Didi Global Inc., the Chinese ride-hailing giant, has been gearing up for a much-anticipated IPO on the New York Stock Exchange. Its debut on June 30 raised about $4 billion in new funding, giving Didi a valuation of $67 billion.
We can think of Didi as Uber of China. And Uber is in fact a major investor in Didi, though not as its first choice. Didi has been so competitive that Uber decided in 2016 to cede the Chinese market. Uber sold its China operation, and in return it retained about a 12% stake in Didi. You could call it a win-win.
Like Uber and Grab in Southeast Asia, Didi also struggles with profitability. “We have incurred significant losses since inception, and we may not achieve or maintain profitability,” Didi wrote in its IPO prospectus. Didi did earn profits in Q1 this year, but that’s largely due to a one-off investment and not from ongoing operations.
Still, like all things in China, Didi has grown in a market where speed is unmatched by most countries. And it’s the market dynamics that can foretell where the global ride-hailing industry is heading.
I’ve discussed Didi’s IPO on Yahoo Finance during a live TV interview 📺. You can watch it here.
The Big Gets Bigger, But Only Up To A Certain Point
Most companies must make a profit to justify their valuation. The only reason the capital market has been irrationally generous toward ride-hailing apps is because they are platforms. Platforms are attractive because of the so-called network effect. Venture capitalists would argue that the value of a platform largely depends on the number of users. Drivers are on one side of the platform, riders on the other. The more people use a platform, the more inherently attractive it becomes, motivating even more people to use it. And once a platform reaches a certain size, it becomes too dominant to unseat.
Except in ridesharing, it turns out that the mere presence of one additional competitor can lead to ruinous competition. It’s virtually impossible to differentiate product offerings. It’s hard to think about the true differentiation between Uber and Lyft. It’s not the sort of market differentiation that you see between an iPhone and an Android.
Ride-hailing’s network effect is also limited to one location. For instance, if you’re using Uber in New York, you don’t necessarily care about the service level in London. Uber’s network effect is always local. In contrast, Facebook’s network is global. Advertisers such as P&G and Nike care a lot about the size of Facebook’s audience, from London to Hong Kong. The result? Ride-hailing can easily succumb to a price war. Discount coupons and driver incentives quickly eat into profit margins.
The implication is this: A ride-hailing app can work only on dominating one market at a time. It needs a huge war chest to fend off competition. Then it can raise prices for its broad customer base to restore profitability.
And that’s exactly Didi’s strategy.
Stick to One’s Knitting
Didi was founded in 2012 by former Alibaba employee Will Wei Cheng, who currently serves as the chief executive officer. Cheng was joined by Jean Qing Liu, a former Goldman Sachs banker and the current president of the ride-sharing company. In 2015, Didi merged with its rival, Kuaidi Dache.
Today, Didi’s dominance in China is unquestioned. It has grown to account for 90% of all online car bookings in 2020, two-thirds of which come from the top 30 cities. And yet, it suffers dismal results overseas. The company’s expansion into other large developing economies, including Brazil, accounts for less than 2% of revenues.
Compared to Uber and Grab, Didi is far more focused on ride-hailing, staying far away from online food delivery and financial services.
The reason is straightforward. China’s digital economy is advanced. China’s food delivery giant Meituan hit a valuation of $100 billion amid the pandemic last year. Ant Group, an Alibaba affiliate, is estimated to be valued at $144 billion, despite its scrapped IPO last year. These are fierce competitors. There’s no way Didi could edge into their business areas.
Instead, Didi has focused on innovations closely related to its core business. It installed a “SWAT team” to respond to safety incidents. It also installed video cameras in its ride-hailing vehicles. These features are uniquely Chinese and costly. But Didi had to do so after the murder of two passengers in 2018 to restore public trust. Product features must evolve alongside local needs.
And so there is one huge opportunity and one huge threat.
The Final Upside—and the Down
Didi sees promise in autonomous driving. It’s seeing cutting out the need to pay drivers, which accounts for 50% of the company’s costs. It has a team of more than 500 members working on Level 4 autopilot for its fleet. It partnered with Swedish automaker Volvo to supply the autonomous vehicles.
The company also designed an electric vehicle itself, called the D1. It claims it has built China’s largest charging network. That’s more than 30% market share of total public charging volume in the first quarter of 2021.
All these suggest a move toward becoming a transport utility provider. Didi is doing the hard engineering stuff at a time when the capital market is still generous and patient. And if it gets ahead with its autonomous technologies, it can license its algorithm to other fleet companies and carmakers. And that’s a good business.
The real risk for Didi lies in antitrust laws. Its long-term profitability clings to its ability to dominate Chinese cities one at a time. It’s in a business of natural monopoly, which requires tolerance from local governments. And if it’s a monopoly, there’s always a risk of being regulated like a monopoly and being turned into a quasi-state-owned enterprise.
Thanks for reading—and be well.
PS. What’s your viewpoint about the future rideshare economy? If Uber or your favorite app is to increase 10% of its rate, will you still use it at the same frequency as now? What about a 5% discount? Will you use it more?