Has the day of reckoning for the gig economy arrived?

In recent years, cheap money has prompted a remarkable influx of start-up businesses in the gig economy sector.

Ride-hailing taxis, takeaway food, and rapid grocery delivery have all seen enormous growth in well-funded entrants. However, with minimal economic growth, inflation and interest rates rising, storm clouds may be gathering for this widely-used market as recession bites in the coming years.

In 2009, Travis Kalanick recognised major limitations in the San Francisco taxi industry. His objective was to start a new operator that would combat the expensive, metered and tip-oriented basis of the traditional taxi services, which were rarely available when most needed, and almost always cash-only.

The ride-hailing app Kalanick developed connected users directly to drivers and was so effective it was rapidly adopted across the US.

The innovation spread wider still in the years that followed, soon established globally through similar initiatives such as Lyft in North America, Ola in India, Grab in South East Asia, Didi Chuxing in China, and numerous others.

Takeaway food delivery soon followed suit with the convenience of DoorDash, Grubhub, Uber Eats, Just Eat, Deliveroo, and many further variants. More recently, a huge number of firms including Getir, GoPuff, Gorillas, and Jiffy have entered the grocery delivery market – an industry willing to supply small numbers of grocery items or alcohol at very short notice, in as little as an hour or even 10 minutes following an online order.

Will Gig Business Models Ever Make Money?

One common characteristic shared by most of the industry players is an inability to generate profit. In fact, despite enormous venture capital funding from the likes of Sequoia, Softbank, and others, profitability seems as far away as ever. Uber has now been in existence for 13 years and although narrowing, its losses are still substantial. This raises the question of whether the basic economics of these industries will ever work.

So, what are the difficulties which have beset such a fundamentally innovative and well-used industry? One problem is low entry barriers – virtually all these services can be replicated by others at town level.

In different cities, competitors and their market shares often differ significantly. Nearly all taxi businesses now have an app, and takeaway businesses can arrange their own deliveries. The consequence of low entry barriers is many competitors. There is a plethora of competition in the rapid grocery delivery industry, and one wonders why so many believe there is a “pot of gold” awaiting those entering.

This leads us to ask what circumstances might allow these industries to become profitable, or will charging more economically viable prices simply kill demand?

There seems little doubt that the coming global slowdown will affect disposable incomes. The use of these services may well be seen as optional to many when set against cheaper alternatives, such as takeaway collection, and walking, or using public transport in place of ride hailing.

Most of the players in the gig economy have long been subsidising their prices to attract customer demand, while paying generous driver wages to attract deliverers.

The objective is to create 'network effects', whereby increased demand attracts more riders/drivers who want continuous work as opposed to long waits between jobs. High availability of riders/drivers allows responsiveness that attracts customers in the first place.

This virtuous circle of network effects is intended to increase scale economies leading to a 'winner takes all' objective.

Over the last year, ride-hailing and takeaway delivery drivers' remuneration has become less attractive. Prices to customers have increased in a bid to break even, as opposed to the reliance on investors who are growing understandably reluctant to subsidise the losses.

The hope is that the habit of using these services has become sufficiently ingrained for customers to continue usage, regardless of spiralling prices. So far this has largely been the case, and losses have generally been reduced.

Uber, for example, has reduced annual earnings losses of $5 billion a year to approximately half that in their 2022 forecasts. Evidently, some progress has been made, but will the ride-hailing industry ever justify its stock market valuations, which, for Uber alone, still stands at more than $50 billion?

Is the gig economy starting to contract?

The worst may still be to come for the gig economy. High inflation has arrived in much of the western world, together with increasing interest rates.

Typically, such inflation results in people being poorer as pay rarely keeps pace, in turn reducing customer demand. In addition, driver wages are forced to increase as fuel prices add further costs to the service.

These factors combined reduce demand due to affordability. In short, it is no longer a matter of choice or habit: many people will simply not have enough money to use Uber and will utilise other options.

The evidence suggests that prior to the advent of app-based services, people used cleaner, more sustainable transport services anyway. Gig services will contract back to a smaller number of users who can still afford them. In turn, the gig economy will have to cut back overheads in an effort to break even.

