I think we are officially at the end of Phase I of China’s bike-sharing / bike-rental phenomenon.

• There are now a couple of clear leaders – Mobike and Ofo.
• The services are experiencing tons of daily usage by Chinese consumers, and growth is continuing rapidly. This is definitely not a fad.
• The economics of the business are becoming clearer. Rental revenue is still the foundation. Advertising revenue may be part of the picture. Some Ofo bikes, for example, have had Minions advertisements on them (see picture below). And perhaps delivery and e-commerce revenue will come in the future.
• Finally, recent numbers coming out of a Mobike White Paper are pretty interesting. The 2017 Mary Meeker / Hillhouse report on the industry has a couple of good slides on this as well.

Looking forward to Phase II of this bike-sharing phenomenon, a couple of questions seem pretty important – or at least pretty interesting. Here are the five questions I am thinking about.

Question One: Will Mobike and Ofo merge?

I think this is the big one. And it will ultimately depend on their behavior towards each other. Signing up customers with an entirely new service is actually pretty cheap if you’re an early mover. Mostly because you are really only convincing customers to try a service for the first time. That is a lot cheaper than fighting for the few remaining customers or stealing customers from your competitors. Plus, there is a fascinating phenomenon going on with how people sign-up for these services. New customers appear to be almost free for the companies in terms of marketing spend. Well, except for the price subsidies.

For China’s bike-rentals, this “blue ocean” type of growth has been going on for about a year. Mobike, Ofo, and a few others are growing as fast as possible in wide-open markets. But this is going to slow eventually (or end) and then they will have to decide whether they should really tear into each other or team up. Kuaidi Dache（快递） and Didi Dache（滴滴） faced the same question and, after a pricey subsidy war, they decided to join forces and become Didi Chuxing in 2015. Similarly, Uber China and Didi Chuxing spent a year (and a couple billion dollars) fighting each other for drivers and riders before eventually merging.

It is actually hard to predict whether market leaders will fight or co-exist peacefully. Coke and Pepsi don’t really get into price wars. But they have in the past. Cereals tends to be a friendly (and profitable) market. Other markets are bloodbaths. We don’t know how Mobike and Ofo will behave towards each other when they turn their guns and capital on each other. Per Berkshire Hathaway Vice-Chairman Charlie Munger, “Many markets get down to two or three big competitors – or five or six…And in some of those markets, nobody makes any money to speak of. But in others, everybody does very well. Over the years, we’ve tried to figure out why the competition in some markets gets sort of rational from an investor’s point of view so that the shareholders do well, and in other markets, there’s destructive competition that destroys shareholder wealth.”

Given that the backers of Ofo and Mobike are pretty much the same as those for the ride-hailing services of Kuaidi and Didi, I think a merger between the leaders is a definite possibility at a later point. Not today but probably when growth starts to slow, when customer acquisition costs start to rise, or if a price war breaks out.

One sub-question within this is whether bike sharing is going to be a winner-take-all market, like ride sharing. That situation is actually pretty rare. Most markets don’t naturally consolidate to one to two players. There usually are five to six players, or they remain fragmented and we see new players entering. In bike sharing, thus far, there aren’t any clear competitive advantages yet (see question four), just a race in market share, scale and operating improvements. We could see several or maybe a lot of players surviving, such as in business-to-consumer (B2C) e-commerce.

This is one of the big differences between these bicycle rentals (which isn’t really sharing) and ride sharing (which has powerful competitive advantages). Ride sharing is a winner-take-all market, and Didi has more than 90 percent of the entire market by virtue of a network effect and some other advantages. WeChat, Didi, Taobao, Facebook, and Whatsapp have similar advantages and dominate their respective markets. Bicycle sharing very well could end up a handful of companies – or it could remain somewhat fragmented.

Question Two: Will Mobike’s subscription model take off?

In late June, Mobike announced a new Netflix-style subscription model. In this alternative pricing model, riders pay a monthly fee and get up to two hours riding per day. Mobike says the goal is to “increase loyalty.”

This is a move I have been waiting for since last summer. As I described above, these businesses do not have the powerful economics of ride sharing or home sharing (yet). They have stunningly powerful consumer uptake and they are highly innovative rental businesses. But they do not yet have any hard barriers that make it impossible to take their markets and customers. They will eventually need to build something that either gets them economies of scale, higher switching costs, or some other barrier to entry. A subscription model would increase the switching costs.

Software companies frequently go for high switching costs (try replacing Microsoft on your PC or Android on your phone) plus economies of scale in marketing and/or research and development (R&D). The former lets you charge a bit more because it is hard to switch to a competitor and the latter lets you outspend your competitors on R&D (or marketing) because you are much bigger and these are mostly fixed costs (say 10 percent of sales). Being able to charge more because your customers are locked in to the product and then being able to spend more because you are bigger creates a barrier to entry for potential competitors.

