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6 Reasons to Buy This Innovative Disruptor

Erik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you want to own a longterm winning company, you have to gain some idea of its grande strategy. One method for gaining such insight is to craft what business schools call SWOT, for “Strengths, Weaknesses, Opportunities, and Threats.” Each of these four topics represents a different big-picture lens with which to look at the company and its industry. It enables the managers to establish a plan of action leveraging the company’s strengths to embrace its most valuable market opportunities, while fending off the threats to its profitabililty by shielding its weaknesses.

I’ll now apply this technique to Zipcar (UNKNOWN: ZIP.DL2) so we may have a clearer picture of its future and what it needs to do to successfully get there. The company’s strategic strengths are the six reasons an investor would want to buy this company, so let's begin there.

Strengths :

First Mover in the Car Sharing Industry

Zipcar has a huge 10 year head start on its competition. It has cars in over 250 college campuses and in 20 metropolitan areas which provide it the best brand awareness and mindshare in the industry.

Profitable Core Business

Its three first tier metropolitan areas and associated college campuses are solidly profitable while their membership continues to grow. More significantly, that profitability continues to increase, rising from a pre-tax margin of 23% to this quarter’s sterling 29% margin. The business in these cities is mature, yet far from saturated.

Information Advantage

Key to their success from the outset is that the details of all member transactions and activities are recorded and analyzed. This now-vast database and its peerless analytical tools enables management to determine how many of what kind of vehicle to put where and when. Their continuous analysis further enables them to rapidly adapt to changes in their customers’ preferences on a location-by-location basis. With ten years experience developing such analytics, they are now very good at it.

Single Focus Business Model

Unlike their big-dog competitors, such as Hertz (NYSE: HTZ) or Avis Budget (NASDAQ: CAR), their sole purpose is to substitute car ownership with car sharing. All of their energy and funding go to that one goal. The culture at their big competitors, in contrast, are resistant to siphoning off much-needed capital from the primary business to fund what many of their vice presidents surely consider to be a distracting side show.

Prize Parking Locations are Hard to Duplicate

Their first mover advantage has given Zipcar ten years in which to snap up the best parking lot real estate in the best car-sharing cities in America. Members have to be able to make a short and safe walk to where the cars are or the business just won’t work; and you can’t just build a new parking lot where ever you want it. If Zipcar already has the best asphalt in town, their competition is put at a significant disadvantage.

High Barrier to Profitability

Zipcar’s CEO, Scott Griffith, has stated in conference calls that while the barrier to entry is low, the barrier to profitabililty is high. The implication is that to become profitable requires all of the strengths already listed above. None of their competition comes even close to having these ingredients.

Weaknesses :

Low Barrier to Entry

The barrier to profitability may be high, but that doesn’t keep the wolves at bay. With entry into the business so easy, the big rental companies can afford to give it a go. Even if they are never profitable, they can still snuf Zipcar’s profitability and ultimately endanger its viability. They can most certainly ruin its value as a long term investment. In addition, there are myriad direct competitors scattered throughout the world.

Many Alternatives to Car Ownership

There are many other alternatives to car ownership which potential customers can use instead of Zipcar, and they are typically most abundant in Zipcar’s best locations. These include cabs, buses, rental cars, trains, and peer-to-peer car sharing. And let’s not forget walking.

Small Compared to Competitors from the Rental Car Industry

Though Zipcar is the largest pure-play car sharing company, it is dwarfed by car and van rental agencies. Hertz, Avis Budget, and National have 10-20 times the market cap of Zipcar and have been open for business decades longer. These companies have a lot of muscle if they choose to flex them in Zipcar’s playground, while Zipcar can only expand as fast as it earns operating profits. I’ll speak more on the competition, below.

Opportunities :

New Second Tier Cities

With its original, first tier cities now well established, profitable, and still growing; Zipcar has turned its attention to expanding into smaller American cities with less well developed public transportation, most recently in Austin and Miami. There are a lot of these. I will be looking to see if they can surmount the more car-ownership-centric cultures of these cities to make them as profitable as their first tier cities. If they can, they have huge, if gradual, growth in front of them.

New College Campuses

Zipcar began on campuses, and it remains their best point of entry into a new city. They can begin small and concentrated with a clientèle for whom car ownership is a real burden. Once their mindshare is established in the city, they have easier entré to reaching the wider working public. They recently improved this transition method in Miami by involving the city council in promoting Zipcar throughout the city.

