September 01, 2008
Creative Absorption: Wave a long goodbye to Zipcar

Zipcar is a short-term car sharing program that doesn't have a commons problem (like Frank's community bike programs), but the private company still can't make a profit and its model is destined to be absorbed by Hertz, Enterprise, et al.

Zipcar members pay a standard two-part tariff and Zipcar foots the bill for gas, insurance and maintenance. In dense cities where it's available, there's a $50 annual fee and a $7 hourly rate up to $77 a day. There is not much variation in prices, except on college campuses that offer green subsidies (e.g. Bowdoin College and Rice University). Businessweek has an informative story on Zipcar's profitability:

Since Zipcar was founded in Cambridge, Mass., in 1999, it has expanded into more than 50 cities. Fueled partly by high prices at the pump and the green halo of a car-sharing model, membership this year is on pace to grow 80% over 2007, to 300,000 members.

There's just one blemish on Zipcar's rosy complexion: red ink. ... Simply put, Zipcar's all-in-one price scheme leaves it vulnerable to volatile fuel prices and other costs. "I lose sleep at night knowing I'm paying for gas for 225,000 people," says CEO Scott Griffith.

The solution, he says, is scale. The bigger Zipcar's customer base, the more broadly it can distribute its operating costs. That's one reason Griffith merged his company last October in a stock swap with Flexcar, a West Coast competitor backed by AOL (TWX) co-founder Steve Case.

In short, Zipcar is a good idea whose economy of scale has not yet come. But suppose the innovation leads significant numbers of people to change significantly their driving habits. Schumpeter describes such forces of change as the innovations that are the destructive sources of economic growth:

The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumer's goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation--if I may use that biological term--that incessantly revolutionizes the economic structure FROM WITHIN, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism...

[I]t is not [price] competition that counts but the competition from the new...which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. [Capitalism, Socialism and Democracy, pp.83-4].

Hmm. I don't see the likes of Hertz and Enterprise running for their lives. Instead they're mixing Zipcar's idea with their own scales of operation:

Long term, [Zipcar's] biggest worry may be competition from giant car rental companies, which have begun to clone Zipcar's approach. Hertz (HTZ) is offering hourly rates, gas included, in New York and Boston. And privately held Enterprise, the world's largest rental provider, launched a similar program, WeCar, in St. Louis, which could go national. "The big players do monthly, weekly, and daily rentals," says [industry analyst Neil] Abrams. "Hourly rentals are the obvious next step."

William Baumol calls this the routinization of innovation.

[T]he independent entrepreneur provid[es] many if not most of the more revolutionary and heterodox contributions, while the routine innovation activities of the oligopoly corporations take those contributions and improve and extend them, often well beyond what their capabilities could have been imagined to be. [Free Market Innovation Machine, p.57]

Innovation isn't always the destructive force of the popularized Schumpeterian view. The market selectively absorbs profitable creations into existing industrial organization. For Zipcar in the long run, that means a shrinking and perhaps zero market share unless it holds onto niches like urban colleges. For the customer, routinization means falling prices and greater access for the masses. Again, Schumpeter:

It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.

What about existing car rentals and sales? Isn't there destruction there? That depends. Is the growth of short-term rentals coming from people ditching their existing cars, or from people who already don't have cars and are now driving more miles? That would say a little something about that green halo...

Posted by Edward J. Lopez at 11:50 AM in Economics

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