Last month, the California Labor Commission made a ruling against Uber that could have big implications for the $50 billion ride-hailing company.
A San Francisco driver, Barbara Ann Berwick, filed a federal class-action claim against Uber saying she should be considered an Uber employee, not a contract worker. The California Labor Commission agreed with Berwick because it deemed Uber drivers are "involved in every aspect of the operation."
Uber argues that the class-action part of the suit should be dropped and is appealing the ruling.
But if Uber doesn't get its way, the lawsuit could seriously impact Uber's business model. In a worst-case scenario for Uber, it would have to reclassify all of its California drivers as W-2 employees, as opposed to independent contractors, which would be expensive.
The cost difference between employing W-2 workers and 1099 contractors, which is what Uber's drivers currently are, is a lot. For common-law W-2 employees, employers need to withhold income taxes, Social Security and Medicare taxes, and pay unemployment taxes, according to the IRS. The same is not necessarily true for an independent contractor.
W-2 employees also get benefits that contractors often aren't offered, and in general they have more labor protections and job stability.
There are some benefits to being a contract worker, though. An employer can't really control how a contract worker behaves--which hours they clock in, how to dress, or customer interaction, for example. Uber argues that not all of its drivers would actually want to be full-time Uber employees, because they have flexible lifestyles as contractors.
But let's imagine the worst-case scenario for Uber were to happen.
How big a deal would it be for Uber to turn thousands of drivers into W-2 employees? It's estimated to have 45,000 drivers in California alone. And how much would it cost?
We talked to some startups that have decided to classify their laborers as employees to get a better sense of what kind of an undertaking a reclassification would be for Uber.
The bigger a startup is, the more difficult it is to reclassify its workers
In May 2013, before Marcela Sapone officially launched her startup, Alfred, she and cofounder Jessica Beck were using contractors to run errands for their clients. Alfred is a startup that seeks to automate weekly errands and home chores with an army of local workers.
Five months later, Alfred's cofounders decided to convert their laborers (Alfreds, as they're called) into W-2 employees. "We spent hours and hours with lawyers--we spoke to four law firms--about the potential implications and the differences between the two classes of workers," Sapone told Business Insider. "And then we actually had to change our whole payroll system. We couldn't use [payroll provider] Zenefits because we had two different classes of workers, even though they were both W-2s."
Sapone says it took a lot of time to get up to speed and there were a lot of administrative costs to reclassify her workers. Then, she and her cofounder had to increase the hourly wage of their employees "because we no longer did overtime," she says.
And then there was the paperwork. "We had to get everyone to sign these documents about what it meant to do the switch, and how we were going to do tax withholdings and had to get everyone to sign W-2 forms," she said.
At the time that Alfred reclassified its employees, the company was in its infancy--it still only operated in Massachusetts. "Reclassifying would be incredibly difficult to do if we had waited longer," Sapone says. Because labor laws are localized, it requires work on a state-by-state basis. "It would have been even harder if we were in more than one geography," she adds.
Uber is currently operating in more than 300 cities.
Educating employees can take a while
Last month, on-demand-shipping startup Shyp announced it would be reclassifying its couriers, known as Shyp heroes, to W-2 employees. (Its warehouse workers and drivers were already W-2 employees.)
A memo from Shyp CEO Kevin Gibbon said the move was meant to invest "in a longer-term relationship with our couriers," and was an operational decision to let the company have better quality control over the Shyp experience.
"A move of this magnitude takes so much planning cross-functionally ... it requires so much work from operations, HR, marketing, engineering," Johnny Brackett, Shyp's head of communications, told Business Insider.
"Now that we've reached such a high volume of shipments in all of our active markets and we have such aggressive plans for expansion, it just wouldn't be sustainable at scale to maintain the Shyp experience with the 1099 model because of scheduling and training and things like that. So over the past year it's literally been on the first two agenda items of every executive team, every board meeting."
Since laws vary by location, Shyp is rolling out the changes city-by-city. "We are going to launch in Chicago later this year, this summer or early fall, so that will be the first Shyp market that is entirely W-2 from launch," Brackett said. "It's just going to take some time to transition the other guys."
To implement its W-2 plan, Shyp's courier managers--basically community managers that oversee Shyp's delivery people--will sit down with each and every courier and give them a job offer. The responsibilities will vary from their current roles as delivery people: There will be added supervision and training and implemented scheduling, which Shyp cannot legally have its couriers carry out as contractors.
