Opinion: Why Uber and Careem should merge

We’ve been hearing the rumors about Uber and Careem discussing a potential merger for months now. Both the companies have been careful with how they respond to questions around it but haven’t denied the talks. They’ve also received warnings from Egypt’s competition watchdog that intends to slam heavy fines if the two companies move forward with the merger without authority’s prior approval.

After Careem successfully raising $200 million in latest funding two months, the rumors seem to have died for now but the merger can still not be ruled out.

Many in the region are against the merger or acquisition (whatever you’d like to call it) but in this article I try to explain why it makes sense for both these companies to merge their businesses in Middle East & North Africa. Here are my two reasons.

1) Unit economics do not support price discounts

There’s this common conception about the ride-hailing industry when it comes to competition. Investors and the media often label it as a “winner-takes-all” industry. That may be true for some of the markets, not for all of them as all markets were not created equal. And that explains Uber’s withdrawal from several high-growth regions including Southeast Asia, where it sold its business to Grab and China where it exited to Didi.

The biggest ride-hailing company of the world, however, has been successfully navigating its way in the US and even though its losing market share to its main rival, Lyft, Uber is, dare I say, is close to profitability (or breaking even) in at least some US cities. This brings me to my primary assumption; some markets are pure volume plays, operating on depressed prices. Compound that with the nature of ride hailing to dominate on the supply and demand fronts and you get a market unable of sustaining competition; a true winner-takes-all.

The process of identifying which markets are low-margin is quite arbitrary in the absence of any detailed financials from any major ride hailing company, but a lot can still be inferred from what’s available in the public domain.

Ride hailing companies operate on the core premise that their services are cheaper than the local taxi service. Yes, there are several other key features including higher quality and friction-less payments, but pricing has always been key for acquiring users. Looking to a market’s local taxi industry can provide limited insight into a market’s profitability structure.

Most Uber markets operate at a significant discount to local cab services

Cities in the US and Europe have Uber fares at more than 20% below cabs.

The basic foundation of a ride hailing company’s business model is following:

1. Undercut a local market’s taxi service on pricing and spend heavily on customer acquisition (CAC), meaning negative contribution margin
2. Low pricing grows the demand-side of the ride hailing network (riders) and in turn, the supply-side grows (drivers)
3. The network hits its liquidity threshold (minimal wait times)
4. Sustained low pricing and lowered CAC, resulting in positive contribution margin

Pressured pricing can however spoil that progression. In cities with cheap and accessible taxi services, a typical ride hailing company (let’s call it ‘XYZ Cab’) cannot easily compete on pricing, but can only use it as a gateway to customer acquisition and pray that they stick around when it raises prices and pulls back on the discounts and free credit. Here’s how the business model plays out for XYZ Cab.

1. Discount pricing… check
2. Network establishment and growth… check
3. Liquidity threshold… done
4. Low pricing + high CAC means negative contribution margin

Typically, XYZ Cab would be unable to raise prices, provided that the alternative being a taxi is already cheap. Instead, XYZ Cab would continue subsidizing its rides through offers and discounts to maintain its network liquidity, raising its CAC and burning cash in hopes it can drive out competition, but that doesn’t happen, at least not fast enough. Soon enough, XYZ Cab finds itself stuck in low-margin hell with no way out.

Data shows that markets with pressured pricing are typically large metropolitan cities in developing countries, with cheap and accessible taxi services. This is not only true of some key markets in Southeast Asia, but also Middle Eastern cities like Cairo, which is one of the biggest ride hailing markets in the region and certainly a contested battle ground between Uber and Careem. Unit economics are however more favorable in the Gulf region, with room to undercut local taxi services and still get the contribution margin in the green.

2) Low motorization rate is a structural supply bottleneck

While unfavorable unit economics might be exclusive to Egypt, markets across the Middle East are capped with limited supply, just like Southeast Asia, with below average motorization rates. This in turn creates two major roadblocks:

• Operating below the liquidity threshold: Less drivers raises a ridehailing company’s average wait time, rendering its network inefficient.
• CAC inflation: Limited supply can take a further toll on CAC as two-sided marketplace CAC will be a sum of spending on both user acquisition driver acquisition. The scarcer the drivers, the higher the spending.

The Middle East and S.E.A share a lower motorization rate compared to Europe

Egypt, Saudi and Turkey are collectively 58% below the average global motorization rate.

There is no plug-and-play answer to why this merger should happen, given the disparity in market structures across the region, but with most countries coming short on pricing, supply, or both, means that the best way forward for the two companies is consolidation.