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Uber, Lyft face higher costs regardless of Calif. legal battle outcome

Uber Technologies Inc. and Lyft Inc. will incur higher costs and risk missing their targets to turn profits in 2021 regardless of whether they win their fight against California's law to reclassify drivers as employees, according to experts.

Uber and Lyft, along with delivery companies DoorDash Inc., Postmates Inc. and Instacart, have pumped a combined $185.1 million into a California ballot measure that would overturn the new law. The ballot measure, Proposition 22, would allow companies to keep gig workers as independent contractors instead of employees while adding some protections for those employees.

California is a major market for ride-hailing companies. Lyft has approximately 300,000 drivers in California, while Uber counts more than 200,000. California made up 16% of Lyft's total rides in 2019, while the state accounted for 9% of Uber's global rides and food delivery gross bookings for the same year, said Santosh Rao, head of research at Manhattan Venture Partners.

Experts expect the Nov. 3 vote outcome will inform how other states approach regulating gig-economy employment schemes. Regardless of how voters decide on Prop. 22, both companies face additional costs in California to provide drivers additional benefits and protections, experts said.

"Some of the costs will be passed down to the riders, increasing the fares," Morningstar analyst Ali Mogharabi said of Prop. 22's potential passage. "But overall, these costs are probably much lower than what they would incur under [California's law]."

Those added costs risk derailing the companies' profitability targets for 2021. Both Uber and Lyft continue to operate at a loss and the coronavirus pandemic has hurt ridership, especially in the first half of the year.

READ MORE: Sign up for our weekly election newsletter here, and read our latest coverage here.

Uber and Lyft could each face more than $392 million in annual payroll taxes and workers' compensation costs if drivers are reclassified as employees, according to a Reuters calculation.

Uber contributed a total of $50.1 million supporting Prop. 22 as of Sept. 27, while Lyft reported $48.3 million, according to state-level campaign finance disclosures. DoorDash reported $47.7 million in contributions, with Instacart contributing $28 million and Postmates reporting $11 million.

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In an emailed statement, Lyft said the vast majority of its drivers want to remain contractors instead of becoming employees. "But if Prop. 22 fails, hundreds of thousands of California drivers could lose the opportunity to earn on Lyft entirely," the company said.

Uber did not respond to a request for comment.

If Prop. 22 does pass, California lawmakers likely would not challenge the victory at a time when states want to create as many jobs as possible for people amid the coronavirus pandemic, Morningstar's Mogharabi said.

"Given the pandemic and the overall economic downturn, I'm not sure if the lawmakers of California would want to drag this further," Mogharabi said.

A long legal road

California Gov. Gavin Newsom signed Assembly Bill 5, or AB5, into law in September 2019. It went into effect in January, requiring gig-economy companies to classify their workers as employees instead of independent contractors if the workers meet certain criteria.

AB5 provides minimum wage — $13 per hour in the state — paid leave, overtime pay and access to federal benefits under the Affordable Care Act. It also gives gig workers the right to unionize. Prop. 22 is offering an alternative, including paying drivers at least 120% of the local minimum wage for time spent driving; reimbursing drivers 30 cents per engaged mile; and offering healthcare subsidies and accident insurance. Prop. 22 proponents said the measure also protects drivers' rights to control their own schedules and gives them the flexibility to work on multiple platforms.

Uber and Postmates sued the state over AB5 in December 2019, while California filed its own lawsuit against Uber and Lyft to try to force the companies to comply with the law.

In August, an appellate judge agreed to delay the AB5 order for Uber and Lyft after the companies said they would need to suspend service in the state to comply with the new law. The ride-hailing rivals are set to present oral arguments in court Oct. 13.

Between the two companies, Lyft could see more of an immediate impact of any change to how it classifies its employees as California accounts for a much higher share of its revenues, said AB Bernstein analyst Mark Shmulik. Uber is a more diversified global company, so California's outcome is potentially less critical but it is also more exposed to other states that could come up with similar laws regarding drivers.

Higher costs either way

Regardless of the election outcome, Uber and Lyft will still face higher costs to offer drivers additional benefits, though complying with California's new law would be costlier, experts said.

Alison Stein, an economist at Uber, said the company estimates prices would need to increase 25% to 111% across different parts of California to make up for increased costs if Prop. 22 fails and Uber must reclassify drivers.

"Larger cities would be able to support lower prices when compared to less urban areas, where sparse demand makes it more costly to sustain a business under an employment model," Stein said in a May 28 Medium post. Higher prices would reduce demand for trips, said Stein. The company expects reduced demand would result in a trip loss of 23% to 59% across California, with less-populated areas feeling the biggest impact, Stein added.

If Prop. 22 fails, Uber and Lyft might cut back on how many drivers they employ, according to Morningstar's Mogharabi.

"There are not going to be as many drivers out there, which means that the timely response or the timing of responses to the rider request is probably going to be a little bit slower," Mogharabi said.

Reclassifying drivers as employees would mean Uber and Lyft will most likely cut down service, especially in more rural and less-profitable areas, Manhattan Venture Partners' Rao said. The number of hours drivers can work will be limited, and the flexibility of the job will be gone, Rao said.

"So the drivers are going to lose because they're going to have less hours, and the passengers are going to lose because they're not going to have service as they have now," Rao said, adding that the costs of rides will also go up.

The election battle in California comes when Lyft and Uber are already suffering a drop in ridership numbers because of the coronavirus pandemic. Uber's users were down 44% year over year in the second quarter of 2020 and Lyft's were down 60% year over year. Uber has been buoyed by its food delivery business, however, as consumers have been ordering more takeout during the pandemic.

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Eyes on California

The outcome of the battle in California could influence other states on how to proceed, experts said.

The result could set a precedent for how other states approach the legal classification of ride-hailing drivers, according to Wedbush analyst Dan Ives. Prop. 22's failure would deal a financial hit to Uber and Lyft in California and possibly other states, Ives wrote in an Oct. 5 analyst note.

Elected officials in other states are likely paying close attention to the outcome of California's vote, "especially those states that have already taken an active role in capping food-delivery take rates, congestion charges, etc.," Shmulik said.