How China’s New Ridesharing Rules Choke Uber and Didi

Uber China faces intellectual property, pricing challenges
July 31, 2016 Updated: July 31, 2016

Beijing legalized online car hailing apps such as Uber China and its homegrown rival Didi Chuxing nationwide. The move prompted Uber to praise China as “forward-thinking when it comes to business innovation.”

But upon closer inspection of last week’s guidance—effective Nov. 1—shows that China’s decision is more advantageous to the state than to enterprising businesses in the car hailing industry. Many stipulations are open-ended and at least one rule could severely hamper Uber China’s expansion strategy.

Car hailing has experienced fast growth in China, where a large part of the young population use smartphones on a daily basis. The Beijing-based Didi, which counts Apple Inc. as ones of its investors, said it manages more than 10 million rides a day.

Uber China, Didi, and smaller competitor Yidao Yongche have previously resided in a legal gray area. In some cities, protests by existing taxi drivers flared and car share drivers faced arrest and car impounding. In others, they were left alone and ridesharing became the primary transportation alternative.

The newly announced rules have yet to be adopted by regional and local jurisdictions, but they nevertheless move the industry into national legitimacy and legality, and offer a framework in which the businesses can operate.

Basic Framework

Guidance issued by Beijing requires online car hailing services to maintain cars that cannot have more than seven seats and must not exceed 600,000 km (372,000 miles) on the odometer. In addition, licensed drivers must have three years of minimum driving experience and no criminal record.

The regulations also give Beijing more oversight on deployment of ridesharing apps and control over their expansion. The Ministry of Transport also announced that local traffic regulations and fees would be determined with input from local authorities.

In one fell swoop, the Chinese Communist Party both legitimized an industry and brought it under its tight control.

Some of the more draconian rules—such as requiring all vehicles to be registered for commercial use—were removed from the original proposed guidance issued last October. That would have made part-timing driving, a central tenet of the sharing economy, prohibitively expensive.

On the surface, the news is a welcome respite to Uber China and Didi, both of which closed on a fresh round of funding last month. Didi, the biggest car hailing service in China, raised $7 billion in its latest round.

Controlling Data

In one fell swoop, the Chinese Communist Party both legitimized an industry and brought it under its tight control.

Article 5 of the new rules—published July 27 in Chinese in Xinhua—requires the ridesharing companies to establish physical servers in China and obtain state approval to operate a telecommunications platform. User information and car related data must be stored within those China-based servers for two years. While the Ministry of Transport did not name any specific company, this stipulation seemed to be aimed directly at Uber China.

Like other foreign tech companies operating in China, Uber China would be subject to security checks. China’s controversial cyber security law enacted last year forced technology companies to build so-called backdoors into software and hardware, hand over source codes, and release encryption keys. Said differently, Beijing wants access to the intellectual property which is the chief source of value for technology firms.

It also deepens privacy and human rights concerns. In the hands of the Chinese Communist Party, data and information collected by these so-called security measures would be another tool used by the party to monitor the whereabouts of its citizens, as well as to locate and arrest political dissidents.

Regulating Pricing

Major potholes remain on the road ahead for the car hailing companies, specifically for Uber China.

Article 21 provides framework of competition, and would likely derail Uber China’s business model and current strategy to procure market share. It states that companies cannot try to achieve dominance by offering “below cost” rides or “disrupt the normal market order, impair the national interests or legitimate rights and interests of other operators by improper price behavior.”

Without providing specifics, Beijing announced that pricing would be scrutinized at both the national and the local level. The open-endedness of that regulation is a risk to the entire industry. But one thing is certain—Uber China’s strategy to attract new customers using aggressive and “below cost” pricing would likely be banned.

Entering a new market is always a cash-burning affair, and Uber CEO Travis Kalanick disclosed in February that Uber lost $1 billion last year in China. Much of Uber China’s initial success in Chinese cities comes down to its strategy of using cash to attract new drivers and new riders. To expand into new cities, Uber doled out big bonuses to procure drivers, sometimes paying up to three times the amount of the fare. For riders, Uber sometimes kept fares unusually low to attain new customers by paying drivers subsidies. The dual-pronged approach has kept Uber rides much cheaper than regular taxis in new target cities.

Both Didi and Uber are looking to achieve profitability by slowly weening drivers and customers off subsidies. At the Converge Technology Conference in June, Liu Zhen, Senior Vice President of Strategy for Uber China, said the company’s cost per ride today is 80 percent less per ride than last year. But that’s expected for a maturing business that has fewer new cities to expand into. Didi also announced last month that it is profitable in half of the cities it operates in.

Similar to other policy proposals issued by the Chinese Communist Party, much of implementation and enforcement is left vague. Cities and provincial governments will retain power over details.

And that has the potential to stifle innovation and increase costs for ridesharing startups, both foreign and domestic. Didi announced in a statement last week, “We call for local authorities to adopt market-driven approaches that encourage innovation and new business models.”