Uber-Didi deal more about China than about Uber, Didi

With the Uber-Didi deal, China has shown the world how to carve out a near monopoly in urban transportation that’s also highly regulated, hugely competitive


Photo: AP
Photo: AP

Let’s lift the veil for a moment. On 28 July, China announces new regulations for cab-hailing services. Barely 48 working hours later, Uber decides to sell out its Chinese business to Didi Chuxing to create a cab-hailing company with over 90% market share. Is it a mere coincidence?

Not likely. If these events are connected, and I suspect they are, then a government/regulator has just facilitated the creation of a monopoly in China, with the Communist Party’s blessings.

China has demonstrated again and again that it will not allow foreigners to control its vital assets—and what’s more vital than its entire digital ecosystem? Almost every Western tech giant has learnt it the hard way—that China has its oligopolies (the trio of Alibaba, Baidu and Tencent) and the government protects them fiercely.

And why not? What China has essentially done is that it has created a giant utility out of Didi-Uber, a near monopoly, highly regulated—yet driven by the profit motive—unlike an inefficient bureaucracy-laden utility.

Now, it wasn’t as if Didi was given all of this on a platter.

This state-led economic model allowed Didi to merge with its local rival Kuaidi. The new merged entity had to then clearly demonstrate that it had the capability to compete with the world’s best. Only then was it anointed a monopoly and allowed to buy Uber. In a sense, the fittest has been rewarded, provided that it eventually plays by the rules that were set for it.

The logic behind this economic model is simple: the government knows that a state-controlled enterprise will not be able to harness the energy of its entrepreneurs, so it carves out markets for them to play in, provides a cushion of state debt and benign regulations, and allows them to build scale rapidly.

Here’s an excerpt from The Economist:

“A third group of firms appears to be fully private, in that the government owns no direct stake in them. Their bosses are not political appointees, and they are rewarded for commercial success rather than meeting political goals. But they are still subject to frequent meddling. If they are favoured, state-controlled banks will provide them with cheap loans and bureaucrats will nobble their foreign competitors. Such meddling is common in areas such as energy and the internet.”

This schema has been used in company after company—allowing the build-up of the three giants who rule the roost in their respective “core” segments. Alibaba for e-commerce and payments, Baidu for search, and Tencent for social media. Of course, these companies compete, but they do collaborate when they get a gentle nudge from the powers-that-be at the Communist Party office. An example of this is Alipay—which was allowed to grow despite there being no regulatory framework for online payments. Today, Alipay has over 450 million users and has almost 70% market share in mobile payments, and has created a frictionless escrow and payment system which has been the bedrock of China’s Internet boom.

This is the reason that no Western Internet company has been able to make any headway into China. Google and Facebook have been effectively kept outside the market. Amazon lost the battle and gave up. Only Apple—which has a huge manufacturing base in China and has created jobs there, and has agreed to comply with demands of the Chinese government regarding storage of Chinese users’ data—has been able to craft a working arrangement to build its China business.

Here’s a bit more perspective from The Wall Street Journal:

“President Xi Jinping—with the help of conservatives in government, academia, military and the technology industry—is moving to exert influence over virtually every part of the digital world in China, from semiconductors to social media. In doing so, Mr Xi is trying to fracture the international system that makes the internet basically the same everywhere, and is pressuring foreign companies to help.”

The context in this piece may be Internet censorship, but the broad principles drive the Communist Party’s agenda of “Internet Sovereignty” and putting its Internet businesses behind the “Great Firewall”. Uber’s case is another example of success—ironically, Didi-Uber is now a monopoly whose significant shareholders are the Chinese trio of Alibaba, Tencent and to some extent Baidu. If anything, these three shareholders will strengthen Didi’s monopoly by blocking any local entrant. Between the three—they control over 70% of China’s Internet traffic.

In the case of Alibaba, the unprecedented state support initially was evident, as this story from Forbes points out:

“Since the early days, Alibaba has been supported by the Chinese government which used Alibaba’s Taobao and Tmall sites to do billions of dollars of transactions between various government agencies which allowed Alibaba to post eye-popping revenues and growth in the early days.

“The Chinese government still conducts a lot of trade between its various agencies using Alibaba platforms so as to ensure the continued scorching growth rates that Alibaba has been able to post year in and year out.

“In almost every single line of its various businesses, Alibaba is by and large protected by the government from foreign competitors. I have been saying for almost a year that between the government related intra-trade and the sale of fake goods that occur on Alibaba’s various B2B, C2C and B2C trading platforms, there is not a whole lot of actual business occurring when looked at on a percentage of overall revenue basis. A large portion of Alibaba’s revenues on its various auction sites continue to be various Chinese government entities doing business with other Chinese government entities.”

If you pull back, you have to simply marvel at the ingenuity of the Chinese. After all, the objectives of its strategy are remarkably clear: protect a few domestic firms, allow them to build efficient near-monopolies and in fact, actively encourage them and then govern them with a benign eye to ensure that they don’t abuse their power. You get the best of both worlds—a bunch of entrepreneurs who are driven to compete and make billions, and an efficient utility for your consumers that cuts down transaction costs and friction in your economy.

The Chinese don’t see the fact that a few billionaires get created along the way as a large social cost, particularly because those billionaires are beholden to them to do their bidding—and will not abuse their firms’ monopolistic powers against Chinese consumers. This allows the creation of large, scalable cash-rich companies, which have the economies of scale to compete in international markets and buy the best technology assets.

