This week in Product | Strategy | Innovation, we will expand on last week’s update [U4] on the freemium business model used by Spotify [E4] and other companies. This week we will explore alternatives when free is not an option. But if free access to a limited scope of services has enabled such great success for Box, Slack, Zoom and other companies, why wouldn’t it make sense for other businesses?
As mentioned in the prior update, free services require something approaching a huge Total Addressable Market (TAM) to scale to at least 10’s if not 100’s of millions of users and low costs to effectively acquire, scale & sustain a growing user base. But recurring subscription-based business models might require hardware to deliver services. This likely narrows the TAM to focus on a specific market and certainly raises the cost to scale and sustain a growing user base. So to explore this further, let’s dive deeper into the business models and pricing strategies for 2 companies that approach transportation differently for now:
Uber
Tesla
Uber disrupting car ownership and taxis with direct-to-consumer Transportation-as-a-Service (TaaS)
Uber Technologies, Inc. was founded in 2009 as Ubercab at the tale end of the financial crisis out of frustration from personal experiences hailing taxis or hiring private drivers by Garett Camp and co-founder Travis Kalanick. In the earliest stages of the company, the focus was on building out mobile apps for both a rider to hail a ride from a specific address to a specific destination at a specified price and a driver to accept the job with the mobile app also guiding navigation to control cost. Regulatory challenges made using taxis too difficult, so Ubercap morphed into hailing black car services at 150% the price of a taxi. These black car services used the on-demand Uber rides to fill in gaps with their own scheduled rides.
Uber has always provided the mobile app to riders for free to download to their own smartphone. For a number of years, Uber provided an iPhone to drivers to control the technology stack from smartphone device, cellular carrier and mobile app. This cost was recovered with favored pricing by Apple for the phone, cellular carrier and ultimately the revenue-share between the driver and Uber for the fare. Uber could also require a minimum weekly revenue generation by the driver to cover the cost of the technology and then charge a fee on the weeks that minimum was not reached.
Ubercab did eventually launch out of alpha and beta testing with some elements of a freemium business model with no commitment from riders who downloaded the mobile app and the technology stack for the drivers including insurance to cover the rider during the hired ride was just a part of the infrastructure cost to deliver services to riders. Ubercab put controls in place using driver navigation and revenue-sharing to offset these infrastructure costs to build a very scalable global business model.
But as Ubercab transformed into the Uber brand, it unlocked its full commercial potential realizing there was a wide spectrum of on-demand TaaS consumer needs that required a “customer experience stack” with multiple price points to match drivers and their vehicles to deliver the right product and service. For example, using Uber to travel in March 2021 from Brookline Coolidge Corner to Boston Logan Airport, a rider prospect would have multiple options on the Uber mobile app to choose the desired level of service with a price for each and the estimated time of arrival. The service and price varies across a wide range, but so do the needs of a family of 5 with luggage and skiis for a 1 week ski trip to Utah with a flight in 2 hours vs. a student meeting friends after school for coffee in 20 minutes.
Premium
Black SUV luxury car service (need: family up to 5 for trip with luggage/skiis), $58
Black luxury car service (need: business trip w/ more control on time), $47
Economy
UberXL (need: affordable SUV ride for up to 5), $36
Taxi, (need: desire to use a local taxi-cab service) $31-40
Uber Pet (need: affordable ride for passenger(s) plus and pet), $32
Comfort (need: desire for newer car with extra legroom), $27
Uber Green (need: customer desire for low emission ride), $26
UberX(need: affordable ride), $23
WAV (need: affordable wheelchair accessible rides), $22
Pool (need: temporarily unavailable, multiple riders to lower cost), $15 (estimate)
Transit (need: affordable ride to public transportation), $2.40
However, when Ubercab launched in San Francisco in 2010, they only had the equivalent of the Premium Black luxury car service above. This allowed Ubercab to attract professional limo drivers between scheduled trips to fill out the driver’s schedule with riders who were looking for more luxury than a taxi for certain trips to the airport or a business dinner with a client. The Ubercab trip was more expensive than a taxi, but less expensive than hiring a professional driver to provide the same service since that would be another scheduled trip vs. an on-demand request in a competitive marketplace where other drivers are presented the same opportunity on their mobile app.