Gig economy riders are treated as casual labour and paid separately for each delivery. Riders don’t get paid for their waiting time. Their casual income is entirely dependent on demand. If that falls, so do their earnings and their interest in doing the job.

Unlike the ride-hailing industry, takeaway food delivery riders have other jobs or are students augmenting their income.

In contrast, taxi ride hailing is the main source of income for most drivers and so governments are targeting the industry to behave as employers, provide appropriate benefits and a minimum wage per hour. This drives up the costs of the ride-hailing firms and so fares have to increase. The cars are now still very convenient but are they cheap?

Governments tend not to regulate highly fragmented markets supplied by many small suppliers. However, when dominated by major players such as Uber, then governments introduce regulations to control their activities which are liable to increase their costs.

Similarly, unions start to appear, attempting to upgrade terms and conditions so as to improve the lot of drivers. They now have a large, well-financed employer with perceived deep pockets to negotiate with.

Larger corporates also tend to develop overheads, head offices, functional management, and advisors. All this drives costs into the industry, which passengers ultimately have to pay for. The more customers have to pay the less they are likely to use it.

In which markets does the gig economy thrive?

The gig economy is more likely to be successful in countries with a major disparity in income between the rich and the poor. So, it is likely to flourish in the US, India and China in which affluent middle classes are developing rapidly while unskilled wages tend to be very low.

In the US, major disparities exist between the affluent and poorer sectors, which is likely to perpetuate the gig economy on a localised basis.

However, European countries tend to exhibit less of these extremes, and so the costs of unskilled labour are relatively high, driving prices to a level that will make customers think twice. European markets are also more strictly regulated and so subjected to higher employment costs.

The technology sector has always suffered rapid change both in terms of developing technology and changing customer tastes. What appeals to customers this year may not do so next year.

As a consequence, successful business models may have short life cycles. Facebook is having to fight off TikTok, while Amazon may be fine for searching for certain items but people may shop around for more attractive, competitive websites with wider ranges.

Advanced technology may also mean that these are industries in which demand may switch either through fashion or popularity.

Another factor relevant to the success of gig industries is the density of demand. Concentrated urban populations mean more work in relatively small geographic areas, which cuts travelling and waiting time for drivers between jobs.

Densely populated, largely affluent cities such as London will provide more fertile ground than dispersed, less prosperous provincial cities. If these patterns continue, services such as rapid grocery delivery in the UK are unlikely to prosper outside London, which may be the case for other gig economy services.

It seems unlikely that gig valuations will ever recover to the levels seen in recent years. Tech markets are in fact slowing. According to Crunchbase, there have already been 60,000 redundancies in the technology sector this year, with more likely to follow.

Governments and central banks are no longer printing the vast amounts of money through quantitative easing used to buy corporate bonds, and it was this that gave corporates a low-cost source of funds to invest in gig and technology businesses.

Furthermore, central banks are increasing the costs of borrowing and buying back bonds to reduce liquidity levels. The excesses of recent years are coming to an end and valuations are suffering.

What does the future hold for the gig economy?

What we do know is that a recession will mean concentration for the gig economy. Ailing competitors will be acquired by bigger players.

Rapid food delivery is already seeing this trend as competitors disappear – they either produce cash fast or sell out, and most are taking the latter option.

A more concentrated industry usually means higher prices and Government attention, which usually leads to regulation and reduced profits.

High inflation will create significant pressures for the gig economy as drivers’ wages increase and the ability of customers to pay increasingly dwindles.

The sector will likely shrink and some players will disappear altogether. A new streamlined version of the industry may well emerge with fewer players, higher prices, and, over time, better profitability once the recession is over.

Some industries, such as rapid grocery delivery, may only survive in small areas of extreme affluence., while reduced funding means players will be forced to address the economics of the industry and increase prices regardless of the impact on demand.

More central cost-cutting is already a feature of the tech industry this year – will the gig industry become the next casualty of the current economic crisis? In short, will you be so quick to open an app for a takeaway or order an Uber in the coming months?

Read the original article at World Finance Review.

John Colley is Professor of Practice in Strategy and Leadership and teaches Strategic Advantage on the Full-time MBA, Executive MBA and Distance Learning MBA.

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