Catch 22: The Future of the Gig Economy
Last week, a judge in California struck down Proposition 22, a ruling which may have long-term implications for the gig economy.
As you can imagine, during the past week, I have received more calls than ever to talk about this.
Even if you don't follow the gig economy or live in California, you are most likely using Uber, Lyft, DoorDash (or some other app-based firm), so this decision may have long-term implications for you too.
Let's start by clarifying what striking down Proposition 22 means. To do that, we first have to understand what came before: AB5.
What is AB5 and Prop. 22?
California Assembly Bill 5 (AB5) is a law focused on gig workers that requires companies who use independent contractors to reclassify them as employees. AB5 was built on a California Supreme Court Case in 2018, which ruled that companies must use a three-question test (the ABC test) to determine how workers should be classified.
The “ABC Test” considers workers “employees” unless the hiring company can prove that the worker:
is free from the control and direction of the hiring entity
performs work outside of the usual course of the hiring entity’s business
is customarily engaged in an independently established trade, occupation, or business.
Lyft and Uber saw this as a direct threat to their business model and threatened to stop operating in California if they were required to comply. For a while, they even tried to argue that drivers were doing work outside of their primary business (and considering that drivers were primarily lobbying as opposed to driving at the time, they were not all that wrong).
In support of these firms (and contractors in other sectors who also saw AB5 as too restrictive), Proposition 22 was passed in November 2020, aiming to maintain the status quo pre-AB5 and classifying app-based employees as independent contractors. The stated goal of the propositions was to give app-based workers their continued freedom and flexibility as independent contractors.
And as a token of providing legal guarantees and benefits, Prop. 22 included a minimum earnings requirement, compensation for additional expenses, non-discrimination protections, and ACA-compliant healthcare.
But perhaps the most controversial part of Prop. 22 is that it allows companies to avoid labor laws and potentially exploit workers. Contractors are not afforded state and federal employment protections such as workplace safety and anti-discrimination laws. As independent contractors, gig workers remain responsible for their taxes and social security and miss out on paid leave and unemployment benefits.
Why Strike Down Prop. 22?
I am not a legal expert and will refrain from pretending to be one on the internet, but the main issue the judge cited was “the inappropriate intrusion into lawmaking.” The judge agreed that the measure inappropriately shackles state lawmakers, preventing them from implementing a system of workers' compensation. He also ruled that the ballot measure violated the state constitution by defining an invalid system to amend the measure by requiring a 7/8 legislative "super-duper majority" to amend any portion of the new law.
But probably the most critical aspect is the notion of voter confusion. The judge concluded that the "theme, purpose, or subject" of the ballot measure was to protect an opportunity for people to drive their cars for delivery purposes on an independent contract basis while receiving minimum welfare standards. But by also blocking Prop-22-covered workers from collective bargaining, he ruled that the ballot measure veered too far from its purpose, rendering it inappropriate and invalid.
I cannot talk about the likelihood of an appeal or the possibility of similar rulings in other states, but I will try to explore the long-term and short-term implications, assuming this ruling stands.
Let’s summarize the main issues:
Minimum wage: Under Prop. 22, gig workers will be paid 120% of California's minimum wage only during active hours for ride-share drivers: when they have a passenger in their vehicle or are en route to pick up a passenger. So, are they not being paid while they wait for their next ride request?
Benefits: Prop. 22 requires workers with 15 active hours a week to receive a health care stipend. But as independent contractors, gig workers remain responsible for their taxes and social security and do not qualify for paid leave or unemployment benefits.
Protection: Contractors are not afforded state and federal employment protections such as workplace safety and anti-discrimination laws. Specifically, the proposition does not allow contractors to bargain collectively.
Should we be Surprised?
As an investor or an observer of this industry, are you surprised? As I mentioned, I am no legal expert, but I did not find the overall decision the least bit surprising.
There is a trend here. Prior to AB5, gig workers were classified as contractors without any protections. AB5 classified them as employees with the full protections this entails. Prop. 22 kept only a few of these rights in an effort to meet them “halfway.” But the reality is that Prop. 22 is still quite far from “halfway,” it is more like 20-80 in favor of the platforms, but it’s a start. The California judge saw this for what it was and shut it down. As more workers shift toward gig-like models, I expect this trend to continue. I expect the essence of Prop. 22 to grow over time, either through legal challenges, new regulations, and laws, or future business decisions.
Prop. 22 can serve as a base to negotiate more rights and protection for a new breed of employees; contractors with benefits.
This is not a legal matter, just business. As I previously wrote, the main feature of the gig economy is that platforms have to compete on both sides of the market: they need to attract both customers and ‘suppliers’ (i.e., workers).
For a long time, these platforms were competing by offering drivers more work and higher wages (or better promotions). But there is a limit to how much you can use these tools. Entering a bidding war with your competitors is not a very sustainable equilibrium, especially when you are squeezed by the consumers' willingness (or lack of willingness) to pay.
These issues were amplified in the post-Covid era when drivers were reluctant to return and the firms increased the prices in hopes of providing more incentives. The solution they offered angered consumers and didn't bring enough drivers back. Through discussions and observation, it is clear to me that drivers want to gain more stability. Not only in terms of schedule, but in the overall terms (income and benefits).
My advice to these platforms has been to offer benefits and protections rather than compete on wages. In particular, to deliver better health care benefits paid leave, and retirement planning.
