Background - The Taxi Business Model
The Poor Driver...
Dear Readers,
I recently had to take a taxi due to work-related reasons, and on my ride back home, I had a fascinating conversation with the driver. I say, fastening conversation, but the poor driver had to live through my "interegation" as I tried to sustain my curiosity. Anyway, our discussion revolves around how he operates his cab, how he earns money, how he could go to his competition, etc. Through the conversation, I realized that I have never thoroughly thought through the actual business model of how taxis can operate. I have heard that Uber and other ride-sharing apps will take over the taxi business for years, but is this true? Let's take a look and try to come to some conclusions.
BRIEF HISTORY
When the wheels of everyday life come off the rails, it's the taxi that gets us back on track (I know, cheesy, I am just simultaneously studying the rail business), but where did this unsung hero come from? The next time you hail a cab, spare a thought for the centuries of history behind this simple act. From ancient dignitaries to modern-day emergencies, taxis have been there, often in unexpected ways, to transport people in need.
The early traces of taxis could be traced to ancient Greece and Rome. Here, unlike the trademark yellow cabs, wealthy citizens used litter carried by slaves to navigate the city streets. Of course, that is hard to relate to in today's world, but a parallel can be seen in Rickshaws (person-pulled carriages, you can Google it, they look pretty cool), where street vendors can still "drive" clients to destinations. The notion of taxis stalled until more road infrastructure was systemized, and the demand only picked up for such service in the 17th century when cities were getting more dense. In 1605, horse-drawn carriages for hire appeared in London and Paris. These were called "hackney carriages" (from the French word hacquenée, meaning an easy-to-ride horse). The first "machine" power taxis came in 1823 when steam-powered taxis were introduced in London. Here is a little-known fact: electric-powered taxis (Barsey electric cabs in London in 1897) came before gasoline-powered taxis (in 1899 by Daimler in Germany). Another significant development in the history of the taxi was the introduction of the taximeter in 1907 (New York).
While researching taxis, I also came across this very cool fact in history that was completely unexpected. The fact revolves around taxis significantly contributing to a WW1 battle, securing a French and British victory over the Germans! During the First Battle of the Marne, in a 24-hour window, about 600 Paris taxis carried 6,000 soldiers to the front lines, a distance of fifty kilometres. This action surprised the Germans, who witnessed one of the first recorded uses of motorized transportation in battle (September 7, 1914). Even more fascinating is that, following city regulations, the taxis dutifully ran their meters. The French treasury reimbursed the total fare of 70,012 francs (about USD 429,422 or CAD 584,014 today).
Today, the taxi industry is on the brink of a revolution as self-driving cars are hitting the roads (Google's Waymo, Tesla automation, various Chinese EVs). Robo-taxis promise a future of safe, efficient, and accessible transportation. But what does this mean for the classic taxi? Will it evolve or become a relic of the past? One thing's for sure: the idea of taxis is not going anywhere.
PLATFORM ECONOMICS
Suppose we zoom out and think of what, in essence, is a taxi operation (whether it be in the form of a taxi-sharing app or a city providing transportation). In that case, it's a platform whose primary focus is to make it easy to connect drivers willing to provide a service with passengers looking for a ride. The drivers are attracted to a system where many available passengers require their service (granted with adequate pay). For the passengers, the incentive is to use a service that will provide a driver with quick and safe travel to their destination within a reasonable time (granted, it is not too expensive of a service). These incentives push for a system that encapsulates an extensive network of drivers and passengers that, with its scale, satisfies the different incentives of both parties (also called platform economics). Again, the more drivers, the less time a driver needs to get to a passenger and make the system more efficient. In a way, the bigger this platform gets, the harder it is to switch due to habit formation and the ability to optimize for the number of users to keep prices relatively competitive. So, to paraphrase and emphasize, if I'm a passenger and need a driver at time x, I'm more likely to find it with a higher-rated driver platform. Plus, the ability to choose between more drivers is also a plus. If I were a driver, the more passengers “online”, the more work I would be able to acquire. Other things to keep in mind with the platform:
- Multi-homing is common (users could concurrently use many alternatives, such as a taxi + Uber)
- Switching costs for the user are minimal ( the user can switch, and it doesn't cost them much)
- Users are more sensitive to price than to brand loyalty (otherwise, it would be hard for ride-sharing apps to pop in and out)
- The drivers usually have varying incentives than their platform
BUSINESS MODELS
While the underlying premise of connecting drivers with passengers remains constant, the business models through which taxi operations generate profits vary dramatically worldwide. These variations often reflect local regulatory environments, cultural preferences, infrastructure constraints, and historical precedents.
