but it also uses dual-purpose strategies that are intended to address or forestall a particular nonmarket challenge and to benefit its business model, for example, by attracting additional drivers or inducing current drivers to drive additional hours. Three dual-purpose strategies are considered: market engagement, work enhancement, and accommodation.

As a framework for considering dual-purpose strategies, Uber is viewed as a firm that generates three surpluses. The first is profit that accrues to its owners. The second is driver surplus, which is equal to the difference between the utility from driving for Uber and the reservation value of a driver. The third is passenger surplus, which is the difference between the utility from riding with Uber and the utility from other transportation choices such as taxis. The owners surplus provides incentives to enter and exit markets and to choose among single-purpose and dual-purpose strategies. Drivers surplus provides incentives to participate in nonmarket strategies, such as stakeholder mobilization, intended to forestall or reverse regulation. Passengers surplus provides incentives to participate in nonmarket and dual-purpose strategies that could restrict the availability or cost of ride-hailing. The model presented in Section 3 focuses on pricing and the owners surplus, and the drivers and passengers surpluses are identified and used qualitatively in Section 5 to analyze dual-purpose strategies in the context of the three issues.

Nonmarket issues, such as those considered here, are resolved in the context of institutions, and the nature of those institutions differs substantially. The issue of whether ride-hailing is a matching platform or a transportation service is decided in voting institutions, including city councils, regulatory commissions, and state legislatures. The issue of whether ride-hailing drivers are independent contractors or employees is decided in judicial and regulatory institutions, including courts, regulatory agencies, and state and federal departments of labor. The issue of driver qualifications is addressed in voting bodies, regulatory and administrative agencies, and courts. Incorporating all these institutions into a model along with market strategies would result in a very complex model. Moreover, because a nonmarket issue is institution specific, much of that complexity is irrelevant to a particular issue and can obscure rather than clarify the analysis of effective strategies. In contrast to the variation in institutions, local transportation markets are relatively similar, which allows the same matching technology and pricing system to be used in each market.

Thus, the approach taken in this paper is to present a model of a representative local transportation market without incorporating the array of institutions and then for each of the three nonmarket issues to introduce the particular institutions relevant for that issue. A model of a voting institution is introduced where the matching platform versus transportation service is analyzed, and a model incorporating courts is introduced where the independent contractor versus employee issue is analyzed.

The focus of the analysis is on the use of dual-purpose strategies for addressing each issue. For each issue an institutional analysis is presented, and the market model is used to identify the incentives of actors, primarily ride-hailing drivers and passengers, to take nonmarket action in accord with the dual-purpose strategy. A dual-purpose strategy is based on these incentives and its effects can be traced through the parameters of the model.

3. The Model

The model represents a market Uber has entered with UberX and focuses on Uber’s market strategy and the incentives for nonmarket action. The principal parties whose rents are affected by Uber’s operations are the company and its owners, its driver-partners, passengers, and competitors, including both taxi companies and their drivers. As the model illustrates, Uber drivers collectively have nonmarket power because they can be mobilized even though they independently choose whether to drive, and Uber can represent their interests in its lobbying. Others have interests in Uber, even though they are not directly affected. Labor advocates argue that Uber drivers have no bargaining power and should be classified as employees, who then can be more easily unionized. Similarly, safety advocates seek more stringent qualifications for drivers, including fingerprinting, drug testing, and vehicle inspections.

Uber’s most important market resource is the capacity of its network to carry passengers. Capacity depends on voluntary participation by those who choose to drive with it, and capacity is directly increasing in driver compensation. Uber uses dynamic pricing, which differs from dynamic pricing in most applications because its capacity quickly responds to the higher price during surge periods.6 Compensation has two components: the price paid by passengers and the share the driver receives.

The model provides micro-foundations for strategy analysis by modeling individual drivers and travelers. This allows distinguishing between mobilization strategies that focus on full-time drivers from strategies that focus on part-time drivers and between frequent and infrequent travelers and their incentives on the intensive and extensive margins. The model represents Uber’s operation in a representative market, recognizing that markets can differ in their structure and demand and supply characteristics.7

Uber competes with the incumbent taxi industry and with other ride-hailing firms, such as Lyft, on a market-by-market basis. Taxis are regulated on fares, driver qualifications, and employment conditions, and in many jurisdictions drivers are represented by a union. A union competes with the taxi firms to capture rents. Fares are typically fixed and do not respond to high demand, and taxis are generally required to pick up passengers only in their own regulatory jurisdiction but are not required to serve all neighborhoods in their jurisdiction. In contrast, Uber’s policy is to serve all neighborhoods within a local transportation market, which means that Uber serves low-income neighborhoods that may be underserved by taxis.

Ride-hailing companies including Uber and Lyft are privately held, and little is known about how they set prices, their size, market penetration, compensation for drivers, and the number of travelers served, so there is little to guide the modeling of their competition. Competition could be represented by a duopoly model, but in many markets Uber is believed to be considerably larger than Lyft and to have exploited a first-mover advantage. This suggests a leader-follower model of competition. Uber and Lyft have some policy differences; for example, Uber discourages and Lyft encourages tipping, so there is a dimension of competition through product differentiation. It is also possible that the ride-hailing companies implicitly collude in pricing. Regardless of how they compete with each other, both compete with taxis in the local transportation market.

