Uber and Lyft, the two leading ride-share companies, have lost a great deal of money and don’t project a profit anytime soon.
Yet they are both trading on public markets with a combined worth of more than $80 billion. Investors presumably expect that these companies will someday find a path to profitability, which leaves us with a fundamental question: Will that extra money come mainly from higher prices paid by consumers or from lower wages paid to drivers?
Old-fashioned economics provides an answer: Passengers, not drivers, are likely to be the main source of financial improvement, at least within the next few years, mainly because of something called “relative price sensitivity.”
This conclusion may seem to run counter to popular wisdom. Wall Street analysts have suggested that Uber and Lyft will need to squeeze their drivers. Those workers are quite concerned about the possibility. Thousands went on a one-day strike before Uber’s initial public offering in May to demand higher pay and more benefits.
And Lyft, in documents filed in connection with its own IPO, said it hoped to use autonomous vehicles, which don’t need a wage, for a majority of its rides within 10 years. But rather than debate the plausibility — or cost — of amassing an autonomous fleet in a decade, let’s consider what is possible over the short term.
Economic theory predicts that sensitivity to price changes determines who will pay more. And it turns out that passengers aren’t very sensitive to price, while drivers are.
Yes, surge pricing — the practice of raising prices when demand is high — makes many people feel irate. But what people actually do is what is important. The most comprehensive study of rider behavior in the marketplace found that riders didn’t change their behavior much when prices surged. (Like most major quantitative studies about Uber, it relied on the company’s data and included the participation of an Uber employee.)
Passengers were what economists call “inelastic,” meaning demand for rides fell by less than prices rose. For every 10 percent increase in price, demand fell by only about 5%.
Drivers, on the other hand, are quite sensitive to prices — that is, their wages — largely because there are so many people who are ready to start driving at any time. If prices change, people enter or exit the market, pushing the average wage to what is known as the “market rate.”
That’s what always happens when there are no barriers to entry in a market. In 1848, for example, at the start of the California gold rush, the first miners made about $20 per day, on average. The historical data shows that was at least 10 times more than the wage for workers doing what I would classify as similar activities — stone cutting and brick laying — in New York at that time.
Over the next eight years, so many people moved to California searching for gold that miners’ average earnings fell to $3 a day, minus expenses — barely more than they could have made if they had been cutting stones in New York.
What killed the gold rush wasn’t the lack of gold — production tripled over that time. It was the entry of so many competing miners that drove average earnings down so low that most of them barely made enough to stay in business.
And so it is with ride-share drivers today. Another study, by a New York University professor and two Uber employees, found the same dynamic: Higher prices increased driver incomes, but only for a few weeks.
As new drivers entered the market, attracted by higher wages, the average driver had to spend more time waiting for fares. Average pay returned to the level economists refer to as “the outside option” — the pay level of whatever else the drivers could be doing if they weren’t driving for Uber or Lyft.
If for many ride-share drivers the next best option is delivering for an outfit like Domino’s Pizza, or working at a fast-food restaurant, then average pay for the drivers will likely to end up around minimum wage, too.
Some of this is just educated guesswork. It’s not as easy to measure drivers’ average wages — and, therefore, their price sensitivity — as you might think. Since drivers pay their own fuel and depreciation expenses, we need to subtract those costs from their earnings, but we don’t have good data.
Still, a major survey of drivers done last year by the analysis firm Ridester showed average raw earnings for UberX drivers of about $15 per hour, before projected deductions of about $8 per hour.
The bad news for the drivers, then, is that average pay will be low. Also, even if they convinced ride-share companies to raise the share of revenue the drivers keep and to increase benefits, the earnings boost would likely be ephemeral. Thousands of new drivers would enter the more lucrative market, bringing average earnings back down to the market rate.
The good news for drivers, though, is that it won’t be easy for ride-share companies to cut wages much lower. Many drivers will simply stop driving if wages fall.
One of the most important studies of driver behavior (conducted by professors from Yale and UCLA and, again, one Uber employee), confirms the sensitivity of drivers to earnings changes. On average, they increase their hours by 20% in response to a 10% increase in wages. That is about four times larger than the response by passengers to changes in the price of a ride.
Economics says that the likelihood that a person will bear the burden of an increase in profit margins is inversely proportional to their price sensitivity. In other words, because drivers are four times more price sensitive than riders, a reasonable guess is that 80% of the price burden will fall on passengers, 20% on drivers. Uber and Lyft are still building their networks and market share, which complicates matters, and may delay price increases.
Nonetheless, I think that as a passenger, you should take your Uber and Lyft rides now, while they’re still relatively cheap. And, if you’re an investor counting on wage cuts and robots to carry Uber and Lyft to profit nirvana, you may want to buy a certain bridge first.