Before examining these models, it's worth noting that passenger incentives remain remarkably consistent across all systems: price, speed of service, personal safety, and ride availability (through my research, it seems passengers are most sensitive to price, as evident in Asian ride-sharing markets, with uber an exception in the north american market over its "cheaper” competitor Lyft... contradicting I know). Some passengers may prioritize additional features like vehicle comfort or environmental considerations, but these represent specialized market segments rather than core demands.
The Traditional Medallion Model
Even though I'm putting this all under the "traditional model" umbrella, this model encompasses several variations; still, they all share a common foundation: artificial scarcity created through government-issued licenses or "plates" (Cities limit the number of plates ostensibly to prevent oversaturation that would make the business unprofitable for drivers, though the real beneficiaries are often existing licence holders). The business model is relatively straightforward. In a typical mid-sized North American city, a driver might pay $1,000-$2,000 monthly for plate rental, then earn revenue through metered fares. The profit equation looks like this:
Driver Earnings = Meter Revenue - (Gas + Maintenance + Plate Rent + Insurance + Vehicle Depreciation) - Taxes
There are variations on this model; one such variation is an additional player in the value chain who primarily acquires the plates and then directly rents them to operators (officially to make it easier to transfer plates between operators). Another thing to keep in mind is that taxi operators would invest in taxi medallions and treat them as a sort of investment vehicle. For example, New York taxi drivers would buy taxi plates at the start of their careers and work throughout their lifetime, banking on the fact that the New York population would grow over the decades and then cash out at retirement. At their peak in 2013, New York taxi medallions traded for over $1 million each.
Leasing Model
So, back to our intermediary companies. One model exists (which, by the way, was the model my taxi driver (who gave me a ride) followed) where cities sell operating rights to intermediary companies, who then bundle services for individual drivers (as a flat fee or a % of revenue or a combination of both). Here, the lease companies can offer the service of leasing a vehicle, providing a brand name, service application, bundled insurance and much more. For example, for a flat fee of 1300 (in my city, this ranges from $1300 to 1600 depending on the bundle), drivers get a plate, network access, insurance, and unified branding (such as the same logo and car colours). A more comprehensive package is available that allows you to include a vehicle arrangement for a driver. This bundle would run you $3300 to 3600 a month, depending on vehicle size and type (hybrid, gas, electric).
In this model, there could be misaligned incentives between the operators and the tax drivers: the misalignment stems from the drivers preferring not to have too large of a network of drivers (to the point where customers are not turned away) to reduce competition between themselves. However, the leasing company's revenue depends on maximizing the number of active drivers paying monthly fees. Picture a busy downtown intersection: passengers love seeing multiple available taxis, but each driver sees a sea of competition for every fare.
Driver Equation: Revenue from Fares - Lease Fee - Gas - Maintenance - Taxes = Profit
Lessor Equation: (Lease Fees × Number of Drivers) - City Fees - Insurance Loss/Gain - Vehicle Costs (Vehicle Depreciation, Maintenance) - Marketing fees - Platform fees - Taxes = Profit
The lessor has predictable, scalable revenue; the driver faces variable income that decreases as more drivers join the network. Again, you could find variation where a lessee also gets 10% of the revenue, but the principle of the model remains.
Partner Model
You may think, why have a lessee in between? Can't you partner up in a group and circumvent the system? Well, you are not the first one to think so; here is the partnership model. Instead of individual competition, drivers pool their vehicles and revenues, splitting profits based on hours worked rather than individual performance.
Equation: (Total Fleet Revenue - All Expenses) × (Your Hours ÷ Total Partnership Hours) = Your Profit.
While elegant in concept and works great in theory, partnerships face classic free-rider problems. When individual effort doesn't directly correlate with individual reward, and you can't physically oversee everyone's efforts, maintaining motivation and accountability becomes challenging. Every partnership handles this differently, but the fundamental tension remains.