So like Spotify and Square mentioned in a prior profile [U4], Uber created a 2-sided marketplace to match a rider from a pool of consumers who had downloaded the Ubercab mobile app for free with a professional driver who had been recruited to use the Ubercab driver app. But unlike the freemium model where the riders would get a limited scope of services for free, Ubercab presented a firm priced offer to hail a professional driver.
This priced offer to hail a professional driver included details on the driver, the type of vehicle and an estimated time of arrival at no cost, but if the rider accepted the fare, they would have to pay the fare at the completion of the ride with the credit card the rider associated with their Ubercab account. Ubercab charged the credit card for the fare and on a weekly basis, paid the driver the settled fare while holding back approximately 20% of the total fare to help cover the business services Uber provided to the driver for the transaction.
Assuming each driver generated enough revenue to cover the weekly cost of the smartphone and cellular carrier service or Uber charged a minimum fee to cover these costs, Uber was able to offset the primary costs to build out an on-demand fleet of independent contractor limo drivers to provide driver side of a TaaS platform. This allowed Ubercab to create the e-commerce online infrastructure with somewhat fixed costs to operate the core technology, but negligible variable costs to add each incremental consumer.
As the number of consumers and ride requests increased demand, more drivers requested joining the TaaS platform. And as the wait time for a driver decreased with a wider and more dense network of drivers, the faster consumer experience generated more ride requests and word of mouth recruited more consumers. Ubercab limited their market just to San Francisco for almost 2 years to refine their business model and technology but the fast growth of this 2-sided TaaS marketplace validated the need for growth capital to expand to other markets outside of San Fransisco. Then as Uber, the business expanded with an invitation-only limited launch in New York to further refine the model before expanding to Boston, Chicago and Washington D.C. Uber used launch events in each city with startup founders and entrepreneurs to seed the market with buzz before opening up the marketing to a more a broader group of consumers.
Eventually, Uber expanded beyond the Black luxury car service by recruiting non-professional drivers to use their own vehicle to earn extra income through UberX and an expanding list of options. Prior to the pandemic, it was my understanding that at its peak, Uber maintained about 400 professional Uber Black and Black SUV drivers, but 10s of thousands UberX drivers. They also partnered with companies to rent and lease cars to drivers to meet the needs of more individuals seeking part-time or full-time income opportunities.
Uber also added Uber Pool to drive down the price for short trips with multiple riders carpooling to similar destinations from a similar area of town. This also allowed Uber to experiment in Boston over a period of about 6 months with the price elasticity of TaaS demand. Although I have not seen this published anywhere, I think Uber was willing to take a loss on Uber Pool for a period of time to test the demand for ride sharing when the price drops to as low as $2. This would help build a somewhat validated business model for rider demand when a robotaxi option became available to profitably serve demand for services at much lower prices than current pricing for Uber.
The rest is history and Uber has added food and package delivery to further expand their TaaS platform opportunities to generate even more operating leverage and provide more income options for drivers. Consumers also start thinking Uber as a brand more often as they have a growing number of TaaS needs.
Tesla disrupting internal combustion engines and dealerships with a direct-to-consumer electric vehicle sales model?
Tesla was founded on July 1, 2003. Its co-founders are Martin Eberhard, Marc Tarpening, Ian Wright, Elon Musk and JB Straubel Tesla pioneered two founding principles to build a novel automotive vehicle strategy at the time.
Electric motors generate instantaneous torque to leverage for performance. Electric vehicles have historically cost a premium to manufacture due to the high costs for many batteries. But Tesla chose to leverage the acceleration of electric motors to match high-performance sports cars at a fraction of the cost. And the reduced emissions and benefits to the environment are upside features. But performance and the driving experience sells the Tesla vehicle.