"The courier gets told, 'We're reshaping the courier role. We're so grateful to have you on board. Here's what it looks like, are you interested?' We want to take our time transitioning because the couriers who are not interested in moving forward with the W-2 role, we want to make sure they have time to make other adjustments in their life," Brackett said. "We get that this is a change. We're thrilled about it. But we understand some of the couriers are not going to be thrilled about it."
Brackett declined to say how many couriers Shyp has, but he says the company has "hundreds" of laborers, including its newly employed delivery people.
The cost of a 1099 worker versus a W-2 employee
Limited available data makes it impossible for us to know just how much Uber may have to pay up if its drivers get reclassified. But one figure repeatedly comes up in conversations with startups who have gone the employee route: It costs roughly 20% to 30% more to hire W-2 employees as opposed to independent contractors.
Munchery, a full-stack food-delivery startup serving up gourmet meals made by in-house chefs, hired its delivery team as employees. Those who work more than 30 hours a week can get benefits, worker's comp, overtime, and paid sick days.
The company says that hiring its drivers as employees adds an estimated 20%-30% to cost per hour. "However, the aggregate increase in labor cost is lower because classifying team members as employees improves retention and enables us to train them, increasing their efficiency," says Munchery's VP of operations, Kris Fredrickson. "The primary additional costs a company that issues W-2s must bear are payroll taxes, workers' compensation premiums, and employee benefits for qualifying employees."
Likewise, Sapone says that when Alfred made the W-2 employee switch, her overall cost structures increased "by 20 or 30%."
"Suddenly you're paying health benefits. The employee pays some of those benefits, but you're paying anywhere from $200 to $600 in health benefits [per full-time W-2 employee per month]," she said. "You're also having to withhold more, and all of the accounting that comes with it -; there's administrative costs that come with it. State by state, all of the employment laws are a little bit different."
Shyp doesn't have hard numbers for how much it will cost to employ its couriers as W-2s.
"In financial projections, there's nothing surprising for us. The fact that we've always had our satellite drivers and warehouse employees as W-2s is really just closing that gap," Shyp's Brackett said. "It's transitioning the one-third of that group that hasn't been W-2."
Brackett says Shyp has already accounted for increased costs.
In June, $2 billion online grocery-delivery company Instacart announced plans to convert part of its workforce from contractors to part-time employees. Like Shyp, Instacart said the decision to reclassify wasn't a response to the Uber lawsuit--it's meant to improve customer service and efficiency. The company ran a pilot program earlier this year, making some of its shoppers part-time W-2 employees.
"Our shopper experience was better and therefore made decision that it made sense to replicate this model in other places," Andrea Saul, Instacart's VP of communications, told Business Insider. "The biggest cost increases we incur are workers compensation, payroll taxes, unemployment, social security, and Medicare. But even though the model was costlier for us, if it did improve our customer service we thought it was worth it for better service for our customers in the long term, and therefore grow our business."
The problem: None of these startups operate on Uber's scale
The problem with comparing these startups to Uber is that none of them are close to Uber's size. Shyp has hundreds of couriers and delivery people. Alfred has 86 Alfreds. Instacart says it has 100 part-time employees in Chicago and about 200 in Boston, just two of its markets.
Uber operates in hundreds of cities globally. It has had more than a million people drive for the company. It's raised $5.9 billion in venture capital funding and counting. And its core, nondriver team is presumably much larger than that of any other on-demand company.
The most comparable worker-reclassification case study isn't a Silicon Valley startup--it's FedEx. Like Uber, FedEx had been classifying its delivery drivers as independent contractors and not employees, even though they wore FedEx uniforms and drove trucks with the FedEx logo.
A Massachusetts judged recently ruled in favor of FedEx workers, and the case has been repeated in several other states. (FedEx has now successfully appealed, and it is back in court.) When FedEx lost its class-action lawsuit in California, it had to pay a $228 million settlement.
For Uber, $228 million would still be a drop in the bucket. The company is flush with VC funding and is generating hundreds of millions of dollars in revenue annually in its biggest markets. But if Uber has to pay other costs--things like overtime pay and gas and car-repair expenses--it could add up.
Uber CEO Travis Kalanick has dealt with brutally expensive lawsuits before. Kalanick dropped out of UCLA to work on a file-sharing company, Scour, which was ultimately sued for a quarter of a trillion dollars and filed for bankruptcy.
At least this time, Kalanick is armed with a war chest of cash, and his company is prepared for battle.