Uber is using a powerful business strategy to grow into a formidable business. Image: Uber.
Sometimes businesses that look very different from the outside can use surprisingly similar strategies that make billions for investors. Today, Uber is taking a page out of Microsoft's (MSFT 1.57%) book from the 1980s to not only take over the transportation market, but also to spread its wings into new products such as merchandise delivery.
Here's a look at the strategy the two companies are using to rule their respective industries.
The power of the network effect
When computers were new to households and businesses in the late 1970s and 1980s, one challenge was teaching people how to use them. An Apple Macintosh, for example, was very different from a Microsoft DOS- or (eventually) Windows-powered computer.
The more people you could train to use your operating system, the more likely they would be to buy your operating system. The more people using your operating system, the more software developers would create. More software would attract even more users, and so on. Microsoft's operating system business was like a snowball rolling down a hill, growing ever larger as it goes. This is the network effect and it's how Microsoft came to dominate PCs, something it is still profiting from today.
To start the process, Microsoft opened up its operating system to developers and corporate IT staff in ways that Apple wouldn't. In doing so it was able to become the standard in corporate PCs. Once users knew how to use the PC they were more likely to buy one at home.
For Uber, the network effect is equally important, but it's a network of drivers instead of operating system users. More drivers means faster service for customers; fast service times will draw more customers, which will attract more drivers; the cycle continues from there.
UberX has waged a price war against Lyft in the past year while offering minimum guaranteed rates for drivers. This is helping to push Uber's widespread adoption and growth. Low prices attract customers while guaranteed wages keep drivers happy. This keeps the network effect snowball rolling downhill.
Eventually, Uber wants to be the default service for both drivers and people looking for a ride. But that's not where it's going to stop.
UberX is bringing millions more potential drivers into Uber's network. Image: Uber.
Expanding beyond taxis
Uber doesn't just want to use the network effect to dominate the taxi or personal driver market. It wants to expand that infrastructure well beyond transporting people to transporting merchandise.
We're seeing that with UberRush, a delivery service recently launched in New York City. With UberRush, you can order products from merchants and a driver will deliver them, or Uber can courier packages between two places for you.
This is another way to simultaneously keep Uber drivers busy and add value for customers. But I think this is just the beginning. Imagine if Uber were a delivery option for locally ordered items, whether a pizza, a handbag, or groceries. The company could be integrated into mobile ordering systems, accessing your location when you order and matching up the nearest driver for the fastest delivery. It could be a faster way to deliver goods than Amazon.com could possibly create.
If Uber can grow its network of drivers, which stood at 162,037 active drivers in December, there's no telling what markets it could disrupt next. It's all because of the network effect that makes Uber more popular just because it's popular in the first place.
One way to generate incredible returns
The network effect is one of the most powerful tools a company can use to grow and create a durable competitive advantage in a market, but it's also relatively rare in business. That's why Uber is fighting so hard to keep Lyft from becoming a major competitor, and why it is offering high minimum wages for drivers and low prices for customers. Once the network effect takes hold, Uber will own its market just like Microsoft did in PCs.
That's not a bad strategy to follow, and it could make Uber worthy of the $40 billion valuation it has already received from investors.