Ride Sharing Model
We have finally reached the headlines model, the ride-sharing model popularized by models like Uber, Lyft, Grab, DIDI, etc. (fun fact I didn't know: Lyft came before Uber). In the eyes of many, these companies have turned the industry upside down and "democratized ride-sharing." Many have also now horizontally expanded into delivery service applications. The general pattern for the ride-sharing operator's incentives follows the following structure:
Maximize the number of rides by growing both driver & passenger networks.
Minimize costs by paying drivers as little as possible while keeping them engaged.
Maximize revenue by charging passengers as much as you can without driving them away (using strategies such as dynamic pricing or extra fees)
Export all operational risks (vehicle ownership, insurance, maintenance, accidents) to drivers
Avoid capital-intensive assets like vehicle fleets or physical dispatch centers.
Maintain a legal distance from employment relationships to avoid regulatory obligations.
Have a unified information system to keep costs low and provide scalable infrastructure.
The driver's instinct remains the same. As for their equations:
Platform Equation: (Total Ride Fees × Platform Commission %) - Technology Costs - Marketing - Regulatory/Legal = Platform Profit
Driver Equation: (Platform Payment per Ride × Number of Rides) - (Gas + Vehicle Maintenance + Insurance + Vehicle Depreciation + Phone/Data Plans + Taxes) = Driver Profit
What's particularly revealing is how the platform captures revenue on every transaction while the driver absorbs virtually all the variable costs and risks (minus public perception risk from "unfortunate rides," ethical considerations, and pending fair practices lawsuits in cities where taxis were displaced). The driver provides the vehicle, pays for fuel and maintenance, bears insurance liability, suffers vehicle depreciation, and supplies the labour. At the same time, the platform takes its commission off the top and has complete control over pricing and any collected data.
Additional Services
In this piece, I gave a high-level view and have most definitely fallen into the trap of oversimplifying the business model. Still, it provides a nice general picture of the different avenues available for taxi drivers and taxi operators to make money. There are, however, other value-added businesses that sometimes get integrated into the taxi business:
Luxury & Chauffeur Services: Personal drivers, luxurious cars, discrete service, special requests, there is nothing to grant that taxi operators could not provide off course with the caveat of a premium price.
Advertising Revenue: We all notice advertising on the sides of buses and railroads. In many cities worldwide, many taxi companies also supplement their core fare income with advertising on vehicle exteriors, interior screens, and even receipts. For the taxi company, this doesn't cost much beyond ensuring their "inventory" (the cars) maintains a reasonable brand image of cleanliness, etc.
Government Public-Private Partnerships: Here, the taxi business becomes intertwined with essential public services. When taxi companies contract with local governments to provide municipal services – for example, paratransit for disabled individuals or non-emergency medical transportation – they secure stable, contracted revenue streams.
Subsidized Taxi Models for Public Transportation: Similar to the last category, in some areas where building a whole transportation network might be uneconomical, governments sometimes subsidize taxi services to fill critical transportation gaps. This service provides operators with a guaranteed minimum revenue while saving governments money on building out a transportation network.
Franchise Models: Instead of spending all the capital to start from scratch, some taxi operators expand through franchising. Local operators pay for brand recognition, centralized marketing, and operational systems. This model also allows for cutting costs, for example, having one call center serve two different cities, but more specifically, not rebuilding brand image repeatedly.
There are other models we have not explored. For example, subscription models allow passengers to receive a monthly payment for a guaranteed ride. Another stark example of a profit model is models built on communal value, where members share the responsibilities of providing rides (much like seen in carpooling or shuttles between cities). Still, the main focus is either on providing additional, higher-margin services or finding creative, often low-capital ways to increase the overall revenue generated from the existing operations.
THANK YOU
Investment legend Peter Lynch believed that everyday life is a rich source of investment ideas, from noticing popular local businesses to widely adopted products. This "on the ground" observation aligns with his quote, "The person that turns over the most rocks wins the game." I have been practising following that advice religiously and appreciate the cab driver humouring my questions. I think I satisfied my curiosity through the ride and learned a lot from my exchange with the taxi driver. So informally, thank you to him, and I hope you found this piece interesting.
All the best,
Daniel Andreev --- General Partner, 18 Degree Partnership