In the institutional environment, the interests of Uber and Lyft are closely aligned and are opposed by the taxi industry. The more intense is the competition among ride-hailing firms, the lower are their profits and the greater their penetration into the local transportation market; hence, the larger is the number of their stakeholders, drivers, and passengers and the stronger is the ride-hailing industry in the institutional environment, and the larger is the set of stakeholders that could be mobilized to support ride-hailing in the institutional environment. The model and subsequent analysis focus on the market and nonmarket competition between ride-hailing and taxis. Because Uber and Lyft operate in similar manners, the model includes a single ride-hailing company, referred to as Uber, and a taxi industry.

The ride-hailing market has a number of particular characteristics. First, the participants on both sides of the platform are small and numerous. Second, on each side of the platform, participants do not compete with each other. Third, the gain from participating in the market does not importantly depend on the number of participants on the other side of the market because surge pricing tends to equalize driver utilization and traveler wait times. Fourth, switching or multi-homing costs are low, so drivers can drive for both Uber and Lyft and travelers can use both. Fifth, given the regulated taxi price, Uber is a price setter that sets a normal period price, and at times of high demand sets surge prices. Thus, Uber prices on both sides of the platform. On the demand side Uber sets the price paid by travelers, and on the supply side Uber sets the share for drivers.

3.1. The Supply Side of the Platform: Capacity

Uber’s capacity to carry passengers is determined by how many of the pool of eligible drivers choose to drive for it, the number of hours they drive, and when they drive. Passengers directly pay the trip price pU, and drivers receive the price less Uber’s commission. Let s denote the share of the price received by drivers, so drivers receive spU. Uber basically uses the same drivers’ share in all markets, so the share is taken as exogenous to an individual market.8

Cramer and Krueger (2016) analyze data on Uber drivers in five cities with a focus on the utilization rate of capacity. Their analysis “suggests that the exit and entry of UberX drivers during the course of the day equilibrates the market so that drivers achieve essentially the same utilization rate regardless of how long they work … .” Let τ denote utilization, the probability that a driver has a passenger, and assume that drivers can provide one trip per hour. Thus, the expected compensation of a driver is τspUh, where h denotes the hours driven. Based on their experience, drivers are assumed to have rational expectations about utilization.

A dual-purpose work enhancement strategy can both attract additional drivers and increase the hours driven by current drivers, and it can also decrease the incentive of drivers to take nonmarket action seeking employee classification or a specific benefit such as cost reimbursement from Uber. For example, Uber recently gave drivers a “pause button” that takes them out of the availability pool and allows them to take a break, use a rest room, or as Uber’s television advertisement states, enjoy “chilling” without stepping out of the app system. This reduces immediate capacity to some extent but can attract additional drivers by reducing the opportunity cost w or decreasing the marginal cost θ. To the extent that work enhancement increases driver surplus, drivers have less incentive to seek employee status or specific benefits.

Uber has enhanced the driver’s experience in additional ways, including providing insurance to compensate passengers in the case of an accident, guaranteeing auto lease contracts, and allowing drivers to choose music on Pandora. The first can be thought of as reducing the option value βo of travelers, the second as reducing a driver’s operating cost θ, and the third as reducing the opportunity costs of potential drivers as represented by w̄ w̄. All three increase a driver’s surplus, which decreases the incentive to engage in nonmarket action against Uber.

As an example of a dual-purpose work enhancement strategy, in some markets drivers began renting cars to use in Uber service. This allows a person without a qualifying vehicle to drive for Uber, but some drivers did not have the credit rating to be able to lease long-term to obtain low rates. Uber began providing a guarantee for a long-term lease. The lease guarantee program decreases the marginal cost θ of driving, increases capacity, decreases the surge price, and increases profit. The lease program also increases the surplus of those drivers who take advantage of it, reducing their incentive to take nonmarket action against Uber. Providing guarantees has a cost to Uber, but it has dual advantages.

Uber’s extensions into complementary activities such as deliveries also face the driver classification issue, but because of less stringent regulation the incumbent delivery industry typically does not have the links to local government that the taxi industry has. Moreover, passenger safety and security are less relevant issues, and insurance can deal with the standard risks. The delivery industry is populated with a number of large firms and many small local firms, so the industry is relatively competitive. Incumbent firms likely earn modest profits, which leaves them with weak incentives to take nonmarket action to restrict ride-hailing. The competitiveness of the market, however, means that profitability will turn on Uber’s costs relative to those of incumbent firms.

Uber doesn’t want its drivers to be employees

How Uber’s strategy affects workers in the gig economy

The difference between being an employee versus an independent contractor is significant, said Keith Cunningham-Parmeter, a professor at Willamette University College of Law. “Depending on which side of the line you fall on, you either get this huge basket of rights or basically nothing,” Cunningham-Parmeter said.

Most employment rights do not extend to independent contractors. For instance, companies are not required to pay independent contractors a minimum wage or overtime, provide them health insurance or give them regularly scheduled breaks.

But the differences between rights someone is an entitled to as an employee — but not as an independent contractor — can be even more mundane. Independent contractors are responsible for paying their own taxes. And independent contractors aren’t necessarily entitled to unemployment or workers’ compensation unless they have paid into those funds themselves.

Recommended:The government has no idea how many gig workers there are, and that’s a problem

The divide between independent contractors and employees has taken on a renewed significance in recent months as allegations of sexual harassment in the workplace have cropped up increasingly across the country.

Federal discrimination laws only applies to employees, according to Workplace Fairness, a nonprofit public education and advocacy organization. And just a few states grant discrimination protections to independent contractors. Meanwhile, the nature of the jobs these people perform often puts them at a greater risk of harassment.