Government and Corporate Fleets

This may prove to be the biggest growth opportunity over the midterm. Governments at all levels (from townships to the Fed) as well as large corporations are discovering the value of outsourcing their vehicle fleets. Zipcar can dramatically reduce their costs by flexibly providing only the number and type of vehicles they need at any given location and season. This saves them a large and inefficient fixed cost and liability. A related new initiative, one that intrigues me, is to license their fleet management computer systems to businesses. The margins could be quite high for this venture, and deployment very rapid.

International Cities

Zipcar has already ventured into the British Isles and Spain by acquiring smaller companies with similar business models. This is likely to remain their safest route to expanding into new countries as the locals know the customers, culture, and cities the best. Once Zipcar has established themselves by integrating the new company into their compelling customer and fleet control systems, they can expand their presence within the country, city by city, as they are doing in America.

Short Haul Vans and Trucks

The British acquisition, Streetcar, introduced Zipcar to sharing utility vans. It has proven so popular amongst small businesses that they are rolling out significant expansion plans for a new service called Zipvan, most recently in Chicago and Toronto. This taps into an all-new type of customer, and a market that could prove very large and lucrative as companies can readily afford the annual subscription and thus be stickier members.

Threats :

Car Rental Competitors are Entering the Industry

There is no question that the Big Boys are muscling into Zipcar’s turf. Hertz has placed 500 cars in New York City to compete head to head; Enterprise Holdings and U‑Haul (NASDAQ: UHAL) have opened for car-sharing business in major cities, with the U-Haul version competing directly with Zipcar’s new Zipvan offering; and Avis Budget is more quietly tackling corporations. Even auto companies, such as General Motors (NYSE: GM) and BMW have put their toe in the waters to showcase their new car models, and may therefore not care whether they earn profits. In recent conference calls, however, CEO Scott Griffith says they are closely monitoring the cities where the rental agencies are actively competing, and so far there is no sign of erosion of Zipcar’s business.

Membership Erosion and Recruitment Costs

There is alot of bragging about Zipcar’s superb 97.3% monthly retention rates. Let me put a stake in the sand to directly challenge that assessment. It sounds really good until you calculate the annual retention: only 75%. Zipcar loses fully 25% of its members every year. Now think about the costs of recruiting new members to grow the company. If you want to grow membership by 25% per year, you have to spend double the recruitment costs because the first half of your funds are spent simply replacing the ones you are losing. During the most recent quarter, Zipcar grew membership by 18%. That means that two-thirds of their recruiting funds were spent simply replacing lost members. Let’s be clear, not only can membership stop growing, it can decline while still sucking up a lot of cash flow on recruiting.

Car Sharing Never Takes Flight

Zipcar’s stock price at its IPO was $28. That was back when everyone thought there was surely a huge market for car sharing which Zipcar would rapidly penetrate. Today the share price is under $8. The market has stepped back and asked itself just how big is that market really, and how handily can Zipcar – or anyone – capture it? That’s a big point of uncertainty not to be brushed off lightly. It might not be as big as once thought. Yet when one considers the whole world, perhaps it actually is huge; and perhaps Zipcar, or some competitor, will one day discover the real goldmine somewhere overseas. Even if they do, however, it could be so gradual that ZIP, or whomever, proves to be a poor investment.

Alternative Car Sharing Models Win Out

I've highlighted above the many other alternatives to direct car sharing. Zipcar does not see these other “mobility models” as threats, but as complimentary services which are tapping corollary markets. Together they challenge the status quo on car ownership to slowly alter the world’s ownership culture. While this is likely true, it still bears watching. Another model could surprise Zipcar and steal the show out from under them.

New Revenue Streams Fizzle

Zipcar is pursuing several new revenue streams including second tier cities, additional colleges, vans for business, and fleet management. One or more of these could fizzle causing a substantial loss of capital for little to no payback. This would put a real dent in this small company. Yet experiment they must to find where the best revenue streams are; but we want their investments to begin small so they can first determine where to put the big bucks. So far this is what they’ve been doing. We must keep watchful that they continue this policy.

Win by Keeping Wise to the Strategy

Armed now with our own “SWOT team,” we can keep a more informed eye on how Zipcar’s strategic initiatives develop. We’ll know if they are leveraging their strengths to successfully capitalize on their opportunities, and we can tell if their many threats are preying upon their weaknesses to muscle them aside and capture the business. It should prove to be quite the show for many years to come.

 


Erik Eason owns shares of ZIP. The Motley Fool owns shares of Hertz Global Holdings and Zipcar. Motley Fool newsletter services recommend General Motors Company and Zipcar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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