An Evaluation Of How The Proposed Gig Worker Reclassification Will Impact Uber

Summary

• Labor Secretary Marty Walsh told Reuters last week that he supports classifying gig workers as employees.
• To understand why the government is pushing for changes, you need not look beyond Labor Secretary's recent comments.
• If the proposed changes go through, Uber will be hit hard.
• In this article, I will present a few reasons why the U.S. government is likely to reach some middle ground with Uber and other gig economy companies.
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Photo by Cristi Croitoru/iStock Editorial via Getty Images

Uber Technologies (NYSE:UBER) shares declined 6% on April 29 as Reuters reported Labor Secretary Marty Walsh supports the reclassification of gig workers as employees. Uber is fresh out of a legal battle in the United Kingdom where the Supreme Court ruled in favor of drivers who lobbied for changes, and the company had to classify around 70,000 drivers as "workers." The last thing Uber would have wanted is to get involved in an even larger legal battle in the United States, but as things stand today, this is a very likely outcome. After carefully evaluating industry conditions and the threat from the government, I'm convinced Uber has a long runway for growth in the future, and I'm not ready to sell Uber prematurely.

What are the expected changes and why is the government pushing for changes?

If the government succeeds in forcing companies such as Uber to reclassify their contract workers as employees, Uber will have to incur additional costs to retain drivers. Some of these incremental costs include:

1. Health insurance
2. Payments for overtime
3. Minimum wage
4. Payroll taxes
5. Paid leaves for drivers

To understand why the government is pushing for changes to existing laws regarding gig workers, you don't have to look beyond the recent comments on this subject by Labor Secretary Walsh. Speaking to Reuters, he said:

We are looking at it but in a lot of cases gig workers should be classified as employees. In some cases, they are treated respectfully and in some cases, they are not, and I think it has to be consistent across the board. These companies are making profits and revenue and I'm not going to begrudge anyone for that because that's what we are about in America. But we also want to make sure that success trickles down to the worker.

The mission, as confirmed by the Labor Secretary, is not to start a nationwide crackdown on the gig economy, but to make sure contractors employed by companies, especially tech companies, are treated in an acceptable manner.

The response from Uber

Uber, as expected, pledged to fight against the U.S. government to retain its ability to classify drivers as independent contract workers. Companies that employ independent contractors such as Uber and Lyft (LYFT), according to Reuters, are arguing that surveys indicate the majority of their workers do not want to be employees as it would require them to commit to pre-defined working hours. According to a statement released by a group of companies including Uber (which was seen by Reuters), they will push for changes that would positively impact both employers and contract workers. In other words, these companies are trying to reach some middle ground with policymakers without having to reclassify all their workers as employees.

How will all this end?

In February, the UK Supreme Court decided Uber should classify drivers as workers, not independent contractors. From the information that I gathered on this subject matter, a "worker" in the United Kingdom enjoys more benefits than an independent contractor but not as much as a full-time employee. The Supreme Court listed five reasons why Uber drivers cannot be classified as contractors.

1. The company is the sole decision maker when it comes to the rates charged by drivers for rides.
2. Contract terms are set by Uber and drivers do not have a say or any negotiation power when it comes to the terms in their contracts.
3. Uber has constrained the ability of drivers to cancel rides, and the company has implemented strong policies to ensure drivers who cancel rides will be penalized.
4. Passenger ratings are used by Uber to control the payment to drivers.
5. Drivers are prohibited from establishing any business or personal relationships with passengers (for instance, a driver cannot share his contact number with a rider).

These five characteristics of Uber's business model led the UK Supreme Court to rule in favor of drivers in February, and this decision has set a platform for drivers in other countries to push for similar changes as well. I'm not sure whether these five reasons will be cited by U.S. lawmakers as well, but chances are they will, which would make it difficult for Uber to argue otherwise.

If Uber is forced to recognize drivers as employees, operating expenses will increase sharply, making it difficult for the company to reach profitability in the next couple of years. However, I believe regulators and Uber (plus other companies that promote the gig economy) will reach some middle ground because of a few reasons. For ease of reference, I will list them down below.

• The gig economy is gaining traction at a stellar pace in the United States, and many professionals choose to be independent contractors because of the flexibility associated with this. According to data from Statista, there are 57.3 million freelancers in the country, which is more than one-third of the American labor force. A survey conducted by Statista found just 59% of gig economy workers are happy with their financial situation, but 80% of them were happy with what they are doing and a staggering 95% of them believe flexibility is very important. Even though these gig economy workers are likely to support regulatory decisions that would result in an increase in their income, a policy that would classify them as employees is likely to be looked at as an adverse development. Therefore, I would not be surprised if the government is forced to reach some middle ground with companies that are part of the gig economy.
• California voters supported Proposition 22 last November, and I believe Uber and other gig economy companies will use this victory as a base-case scenario to convince U.S. lawmakers to reach some middle ground than to push for adverse changes. Uber's operating costs will increase in any case if other states implement similar changes highlighted by Proposition 22 (for example, guaranteed minimum earnings, contribution toward health insurance, and medical coverage for injuries during work hours), but the hit on earnings will be considerably lower than classifying drivers as employees.
• Except for some rare instances, Uber drivers seem to be happy with what they are getting, especially the ones who are doing this for part-time income. A survey conducted by Georgetown University in 2019 found vehicle financing costs, insurance costs, and vehicle maintenance costs were some of the main issues faced by drivers, followed by a lack of certainty regarding potential income. More than 45% of the respondents had no doubt in continuing to drive for Uber, and 50% of survey respondents were happy to recommend Uber for their colleagues as well. Going by these survey results, it would be difficult to imagine the entire network of Uber drivers in the U.S. supporting policy changes that would classify them as employees.
• According to data from CNet, there were more than 1 million active Uber drivers in the United States in 2020, and this confirms how Uber has created millions of opportunities for Americans to earn a side income (or a full-time income depending on the work hours). At a time when America is fighting to keep the unemployment level at a manageable rate, I do not believe lawmakers will move forward with adverse changes that could result in many more Americans facing financial difficulties. As much as it is important to safeguard the health and wellbeing of Americans who opt to be part of the gig economy, it's important to create a level playing field for companies to thrive as well, which is the kind of balance American lawmakers have achieved for many years in the past.

Changes are coming, without a doubt, but I believe these changes will not require Uber to classify drivers as employees. The company will be forced to implement some progressive changes, and it would be reasonable to expect Uber to pass on some of these additional costs to consumers, so be prepared for Uber to hike ridesharing and food delivery charges.

In the long run, progressive changes (such as the ones introduced by Proposition 22) will accelerate the growth of the gig economy concept as many professionals will feel comfortable pursuing opportunities that were considered too risky in the past.

Takeaway

Uber investors should prepare themselves for a bumpy ride in the coming months, but long-term-oriented investors need not panic as the outlook remains positive for Uber. I expect the company to dominate the global ridesharing industry in the next decade and establish distinct competitive advantages over its closest rivals as a result of the network effect. The proposed gig worker reclassification will prove to be just a bump in the road in the long run, in my opinion.

Analyst’s Disclosure: I am/we are long UBER. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.