The Real Reason On-Demand Startups Are Reclassifying Workers

Over the past several months, a handful of on-demand startups reclassified their independent contractors as employees. Others have publicly acknowledged they’re considering the same move, and have been hailed as the “next generation” of the sharing economy: one that takes care of its workers.

Meanwhile, established companies like Uber, Upwork (Elance-Odesk), LiveOps and even Home Depot have remained firmly rooted in the self-employed contractor model.

Between the political and media-driven reclassification debates, the public perception has largely been that some of Silicon Valley’s on-demand startups are wisely bowing to political pressure, and that regulatory reform will eventually force the rest of the on-demand economy to adopt an employee model.

But shouldn’t we consider why some these venture-backed growth-stage companies are actually making the shift to an employee-based workforce? It’s a hazard to assume marketplaces are reclassifying out of political motivations or purely because it’s “better for their workers” — they’re doing so because it’s a better way to build their businesses.

When examining each business that has reclassified, we tend to discover a mix of three distinct operational characteristics: the ability to scale service with a high customer-to-worker ratio; build a specialized workforce required for high-quality service; and deliver services to the customer with a greater focus on convenience than timeliness.

Scale Via High Customer-To-Worker Ratio

A company like Uber needs a low ratio of active drivers to riders to scale. Uber’s ratio is nearly one-to-one — I call a car, a driver picks me up. Conversely, a driver for a company like Shyp can carry many packages around all day with no gap in service or quality. Shyp inherently needs fewer workers to scale, and their delivery model creates the incentive to hire full-time employees to work full-day shifts.

Similarly, Sprig has figured out a way to stock servers’ cars with many meals while delivering in a timely fashion. Each customer doesn’t need a dedicated server to receive a high-quality experience, so Sprig doesn’t need a massive, Uber-sized workforce to penetrate a city. High customer-to-worker ratios tend to indicate a business model where employee classification makes more sense. Low customer-to-worker ratios are more responsive to demand, so map to a flexible workforce.

Customer Experience Requires Specialization

When Instacart announced their shift from contractor to employee, many assumed they’d acted early to avoid future reform. But Instacart says they’ve been experimenting with new labor models for a long time — with the goal of building the best customer experience.

Instacart represents a unique two-part labor force: one that gathers grocery orders in your local Whole Foods (now employees), and one that drives those perishable goods to each customer (still contractors). To improve delivery time, lower costs and reduce order errors, the in-store workers have to become experts at navigating their local store and resolving stocking issues. The delivery team, however, needs little to no specialization. And we see the worker classification divided along these lines.

Founder and CEO Apoorva Mehta noted that when “delivering items such as fruit or eggs that need to be carefully selected, you realize that grocery shopping can be complicated.” Instacart’s desire for a better customer experience via training and shifts required employment of their in-store team.

Each business in the on-demand economy has a unique model to make their business work.

Similarly, Sprig CEO Gagan Biyani said that one of the primary reasons his company reclassified was “to provide its servers with ongoing training and development.” Biyani increased workforce specialization to enable a better customer experience.

But the specialization trend isn’t limited to the food services industry — Curtis Lee, CEO of on-demand parking app Luxe, has acknowledged that “as we grow, we have realized the need to assert more direct control over the customer experience,” which inspired the decision to offer Luxe’s contractors part-time employee status (though not likely to happen until some time next year). On the far end of the specialization spectrum, telehealth company Doctor on Demand employs doctors nationwide because they require licensing and specialization to deliver on the company’s promise to see a real doctor in the comfort of your own home.

Timeliness (Truly On-Demand Versus Convenience)

I don’t need my packages shipped right this minute. Recently I was willing, albeit grudgingly, to wait 35 minutes for my Sprig to arrive. I need Instacart to deliver my groceries sometime before dinner. Managed by Q (also has W2s) needs to clean our office sometime after I leave and before my team rolls in tomorrow morning. And I’ll gladly schedule my Luxe valet before I even leave my home.

But when I need to jump in an Uber to take me across town, I have the patience of a two-year-old! I needed it before I requested it. Ridesharing is the poster-child of on-demand services, but there are also decades-old sectors that require more timeliness than ridesharing.

LiveOps, a cloud-based customer service platform, powers customer service for companies like Pizza Hut, Electronic Arts and Salesforce. These companies hire LiveOps to deliver support with near-zero time-lag in response to demand. LiveOps in turn supplies flexible contractor service agents who work remotely and have control over their hours and earnings capability.

