Lyft started trading on Friday on the public markets and saw its stock price pop as much as 21% before closing up 9% from the IPO price — all this after already pricing the IPO at the high-end of their range. At Friday’s market close, Lyft has a valuation of approximately $24 billion.



In the prospectus, Lyft touts the following:



“According to our internal data, 44% of all rides on our platform start or end in low-income areas.”



This is celebrated as a positive and noble goal of making transportation more inclusive and accessible. And it should be — we all remember the anecdotal stories in the past where certain cab drivers refused to travel to certain neighborhoods in cities. Like most self-serving statistics, I’m not sure how much we can trust the data — for example, a software engineering making over $300K traveling to the Mid-Market headquarters of Twitter in San Francisco might qualify for this statistic. Also, we don’t have comparative data for cab drivers and how often they were doing the same.



Nevertheless, if it is true, then investors should be very scared of this fact because it means Lyft has a high-proportion of price-sensitive consumers. Given the economics of ride-sharing, this is not going to end well.



If you recall, Lyft lost $911 million in 2018. And this excludes stock-based compensation of $684.8 million because Lyft compensated employees with RSUs that vest only upon the completion of the IPO and will be reflected in Q1 of 2019 financials and then going forward.



There is little room to increase the take rate from drivers since they are already earning around minimum wage in many markets. Rideshare Guy’s survey of Uber and Lyft drivers reports $17 per hour earnings on average before expenses. When you factor in expenses (calculated at $5–10 per hour), take-home pay is much lower. It’s not clear where else Lyft can cut expenses to become profitable. That leaves raising rates on riders as an option. However, Lyft still currently feels the need to subsidize ride-sharing, rather than increase prices. Lyft still spent $297 million on driver referral and targeted rider incentive (i.e. coupons) in 2018 which is a form of subsidization. It’s still unclear how much of this incentive is needed as a result of cutthroat competition between Uber and Lyft and how much is inherent in the cost structure of the rideshare model.



Almost certainly, at some point, rates will have to increase and if 44% of riders are price-sensitive and using Lyft as an alternative to public transportation, that means this will cause a substantial decline in demand and revenues for Lyft.

Lyft itself has confirmed the high degree of price sensitivity of its riders in the case when the Taxi and Limousine Commission in New York City imposed regulations that guaranteed minimum earnings for drivers. Although self-serving and only looking at very limited data, Lyft in its analysis found that when passenger prices increased 24% as a result of the regulations, ridership dropped 26% — meaning ridesharing is highly elastic to changes in price.



There’s a real business here. Compared to the taxi industry, ridesharing (a) increases the utilization rate of a dormant asset (people’s cars), (b) improves quality of experience by having a rating system that increases accountability for drivers and riders, and (c) provides a platform that provides a flexible form of income for people (as opposed to someone having to go full-time on being a cab driver). Lyft also has moved into the enterprise car service and health care patient transport ridesharing model which could be additional revenue streams. I anticipate ads might become a key source of revenue as ridesharing companies look to further monetize their ridership and make the ridesharing economics work.



Still, there IS a risk ridesharing could enter a death spiral, in which they raise rates on consumers, which leads to less demand, which leads to less earnings for drivers, which leads to fewer drivers, which leads to frustration by consumers for long wait times and less demand, which in turn leads to less earning for drivers and so on. Hubert Horan, a transportation expert, has held this thesis from the very beginning: https://www.nakedcapitalism.com/2019/03/hubert-horan-can-uber-ever-deliver-part-eighteen-lyfts-ipo-prospectus-tells-investors-no-idea-ridesharing-ever-profitable.html



Frankly, a big influence on the economics of ridesharing may hinge on insurance expense for ride-sharing companies, whether it ends up being a monopoly or duopoly market, and whether years of subsidies have conditioned the consumer to be “addicted” to ridesharing and, therefore, pay more for transportation when prices rise (I doubt it given the above evidence of price sensitivity though VC subsidies on tech services function the same as the drug dealer’s “first hit is free”).



The most likely scenario is that the ride-sharing industry will be significantly right-sized. The taxi industry was never high margin with cab drivers earning low wages and there being little overhead. It’s not clear that the economics of scaling to billions in revenue by paying high salaries to engineers and employees in San Francisco for a technical scaling solution is much better than the more distributed low cost, small business taxi service model.



Lyft will be forced to increase prices to achieve profitability. Its customers are some of the most price-sensitive and will use public transportation alternatives when prices rise. Demand and revenue will decrease. Ridesharing will return to being a luxury — just like hailing a cab used to be.



The casualty will be Lyft’s valuation. I see Lyft losing up to 70% of its valuation today and retrenching to markets where it has a hope of breakeven. Others have said the same. The declining market cap of Uber and Lyft may end up being the “emperor has no clothes” moment for this era’s labor-intensive tech companies.



Cabs may even make a comeback, augmented by technology for hailing such as Curb or becoming a source of revenue for Uber/Lyft (like in Japan where ridesharing is prohibited and Uber hails taxis), and perhaps the best way to short Uber/Lyft is to buy distressed tax medallions in New York.



But remember this as an example as to why people hate Silicon Valley and the tech industry. This is the exit plan for VCs, late-stage private institutional investors, founders, and employees. Many will be very rich. People inside the company deep down know that the economics just don’t work at this valuation and that it will be public investors left holding the bag. The lock-up period for investors and employees lasts 180 days. You can bet that they are counting the days until September 25, 2019 hoping that the public markets can play the fool.

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