A subscription model is stickier than pay-as-you-go so I’m curious how successful this will be. Mobike could try other techniques like reward programs, integrating their service into another ecosystem (like Didi, Alibaba or Tencent), holding deposits, and so on. And you can even get a certain amount of customer loyalty with branding. Plus, as this is ultimately an offering in convenience, blanketing cities with bicycles does make your service more convenient.

But the key test of this comes when your company’s bike is available right next to your competitor’s – and is 10 percent higher in price. Does your customer still go with you? That unwillingness to switch for a small premium is what gets you the higher operating margin relative to capital and the stable market share that is pathognomonic for a competitive advantage.

The above Kleiner Perkins report mentioned that two-thirds of Shenzhen users ride an average of over three hours per week. This starts to sound like what Warren Buffett calls having a “share of the consumer mind.” When frequency of usage is daily or weekly, a company’s product can become built into people’s lives. Very frequent usage can create a situation where the company occupies part of the customer’s brain. For example, people always buy Heinz ketchup, even though lots of companies can make ketchup. Most people always choose Coke or Pepsi over other colas. Building up this type of loyalty takes a long time (and usually tons of advertising), but frequency of usage is a critical part of it. You do get the impression these bikes are becoming part of customers’ daily lives.

Question Three: Will this work internationally?

Mobike has recently launched in the United Kingdom, Italy and Japan. And they are already in Singapore. And this raises the interesting question of whether these on-demand bicycle businesses will succeed internationally, or if is this just a China thing.

I think this question is really about the business model vs. China’s hyper-adoption of mobile stuff. I have previously argued that these companies are not sharing at all. They are classic tech disruptors in “access and convenience.” That’s kind of jargony, but I argued that new digital and mobile tools (mobile payments, software, apps, smart locks, and GPS) have enabled businesses to provide a new level of convenience for riding bicycles. It is a disruption based on superior convenience, not price.

What I love about these companies is they have exposed how inconvenient owning and / or renting bicycles has always been. It is clear now that owning a bicycle, storing it in your apartment and locking it up around town on the few days you use it is a real pain. Mobike and Ofo have permanently changed people’s expectations. Try convincing someone to buy a bicycle and store it in their apartment in Shanghai now. And it turns out that there is a ton of latent demand. By removing the inconvenience of ownership, people have begun renting in huge numbers. Mobike and Ofo have given people what they never knew they always wanted.

If this bike-sharing phenomenon is mostly about a disruptive new business model and unleashing people’s latent demand, then it should take off in other geographies. Although lower adoption of mobile payments and government approvals could be a problem in the short term in some places.

However, it is also possible this phenomenon is more about Chinese consumers, who are just crazy about anything new on a smartphone right now. This hyper-adoption of anything mobile plus the almost uniform adoption of mobile payments in China has resulted in a series of mobile app phenomena in the past year. If bike sharing is more about this hyper-adoption of all things mobile by Chinese consumers, then bike sharing may not succeed internationally. Or at least not as fast or as much as in China. For example, mobile payments are taking off everywhere, but they happened much faster in China.

Based on the news out of Italy and Manchester, it looks like this is going to work overseas. The US and Europe should get ready.

Question Four: What happens to the big bicycle manufacturers?

This is a body blow for many in the bicycle business. For traditional rental bicycle companies, especially the city rental programs, this is super bad news. Why would you ever rent a bicycle the old way now?

But this also impacts bicycle ownership. Companies like Taiwan-based Giant Bicycles must be panicking, watching a big portion of the market shift from B2C to business-to-business (B2B). People in China are radically changing how they buy and access bicycles and Mobike and Ofo are getting between bicycle manufacturers and a big portion of their consumers. What they will do in response is an important question.

This digital disruption problem is certainly not limited to bicycle manufacturers. Automotive companies are panicking about the arrival of autonomous cars. Retailers are panicking about the growth of e-commerce and online-to-offline commerce (O2O). Per Marc Andreesen, software is “eating the world.” And it seems to be happening particularly fast in China.

Question Five (last one): How much bike damage and theft is going on?

Ok. This is not really a Phase II question but I’m really just dying to know the cost figures for this. From the beginning of bicycle sharing in early 2016, there has been this question of can a “community-minded” business work in China? Aren’t these bikes just going to get stolen? Or crashed by customers? Or damaged by competitors? Or have real estate advertisements stuck all over them?

I was more positive than most on this. It is not a problem unique to bicycles. Most businesses in China have to deal with certain amount of petty crime. ATMs have doors that lock. People know about pickpockets on the subways. And so on. I figured there would be learning curve as these bike companies built in the required security measures.

But the cost of damage and theft is a number I am still hoping to find. I suspect it was probably pretty huge but has now fallen for the market leaders. It could still be particularly brutal for the smaller companies.

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Overall, this is a fascinating phenomenon, and likely just one part of a major disruption to transportation across the board. I think this is just the beginning. Phase II should be fascinating. And it’s just nice to people riding bicycles again.

Thanks for reading, Jeff

Reposted from Amcham China (here)

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I write and speak about “how rising Chinese consumers are disrupting global markets” – with a special focus on digital China. (#ConsumerChina).

Photos by Jeff