Why Uber Failed in China

Hey guys — big news: Today I’m launchinga brand new channel called “A Hill to Die On”. Stick around after this video to find outhow you can be the first to watch it right now thanks to today’s sponsor, CuriosityStream,where you can watch thousands of great documentaries, and Nebula — together just $15 bucks a year. It’s happened countless times before: Athriving American company enters China with 1.4 billion dollar signs in its eyes. It sees in the country almost the ideal market:A middle class well over twice as large as its own and without the generational brandloyalties of America. Because China was relatively late in its technologicaldevelopment, it almost entirely skipped transitional, “in-between” inventions like desktop computersand credit cards, making Chinese consumers generally less skeptical of new technologieslike smartphones. Best of all, all this is available throughone international expansion, one regulatory system, one language, and one culture. Or so, companies think. What they find is often very different. Relaxed regulation turns out to mean the lawis ambiguous and enforced selectively.

Once a business model is proven, competitionmay spring out of nowhere, sometimes with no regard for intellectual property. And what looks like a single, unified marketfrom the outside becomes thousands of unique ones up close. It’s happened, in one form or another, toAmazon, Google, Mattel, eBay, Home Depot, Groupon, and many others. Uber, however, was sure it was different. It wasn’t ignorant of the titans that hadfailed before it, but, in the mind of its outspoken founder, Travis Kalanick, Uber hadfaced many “impossible challenges” from the very beginning — fighting hundreds ofangry cities as the company rapidly expanded across the U.S. Its very business model was at best legallyambiguous, and yet, it succeeded anyway, giving Kalanick a certain unchecked confidence whichmade China look like only another of its familiar hurdles. And to its credit, Uber did not make the classicmistake: Directing the expansion from conference rooms in San Francisco. It tried very hard to build “Uber China”,not merely Uber in China.

After boldly declaring it the company’s“number one priority”, Kalanick devoted himself to the expansion like nowhere else. He spent 70 days of 2015 in the country — nearly1/5th of the entire year. He even joked that he should apply for Chinesecitizenship. Uber created a separate, Chinese company,partnered with local investors like the Chinese tech giant Baidu, and launched in 2013 inthe country’s largest city, Shanghai. At first, things were rocky. For example, it launched with only US creditcard support, making sure the vast majority of locals, who use WeChat and AliPay, wereunable to book rides. Just as embarrassing, the app used GoogleMaps, which is notoriously bad in China. By far Uber’s biggest problem, however,was, well, its entire business model. The company doesn’t own its cars or hireits employees, meaning its only value is connecting people who want to drive to nearby peopleto want to ride. But because drivers and riders are regional,entering a new city is like starting from scratch. Uber may have a monopoly in LA, but that won’tmean anything when it expands to Seattle. The good thing is that once it has the criticalnumber of both drivers and riders in a particular city, they’re very likely to stick withUber.

