Fifteen years ago Joan Magretta (HBR) observed that all business models must satisfy two tests: the narrative – does the story make sense – and the numbers – does the P&L stack up. This remains the standard today.
The narrative has both an emotional and a logical dimension. At the emotional level the narrative needs to connect with several audiences, particularly start-up investors and employees. Guy Kawasaki – serial entrepreneur, venture capitalist (VC) and former Chief Evangelist for Apple – laments the number of entrepreneurs who pitch to him saying ‘we want to make money’. His response: “it’s so depressing … successful companies are those companies that set out to ‘make meaning’, to change the world”.
Uber’s ‘emotional’ appeal stems from the fact it displaces a service many of us find dissatisfying (at a much reduced price). And it allows people to ‘opt in’ as drivers, offering them employment flexibility few of us ever experience. This emotional appeal is a major factor in the explosive growth of Uber – and the explosive growth of Uber is a core element of its business model.
There are other possible overarching narratives. Uber could also displace car ownership; or a third possibility being discussed is as an alternative ‘last mile’ delivery service.
The second dimension of the narrative is the compelling logic: this ultimately shapes the numbers. Valuation expert Professor Damodaran (NYU) argues that “a good valuation is more about the story than the numbers … if the valuation proves to be wrong, the problem will be in the underlying narrative, not the numbers”.
In valuation we should adopt the philosophy of President Dwight Eisenhower (as a General in the Armed Forces):
In preparing for battle, I have always found plans are useless, but the process of planning is invaluable
The pursuit of the numbers forces us to make explicit our assumptions, and crystallises the value drivers within the business model. These critical value drivers focus our thinking at each successive level of business model design.
An exchange over the valuation of Uber illustrates the linkage between the narrative and the numbers. In June 2014 Damodaran valued Uber at $6B: at the time VC’s were valuing it at $17-18B. Bill Gurley, a venture capitalist and investor/Director in Uber, responded that Damodaran had missed the valuation ‘by a mile’ and attacked two fundamental assumptions: the total available market (TAM); and the potential market share.
Damodaran’s overarching narrative was that Uber would capture around 10% of the urban cab/limousine service market – worth an estimated $100B per annum – but that it would maintain its relatively high profit margin.
Gurley argued the TAM was much greater:
- The numerous improvements with respect to the traditional model – better pick up times, cashless transactions and more pleasant rides – will expand the market;
- The radically different economics – UberX is typically around 50% of the standard taxi fare – will dramatically expand the market volume (price elasticity);
- ‘New users’ will be induced into the market.
According to Gurley Uber’s experience in San Francisco is that the market is 3-6x the base taxi market: TAM ca. $300-600B.
Gurley’s narrative underpinning the market share is one of network economics captured neatly in a napkin sketch (literally) by David Sacks (former Pay Pal COO and founder of Yammer): viz.
Gurley argues a market share of 50% plus ‘is not unreasonable’ under these conditions.
The ‘narrative and numbers’ expose the critical issues for scrutiny. It allows us to test the underlying logic, and focuses our business model design on the critical value levers. Adopt the McKinsey mindset: what would I have to believe for this to be true?
There are other important elements of the business model which are not canvassed in this exchange. For example, the current model means that the drivers are not employees, releasing Uber from the myriad costs and complications associated with employees: minimum wages, health care (in the US), unions; rosters; laying off poor performers and many others.
There are also the strategic issues that surround the business model: the competitive responses:
- How will the incumbent taxi industry respond? The incumbent can copy most parts of the Uber model except it cannot match the availability of cars without destroying the capital value of its license network;
- How does Uber outrun those who seek to copy the essence of the model, but refine it to create a point of difference?
And what will be the legislative response? The Uber model circumvents two core legislative domains: it overcomes the need for a taxi license; and its drivers fall outside traditional employment legislation.
So what? The Uber case study illustrates beautifully the power of combining both the narrative and the numbers. No-one can afford to ‘play’ in just one dimension.
Ask yourself these three questions about your business model:
1. Can you describe your business model with a powerful narrative that reflects both an emotional appeal and a compelling logic?
2. Have you applied the valuation mindset to expose the logic and tease out the core underlying value drivers?
3. Does the next level business model design conversation focus on reinforcing these value drivers?
 Putting aside the possibility that the employment is at rates that below minimum wage rates
 Although Damodaran acknowledges he has had to work hard to improve his narrative style; his natural preference is the numbers
 This suggests that the demand (# trips; distance) is up to 10x greater than the taxi market: a staggering number if true
 Damodaran argues that the network effects will not be that great because the service and is both physical and localised. The detail of this argument is outside the focus of this blog