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Saudi Arabia invested $3.5 billion in Uber. That could be bad news for the global economy.

Saudi Arabia's sovereign wealth fund is the latest to make a big investment in Uber.
Wajahat Mahmood

Uber has raised an astonishing $3.5 billion from Saudi Arabia's sovereign wealth fund. It's one of the biggest venture capital investments in history and brings Uber's overall fundraising haul to $11 billion. But while Uber is bragging about the investment, it could reveal a troubling trend in investment trends overall.

In the long run, economic growth depends on our ability to convert cash into productive assets like factories, trucks, machinery, or computer software. But for the most part, recent "investments" in Uber aren't like that. Uber is planning to use its billions to fund brutal, zero-sum price wars with competitors around the world.

Those investments might allow Uber to expand its share of the global ride-hailing market and make big profits for its investors. But money spent on money-losing price competition isn't investment. Price wars do nothing to increase the world's productive capacity.

So the fact that so much money is being invested in Uber — and in other companies deliberately losing millions in an effort to gain market share — could be an ominous sign. It suggests that it's getting harder and harder to spend money in ways that boost long-term economic growth.

Uber needs billions to fight price wars around the world

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Uber CEO Travis Kalanick.
Photo by Steve Jennings/Getty Images for TechCrunch

Running an on-demand service like Uber isn't very expensive. It costs some money to build the Uber app and run the servers that power Uber's car-sharing service, of course. But the most valuable assets required to provide Uber's service — cars — are owned by drivers who work as independent contractors.

Uber says it needs money to finance expansion internationally to places like China and the Middle East. But when you run a purely online ride-hailing service that doesn't own any vehicles, there's no reason it should cost billions to expand into new markets.

Uber needs billions of dollars because it's planning to wage brutal price wars with competitors around the world. The company is planning to lose money on every ride and hope it can outlast its competitors.

I have firsthand experience with how wasteful this process can be. In 2014, I spent a week driving for Lyft. At the time, Lyft was running a promotional program where new drivers could earn $1,500 in a week if they drove for at least 50 hours. I signed up and drove 50 hours in my first week. During those 50 hours, my passengers paid a total of $596. Lyft paid me $1,500, which means that my week as a Lyft driver cost Lyft's investors $904 (I donated the full $1,500 to charity). To put it another way, Lyft's average profit margin on my rides was negative 150 percent.

This is obviously an extreme example. That $1,500-per-week offer was only in effect for the first month, and Lyft presumably hoped drivers would stay on and work for lower pay in subsequent months. But something similar is happening in other parts of the world. As the New York Times puts it, "China is a difficult battleground, as Uber is spending millions in a subsidy war with Didi Chuxing, the dominant ride-hailing start-up in the country."

Ride hailing may be a winner-take-all market

App Car Service Startups Continue To Irk Traditional Cab Companies And Regulators Photo by Justin Sullivan/Getty Images

Like many technology markets, ride hailing exhibits strong network effects: The more drivers a network has, the more attractive it is to passengers, and vice versa.

And network effects can be very profitable. The world's richest man, Bill Gates, made his billions from the network effects surrounding the world's most popular operating system, Windows. The world's richest man under 50, Mark Zuckerberg, is currently profiting from the network effects from owning the world's most popular social network, Facebook.

It's a reasonable guess that ride hailing will also become a winner-take-all market, with the winner reaping huge profits.

But because ride-hailing services operate in the physical world, competition happens on a city-by-city basis. Different Uber competitors — Lyft in the United States, Gett in Europe, Didi Chuxing in China, Ola in India — are strong in different parts of the world. So in each of these markets, Uber needs cash to allow it to operate at a loss — potentially for years — so it can gain market share and prevent overseas rivals from gaining the upper hand.

Billions "invested" in sharing-economy price wars won't produce lasting growth

Uber isn't alone. Across Silicon Valley, companies are pouring millions of dollars into money-losing price wars, in hope that they'll eventually be able to turn a profit once their competitors are driven out of business.

For example, in recent years there have been dozens of companies — including Instacart, DoorDash, Blue Apron, GrubHub, and HelloFresh — offering app-based food delivery services. Amazon and Google have also gotten into the market with delivery services of their own.

While the exact business models differ, the basic idea is very similar: People use the internet to order food. And because there are so many companies with similar business models, they wound up taking big losses in an effort to gain market share. Recently companies have started slashing compensation for their delivery drivers in an effort to finally turn a profit.

These price wars were obviously great for consumers while they lasted. But the process of "investing" in money-losing price cuts as a means to gain market share is fundamentally different from investing in productive assets like factories, stores, or computer software.

When companies spend billions in a race to build more advanced factories or better software, that boost's society's total productive capacity. Tesla, for example, recently raised $2 billion to help it expand its production facilities and meet its goal of producing 500,000 electric cars per year. Even if Tesla ultimately fails to turn a profit and goes bankrupt, someone will likely acquire the production facilities Tesla is building and put them to use.

And to be sure, Uber is doing some of this kind of investment itself. Uber recently opened a research facility in Pittsburgh to develop self-driving car technology. That could produce technology of lasting value.

But a large share of Uber's money is "invested" in a price war, which produces nothing of lasting value. Venture capitalists hope their millions will buy them a share of the monopoly profits that will exist once the price war is over. But they're fighting over a fixed pie of profits — a long, expensive price war doesn't lead to larger industry profits in the long run.

The massive investments in perpetually money-losing companies wouldn't be so worrisome if it were happening alongside big investments in companies using the money in more conventional ways. The really ominous thing about Uber's investments is that they dwarf most other venture capital spending. Companies like Tesla — companies that can transform a billion dollars into productive capital assets — seem to be few and far between. And that's a bad sign for the long-term growth of the US economy.