It only takes 2.7 rides, according to thecompany, before someone becomes a permanent customer. Uber’s strategy, therefore, was to growwith lightning speed. Every major city had its own general manager,who would tempt new drivers with bonuses and new customers with free rides. Becoming a driver was easy, no long backgroundchecks or complicated forms required. This worked pretty well. When it was first. The problem was that, in China, it wasn’t. It’s Chinese competitor — Didi — wasfounded in 2012 and had everything Uber needed: immense scale, a China-first design, and thesupport of government. While Uber operated by disrupting the taximonopoly in each new city it entered, Didi was much more old fashioned — it merelyconnected riders to existing licensed taxi drivers. So instead of inciting chaos and even violencelike Uber, Didi was on the good side of authorities — even helping manage over 1,300 trafficlights in partnership with city governments. In 2015, Didi merged with its closest competitor,giving it near-monopoly control of the market. It became the only company in the world backedby all three of China’s tech giants: Baidu, Alibaba, and Tencent. Apple and China’s sovereign wealth fundalso invested around that time. Uber was behind from day 1. If a Chinese user already had Didi, the onlyreason they’d switch is if it was that much cheaper. To catch up, Uber had to dump insane amountsof money. And, that’s exactly what it did. Uber spent a jaw-dropping $40-50 million USdollars per week on free rides and bonuses in China. It lost, in total, $1 billion every year. With Didi, it played a massive game of chicken— spending this much money was unsustainable, but who would give up first? This metaphorical arms race also created akind-of cold war dynamic. Didi allegedly sent undercover engineers tobe hired by Uber, where they would collect trade secrets and even conduct sabotage. On occasion, Uber would be blocked from WeChat. In China, this was the equivalent of Googlehiding a competitor from its search results — making it effectively invisible to thevast majority of the country. And besides burning through cash like it wasfuel, this subsidy-war also led to an unintended side-effect: fraud. In one Chinese city, Uber reported havingas many drivers as London, Paris, and San Francisco combined. But how many of them were real? When a “new” user was offered a free promotionalUber ride, the company still paid the driver as normal. This created a loophole. Two users, one acting as the “driver”,and the other as the “rider” could collude, taking a fake ride, and splitting the profit. Soon, scammers created entire circuit boardswith rows of SIM card slots, each simulating a fake phone. They would take a fake ride, swap out SIMcards, and repeat. In one Chinese city, fraud accounted for anestimated half of all rides. Over 30,000 fake rides were taken every dayin the summer of 2015, just in China. Uber fought back by creating a database ofIMEI numbers, which are unique to a given phone and thus allowed the company to identifya scammer even after they had reset their phone.

However, Apple hid this number from developersstarting in 2012 for its users’ privacy, preventing Uber from detecting fraud. Uber was undeterred and hired a 3rd partyhacking company to bypass iOS’ security rules, which, Apple discovered, warning themto stop. In its typical fashion, Uber continued anyway,adding a line of code to check if the app was running in Cupertino, California, whereApple is headquartered, and if so, not break its rules. Apple still found out, and called a very angrymeeting. Things were not going well for Uber. It faced massive fraud, trouble with Apple,and over $1 billion a year in losses. Then came the final nail in the coffin. For its first few years in China, Uber operatedin a legal grey area. Like in the U.S., this subjected it to varyinglevels of retribution based on the mood of each municipal government. In the Southern city of Guangzhou, policeraided the Uber office at midnight, accusing it of running an illegal business. In Hangzhou, another police raid was followedby a violent confrontation between Uber and taxi drivers. All this changed in July 2016, after a seriesof high-profile crimes committed by Didi drivers. China legalized the industry, which came withstrict new regulation, like there could be no subsidies and drivers required 3-yearsof experience. From now on, Uber would need to request formalapproval from the local and national government before expanding to each new city. At the beginning of that year, Uber operatedin 37 Chinese cities to Didi’s 400, and had 229 million daily active users comparedwith 908. Just a few short years after it had sprintedinto the country with supreme confidence, it had all finally become too much. Just days after the new regulations were passed,Uber China was sold to Didi. Uber took a 19% stake in Didi, and the leadersof both received positions on each other’s board of directors. Whether this was an embarrassing failure ora diligent strategic decision is still open for debate. On one hand, Uber unequivocally did not achieveits original goals of conquering the Chinese market. It left with only a minuscule market shareand incredible losses. It did not succeed where others had failedin China, and even though government protectionism may be somewhat to blame, Uber certainly mademany unforced errors along the way. On the other hand, Uber spent $2 billion onChina and left with assets valued at seven billion dollars. Viewed purely from the balance sheet, Chinawas, unlike most of the company’s markets, a source of pure profit. It could now invest that money in other, morewin-able markets in Southeast Asia and elsewhere. So, a failure, yes. But, also, a profitable one. It’s too late to get in on the ground floorof Uber, but you can be one of the very first subscribers to my new channel, A Hill to DieOn. Go subscribe now to watch the first two videosas soon as they’re released on October 27th at 11 am Eastern. But, you can also watch them right this secondon Nebula. Nebula is the streaming site I built alongwith my fellow creators to give you the very best viewing experience. Think of it as the “expansion pack” forYouTube: you get videos ad-free, early, with bonus content, and entirely exclusive Originals,like the game show “Money” hosted by Tom Scott.

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