Electric vehicles allow direct-to-consumer sales. Vehicle manufacturers traditionally sell vehicles through a dealer network to end-users. This requires manufacturers to share revenue with dealers who also service and sell parts to repair vehicles. Electric vehicles have fewer parts that last longer and do not need as much maintenance. So dealers offer less value to Tesla than to other manufacturers. Tesla decided to sell its vehicles direct-to-consumers without dealers to help go to market with more expensive cars to manufacturer because they were keeping more of the revenue generated by sales of Tesla vehicles.
The Tesla business model did include showrooms in key malls around North America to build awareness of their cars, but the Tesla website and mobile app are capable of completing a sales transaction with a consumer in just a few minutes. The design options and prices are clearly stated to determine the delivery price. An initial payment is required to reserve a vehicle with the selected options. Final payment is required to take delivery of the vehicle.
So Tesla creates relationships with a growing fanbase that leverages digital tools to buy merchandise and keep up with the company. This shares some aspect of the freemium model to support lead generation on car sales with a free mobile app, but when a vehicle is purchased it is far from free.
Narrow the market for a premium product with unique features
Tesla launched its original Roadster using a car chassis from Lotus so the startup venture could focus on building the battery packs and electric motors. The pricing model was critical to Tesla’s launch. The first 100 Roadsters were sold as the Signature Series before manufacturing to raise money with celebrities and high-net worth individuals to help fund production and recruit some influencers around the brand. Tesla sold approximately 2,400 of these Roadsters because that was the feasible scale to launch and raise the funds to build the next model. Performance was a key feature of these Roadsters. But with this model, Tesla also realized they needed to control the overall design and manufacturing of future models.
So to enter a market with new technology like a high-performance electric vehicle without scalable manufacturing limits the options for pricing. Narrowing the market matches the state of what the company can produce with lower volumes. To generate adequate revenue, pricing must be at a premium. But as the company builds out its infrastructure to support the requirements for higher unit production volumes, the opportunity to expand the market for the next phase of early adoption is possible. Tesla launched its Model S focused on the high-end luxury sedan market to compete with Mercedes, BMW, Audi and other car companies. The overall design of the Model S and safety of the this model were critical to its success. Tesla captured market share in this segment and then expanded further into the luxury SUV market with the Model X.
Expand the market with a range of products targeting different segments at different price points
Success in a narrow market offers the opportunity to go bigger. Tesla expanded into a more mass market sedan segment to advance the transition to sustainable energy with the Model 3. This required scaled production to increase unit production into the 100s of thousands of vehicles per plant. And whereas the Model S was positioned around a $90k price point, the Model 3 was positioned more around $50k. And then the Tesla leveraged shared components and production lines to launch a lower priced SUV with the Model Y in 2020. This will likely be Tesla’s best seller in 12-18 months and is the focus of production in the new plants opening in Berlin and Austin, Texas later this year.
Now Tesla is expanding further with a rumored $25k electric vehicle for the mass market in markets outside the US like China and Europe leveraging new Tesla gigafactories in those markets with unique designs. Tesla will also introduce a new Roadster and CyberTruck in the future to round out it passenger vehicle portfolio similar to what Uber has realized with different service levels and pricing for TaaS. And then the final push for Tesla to dominate transportation with electric vehicles to disrupt and then collapse the internal combustion engine industry will be the release of level 5 autonomous navigation for its vehicles that can then be used to build virtual fleets of robotaxis. The demand for a $2 ride that Uber probably validated with its market research will be realized by manufacturers like Tesla and less so by Uber itself. Building a mobile app is not a sustained competitive advantage.
Uber and Tesla provide great insights for business model innovation and pricing for SaaS businesses. A key attribute is both companies narrowed their markets significantly and launched with premium pricing to match the small scale each company could execute in their formative years. However, that also means both companies had to win over early adopters in competitive marketplaces with a superior service (Uber) and product (Tesla). We will explore this topic more in the future.
Best,
Stephen
Nothing in this post is intended to serve as financial advice. Do your own research.