How Workforce Turnover Threatens to End the Gig Economy

Next time you get in an Uber, ask them how long they have been driving for Uber… The last three I was in were less than a month. There is an interesting phenomenon occurring in the Gig Economy right now. Companies are seeing huge revenue growth at positive and “healthy” gross margins, but still cannot sustain themselves in the long run. In addition to the more publicized challenges of unit economics in these businesses, on-demand marketplaces face another unit economic challenge with their hiring and retention of labor. These aren’t the engineers, developers, and marketing/sales forces at headquarters. These are the massive labor pools of drivers, delivery personnel, cleaners, etc. executing these jobs; and, the problem is the acquisition cost of these employees/contractors compared to the lifetime value they bring the company.

For these on-demand businesses, acquiring a workforce has an associated cost regardless of whether the workforce is classified as contractors or employees. This labor acquisition cost, or LAC, as I will refer to it, is impacted by the salaries of recruiters/hiring managers, advertisement costs on job platforms like Craigslist, materials/equipment provided to new hires, etc. Even when efficiently hiring in mass, the LAC of these individuals ranges from hundreds to thousands of dollars per person. Normally, a LAC of this magnitude wouldn’t be an issue, but because of the high turnover rates of your average Gig Economy worker, it can start to present very serious problems.

For every task someone in the workforce is completing, they are generating revenue for the company. If the company has sensible unit economics on the revenue side of their business (as many claim they do), that per-task revenue generates gross profit back to the company. The risk happens when the workforce turnover occurs so fast that the gross profit brought back to the company never overcomes the LAC. In theory, this is what you need:

Think about the cost of hiring someone as a debt. The company has to pay that hiring cost back before actually making any money that can go to the bottom line. However, the only way to pay the debt back is when the employee/contractor is working and completing tasks; and, if the employee/contractor quits before paying the debt off, the debt defaults. To figure out whether you have a healthy company, we only need to look at averages. I use “tasks”, but tasks can typically be used interchangeably with “hours worked” since completing tasks has some unit of time associated with the effort. For example, here is a healthy gross margin but a failing business model.

So even while growing revenue, and having positive gross margins, the company loses money on every person hired. When you have thousands of people in your workforce, this loss adds up fast. The company never ends up generating profit that goes towards the bottom line or overcomes internal operating costs.

The inputs are clear. You have to retain labor, incentivize them to work the most hours possible in a week, and pay off the hiring “debt” as fast as possible. Ideally, you want large, absolute gross profits that would pay off LAC in a small number of tasks that are quick to complete. However, that’s tough in the on-demand space since most of the services are things ranging from short car rides to home cleanings.

I don’t claim to know what the hiring cohorts and exact LAC for the large on-demand platforms are, but I do know it’s a war out there. Referral bonuses, wage guarantees, and huge spends on job advertising platforms like Craigslist are happening at an unparalleled rate. Here is a screen shot of my Craigslist check from May 24, 2016. I couldn’t fit all the posts for a single day into one capture…

It’s ironic to me that the same benefits around flexibility of hours and the future of work that many of these platforms proselytize about could actually be a serious threat to their longevity. At Homer, we took somewhat of a contrarian view to the on-demand space by choosing to hire employees instead of contractors when we started. Other groups, such as Managed by Q have also taken this path. Among other things, this allows us to engage our workforce and create a culture of retention. We also conduct and monitor an internal NPS (net promoter score) with our workforce on a monthly basis. The same techniques product companies use to assess consumer sentiments towards their products, Homer uses to measure our workforce’s sentiments towards the company. We use the results to adjust our operation/procedures regularly.

I would like to extend my gratitude to the various people who have provided insights on this topic, and especially Homer’s Director of Operations, Marisa Smith, who owned the analysis and understanding of this at Homer.