Also, the fact that the Chinese government has serious global ambitions for its local giants is self-evident. In 2014, a report in Bloomberg pointed out how the Chinese government had supported Alibaba in every which way:

“Chinese government officials are eager for a local company to break into the ranks of tech’s global elite, and the huge payoff for Alibaba will highlight just how valuable official Chinese support can be.”

We’ve yet to see a global success story—but I think we are at the cusp of ownership of a global tech company by the Chinese.

This is not to say that we can or should follow the same system in India. We are vitally different at the core. The government or a political party does not “run” our businesses or our lives. In effect, our regulations are designed to avoid the creation of monopolies. There are structures that create oligopolies which are “natural monopolies”—that is, public goods are auctioned out, like for instance in telecom, the regulators work hard to ensure that monopoly power is not abused. Unfortunately, this leaves Ola to fend for itself—the large marquee investors in Ola have already hedged their bets by investing in Uber—so in the betting game of venture capital, they are a bit indifferent to Ola surviving as a stand-alone company.

Now, coming back to Didi, it is entirely possible that the 20% stake in the combined entity for Uber China (Uber gets a 17.7% stake but only 5.9% of the voting rights in the new entity; investors in Uber China, including Baidu, will get a 2.3% stake) is not born of any economic rationale, but more of a negotiated settlement accorded by the powers-that-be in exchange for perpetual licence and access to the technology Uber creates—a way for China to secure the best technology for its urban transportation and autonomous travel sector. Of course, the way Uber will portray it is that it gave up a battle to fight the war.

It isn’t just Uber chief executive and co-founder Travis Kalanick who deserves kudos for his strategic retreat from the Chinese market. We also need to reserve some for the Communist Party bureaucrat who stitched up this deal.

AUTHOR’S NOTE:

Soon after I wrote this piece, things became even more interesting. Bloomberg reports that Didi and SoftBank are investing in South-East Asian ride-sharing service Grab. This would be unexpected for Uber?—it suddenly finds its new “joint venture” partner in one market has started pumping in huge amounts of funds into its competitors, in essence strengthening an alliance against Uber that is a threat to its plans for global dominance. (Last year, four of Uber’s biggest competitors formed an alliance christened “GOLD”, comprising GrabTaxi in South-East Asia, Ola in India, Lyft in the US and Didi Kauidi in China.)

What’s amazing is that this move comes even before the halo that Uber has done a clever deal has faded.

Was the Uber-Didi deal even more one-sided than one imagined when I wrote this piece?

Uber hasn’t just been outcompeted by Didi in China, it has been outflanked by an ecosystem that worked both overtly (by blocking off Uber from WeChat and Alipay—dominant chat and payment platforms in China) and covertly by the Chinese regulators and government.

This begs the question: was Uber’s retreat a strategic one with clear terms of engagement—that is, defined terms of cooperation and non-competition in other markets (assuming that the Grab-Didi deal predates the Uber-Didi deal and the South-East Asian market is part of the cooperation terms)?

Or was it a “take it or leave” retreat—and Uber has to independently fight battles in markets where Didi and the GOLD (Grab, Ola, Lyft, Didi) alliance plays?

The South-East Asian, Chinese and Indian markets probably comprise half the total addressable market for Uber. Together, they have over three billion people and a car-starved, poor public transport infrastructure. Why would Uber give up half its potential market—especially a growth market that propels its valuation? If eventually, Uber expects everyone in the world to use UberPool (shared car or shared shuttle), most of its customers are here.

It is tough to guess which scenario is true. But what’s clear is that we are headed towards a bipolar world in the ride-hailing business—much like in other Internet services. With Silicon Valley (Amazon, Uber, WhatsApp, Twitter) on the one side and China (Alibaba, Didi, WeChat, Weibo) on the other.

This bipolar world is what the Chinese want. They’ve released a five-year plan with the aim to be a counter-force to the Western dominance of the Web. President Xi Jinping has set his eyes on making China an “internet power”. The bigger war will start when China and the US go head to head in areas beyond commercial interests in the consumer businesses, into strategic issues like encryption and governance of the Internet.

In conclusion, there are two possible outcomes for Uber from its deal with Didi: 1) the world’s highest valued private Internet company, after having taken a drubbing in China, is either pitted against an arch-rival backed by a group of China’s Internet giants, or 2) it has struck a compromise which carves up the world into two parts—one which Uber will dominate, and the other with Didi. And to boot, the cross-holdings (and the moves they may make in the next few days) now make matters so complex, that when one of them loses in a market, does the other win or lose isn’t going to be immediately clear.

This changes things for Ola in India, which has both Didi and SoftBank as investors. Could the combination of these Chinese entities make moves to outmanoeuvre Uber in India?

Without being privy to the contract between Uber and Didi, it is only their actions which will indicate how things will play out, and not their public-speak. Uber CEO Kalanick has claimed a victory; Didi president Jean Liu claimed that their “love will last till the end of time”.

It is great study material for students of Game Theory—is this competition, coopetition or something new?

Read more on www.foundingfuel.com

Haresh Chawla was founding chief executive of Network18. He joined the firm in 1999 when it had revenue of Rs.15 crore. When he moved out in 2012, he had built it into a Rs.3,000 crore media conglomerate. He is now partner at India Value Fund, and mentors several start-ups.

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