A contractual workforce will likely dominate any business model that requires real-time supply response to fluctuations in demand.

On the other hand, companies that are able to spread their demand across a broader time frame trend toward convenience service, rather than truly on-demand service. This enables them to manage a workforce with more consistent shifts, lending itself to the employee model. Shyp CEO Kevin Gibbon says that his company’s “turn is extremely low. We don’t have to worry about demand peaks and valleys. Demand is constant for us.”

This couldn’t be more different for LiveOps or Uber, who experience massive demand peaks and valleys, and must turn on and turn off their workforce accordingly. It makes sense for Uber to “turn on” contractors for gig work, rather than have an employee wait through a mid-day drop in demand. A contractual workforce will likely dominate any business model that requires real-time supply response to fluctuations in demand.

Uber is in a league of its own in Silicon Valley — its business model runs contrary to every characteristic of companies with employee classification discussed above. To make its business work, Uber needs many drivers (scale) at a moment’s notice (timeliness) who require almost zero training (no specialization, although they do enforce reputation-based quality).

Comparing Uber’s workforce requirements to that of Shyp or Instacart or Sprig is inaccurate and unfair. Each business in the on-demand economy has a unique model to make their business work, and each will (and should) classify their workers accordingly.

The Elephants In The Room: Benefits And Flexibility

The other noted upside to hiring employees rather than contingent workers is that businesses can offer employee benefits, and use those benefits to attract new talent. Most on-demand CEOs also acknowledge the flip side: higher cost of employees, due to workers’ compensation requirements and payments toward Social Security or unemployment.

But does that mean this is “better” for the workers? Let’s remember, on-demand workers can already tap into excellent marketplace-provided “benefits” without forcing reclassification. And the Affordable Care Act provides tax incentives to do so with health coverage.

What reduction in flexibility will workers accept in return for employee status?

Should we force businesses to reclassify contractors as employees if they want to better support their workforce? Or, should we find a way to fill potential gaps in income protection with benefit and classification models that fit this new economy? (Full disclosure, I founded Stride Health, which delivers health and income protection “benefits” to contingent workers.)

Arguably the toughest question to answer is what reduction in flexibility will workers accept in return for employee status? Positive moves in reclassification have a corresponding negative impact on the flexibility of the worker’s lifestyle. If 87 percent of Uber Drivers want to “be their own boss” and set their own schedule, how can that work in an employee-based system? And shouldn’t we be able to deliver more education and training to this growing segment without threatening their flexibility with reclassification?

As Maynard Webb, the former COO of eBay and a LiveOps founder, recently told me, “We need to paint a path for a career as an independent, but not remove that independent element. What’s happening is a good thing — and we need to celebrate it — but we also need to support this wave of entrepreneurship with individual access to the benefits and training that used to be provided by their employers when they had to work 9-to-5 jobs.”

It’s time to unbundle benefits from employment classification and empower this new economy to protect and train flexible workforces.

The True On-Demand Platforms Will Stay 1099

We’ll see new employee-based on-demand workforces like Sprig, as well as mixed-classification workforces like Instacart. But we’re not going to see the massive scale, truly on-demand gig work being performed by Uber, Lyft, LiveOps and Upwork (marketplace of professionals) transitioned to an employee-based marketplace.

Nearly every on-demand company that has shifted to employee classification acknowledges specialization as a key reason, so we might expect that business models creating fundamentally new services that require training will trend toward employee classification. And those that trend toward low customer-to-worker ratios and convenience over timeliness will trend toward independent classification.

Those businesses that deliver a commoditized or readily trained experience will likely stick with contingent workers, as will organizations like Home Depot (brands installation contractors) and HourlyNerd (consultants delivered to businesses) that deliver contingent workers hired for their pre-existing specialized expertise. While those workers are specialized, they don’t need training or management, so those organizations can focus on being a marketplace conduit to customers.

Companies like TaskRabbit, Handy and Postmates that mix some of the characteristics addressed above will continue to experiment with their business model until they settle on the right formula. I would (and have) bet heavily on these companies maintaining a pure marketplace approach that allows for maximum flexibility of worker and customer, and pushing ahead new definitions of what it means to improve benefits, education and quality in their labor forces.