And in fact, many fintech firms are moving in this direction. Catch allows gig workers to manage their benefits, (self) paid leave and savings. Steady includes an income tracker to help users monitor their different income streams and total monthly earnings.
These new startups saw what the gig platforms were slow to understand: in the long run, you cannot just compete on prices and wages. If you want loyalty and reciprocity, you need to offer stability and benefits.
So, yes, it was expected that the trend would be to offer app-based workers more benefits and protection.
What's the Long-Term Impact?
The critical question (assuming the ruling stands) is: What do we expect will happen in the long run?
Prices will be Higher, but maybe not much Higher
As I mentioned, in the last few months we have seen increased wages in order to bring ride-sharing drivers back. At this stage, most of this increase was translated to higher consumer prices and longer waits.
Now, imagine a situation where Uber, for example, has to classify its drivers as employees. The cost of an employee is about 30% higher than their wage (which is a common assumption when dealing with the cost of employment). As a new equilibrium emerges, it is expected that part of this cost will be absorbed by the platform and part by the consumer. I expect consumers will absorb a 10-20% cost increase. Note that some of the issues we are dealing with through Covid would not have occurred under different worker classifications.
Lower Valuation for the Platform, but maybe not much Lower
The gig platforms will have to absorb some of the cost, and in a competitive environment on the consumer side, you cannot expect the consumer to pay more just because your cost is higher. Remembering that these firms are currently all losing money, you may ask whether their financial valuations are tied to their unit economics. In that case, the amount of money they can make on every ride will decrease, lowering their value to investors.
Looking at stock prices, it is clear that the ruling had minimal impact. Uber's stock went up from $39.95 to $41, from Friday (the day of the verdict), to Monday (the firm trade day after the ruling). Lyft increased from 45.89 to 47.24, and DoorDash went down, 184.08 to 183.08. In all cases, this is merely noise.
This reinforces my argument earlier in this post that this was reasonably expected and, in many ways, "priced-in."
The Ruling is Serving the Incumbent Platforms
The argument I want to make here is that while the big platforms heavily funded the campaign for Prop. 22, they are also the ones that will enjoy it in the long run, primarily as a defensive vehicle against new firms trying to enter the market. Why? From the three issues discussed above: minimum wage, benefits, and protection, it is clear that scale plays a significant role in the ease of addressing the first two.
When paying minimum wage (even for the time the gig worker is not driving), it is clear that the higher the worker's utilization, the less is wasted on paying non-value-added time. It is much easier to do that on a firm scale. It is essentially the same reason firms outsource their call centers. As the scale goes up, firms can offer higher response times while keeping their utilization high. If a new entrant tries to disrupt the incumbents, they will have to pay for a significantly higher non-value-added time to achieve a similar service level as the big firms.
As sales go up, it's also easier to manage benefits, paid leave, etc. Uber, Lyft, and DoorDash already can do that for their workers. They may not want to, but they have the capacity if forced. This is a massive headache for any new entrant. You can see a similar situation with GDPR in Europe. Any regulation that requires compliance favors scale.
The Ruling will drive more Consolidation in these Industries
Given that the verdict favors scale, it is clear that the next step is to start consolidating the industry. We already see evidence of this, even before the ruling. DoorDash is in talks to acquire Instacart. Uber and GoPuff are in discussions on collaborating.
What drives consolidation? These firms are not just competing with each other. They are competing with the grizzly bears of the industry: Amazon and Walmart. It's clear that the biggest winners (beyond the workers themselves, but this is more nuanced) are Amazon and Walmart. They have limited exposure to the gig economy and have the scale to deal with precisely these issues.
Is this the End of the Gig Model?
The real question is: What does all this mean for the gig economy in general (and not only for ride-sharing and food delivery models)?
In particular, I would like to compare them to other gig firms such as Fiverr or Upwork and focus primarily on the first requirement of the ABC Test: "The worker is free from the control and direction of the hiring entity." The only freedom Uber and Lyft provide is the option to work or exit. Once you take your first ride, there is no freedom. A driver can only decline a limited number of rides and cannot determine the service price. Furthermore, the work is done synchronously, so they cannot even choose the timing and schedule of the work.
When it comes to Fiverr and Upwork, the worker can choose the price and the work time: they usually commit to a delivery time, but the work doesn't have to be done synchronously. Workers can try to differentiate themselves by promoting the different types of work they have done and their achievements in completing them.
In other words, the Uber gig workers do not have the freedom to price, they do not have the freedom to differentiate, and they do not have the freedom of time. The only thing they can do is exit the market. Even if they need to go to the restrooms, they can only do it by leaving the market.
This is a moment of reckoning for the gig economy as a whole. And what is missing in this debate is that we cannot and should not treat all gig workers alike. When we claim that these contractors have the freedom to make decisions, we need to see how much freedom they genuinely have.
I expect a new framework to emerge acknowledging that the more freedom the workers have in terms of their participation (or exit), price, time (synchronous vs. async), and ability to promote themselves, the less protection they will need, and the less restrictive the relationship needs to be. However, the more they are restricted, the more the platform is responsible to compensate through minimum wage, benefits, and collective bargaining.
The less you allow people to differentiate, the more you have to enable them to bargain in groups, regardless of whether you classify them as contractors or employees.
As I have written before, I view gig-type working arrangements to be the future of employment, but we have to find a way to make it fair, equitable, and productive for everyone involved.