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Why Startups Are Making the Expensive Switch to Traditional Employment

Updated: Aug 05, 2015 12:55 PM ET

Correction appended, Aug. 5

On-demand valet service Luxe announced Tuesday that they were expanding to an eighth city, Philadelphia—but that development was tiny compared to news that went out late last week: the company announced that the hundreds of workers who run around cities like Philadelphia in bright blue Luxe jackets, picking up and delivering people's cars wherever users are, will all be converted from independent contractors to traditional employees.

That's a move that will cost Luxe, as well as other hot startups that are reverting to doing things the old-fashioned way (at least in part) amid a mess of lawsuits over the status of workers in the on-demand economy. But they stand to gain a lot in return.

Many Silicon Valley companies have followed in Uber's tracks and developed business models that assume their armies of workers will be treated as contractors. While the brass can't legally tell contractors when to be on the clock, how to do their job or what to wear, they also don't have to pay them overtime or guarantee them minimum wage or remit payroll taxes. The savings for companies is huge—probably in the billions per year for a business like Uber.

But while traditional employees cost more, employers get to exercise far more control over them, telling them precisely what to do and how to do it and, for that matter, in what color and style of outfit.

"It has to do with controlling the user experience," says Luxe CEO Curtis Lee of why they are "making the switch" two years after the service started in San Francsico." After a while you realize that some of the trade-offs you were making weren’t really good trade-offs."

Under the contractor model, Lee says, the leaders at Luxe hadn't been able to schedule workers for unpopular hours like late nights on Friday and Saturday; they could only bribe them to come online with higher rates of pay, as Uber does with surge pricing. They couldn't provide thorough training or demand that they be considerate of other valets. "Now we can actually say, ‘Hey, you need to address the customer in a certain manner,'" Lee says.

Kevin Gibbon, CEO of San Francisco-based Shyp, says they made the same change earlier this summer because they wanted more "quality control" over couriers responding to on-demand shipping orders. Sometimes the closest courier wouldn't feel like doing a job, so users would be left waiting for a more willing courier who was 30 minutes away. Other times couriers would respond to a request and then refuse to take whatever the user wanted to ship, perhaps because it was too unwieldy. Under a contractor model, there wasn't much they could do about that. "As a contractor you have the right to accept or reject a job," Gibbon says. As employees, part of the job description can include accepting all requests.

As an employer, Shyp will have to reimburse employees for job-related expenses like gas and car maintenance. Managers will have to make sure workers are taking breaks. Yet Gibbon hopes that they'll also get more loyalty from couriers, who will feel more attachment to the company and will be more likely to stick around—saving Shyp from onboarding someone new and gaining them the productivity of a more experienced courier. People who want more a career path and less of a temporary gig might be attracted to working for them instead of dozens of other startups, he says.

Both Gibbon and Lee deny that the slew of worker-status suits against companies like Uber, Lyft and delivery company Postmates have anything to do with their decisions to abandon the contractor model. But plenty of startups may look at a company like Homejoy and see a cautionary tale. The on-demand cleaning service recently put up its mop for good, saying the "deciding factor" was four lawsuits it was fighting over worker classification.

One of the companies fighting a class-action suit is Instacart, a rapidly growing $2-billion startup that facilitates on-demand grocery delivery. When the business started, most of their contractors were both shopping for groceries and then delivering them, but over time those jobs have split. While some workers still do both jobs, many either spend all their time shopping in a store or out delivering the bags. Instacart recently announced that after a successful pilot, they would be offering some in-store shoppers the chance to become employees.

"We quickly learned that there were a lot of improvements and efficiencies with this new model," says Andrea Saul, VP of communications, who could not comment on the pending lawsuit. "Shoppers got better and more accurate at picking items, so we had fewer order issues. Shoppers also got faster at picking items, so we had more on time deliveries."

Instacart also noticed a better retention rate among those granted employee status and found them easier to integrate into the company culture. "Ultimately, even though the model was costlier for us, the change improved our customer’s experience," says Saul. The lawyers pursuing the case applauded the change but say it doesn't affect the years of expenses, for instance, they believe are due to more than 10,000 workers. Those delivering groceries continue to shell out for their own gas and car maintenance.

The main argument that companies like Uber make is that forcing them to classify their drivers—or cleaners or delivery people—as employees would force them to do away with the freedom and flexibility that attracts many workers to the on-demand economy. Contractors get to work as much as they want when they want. "If I don’t want to go out one night because my stomach’s upset or there’s a Game of Thrones marathon on or my cats are being really cuddly, I’m just not going to go out," says Chicago-based Christopher Gutierrez, who loves driving for Lyft. "I can’t have middle management telling me things and having to abide by different codes."

In a recent motion fighting a class action suit, Uber's lawyers said they might be forced to change their entire business model, making drivers work in set shifts and requiring that drivers work only for Uber.

The smaller companies making this change say they'll be able to retain flexible hours. Luxe's Lee says they'll set no maximum or minimum valets have to work or tell part-time workers they can't also work for Lyft. While he expects more companies to follow in their footsteps, he also says that he doesn't believe that the traditional employment model works for every company. Like a growing chorus of Silicon Valley disrupters and academics, he believers America should rethink employment.

"There are two old paradigms that were created long, long ago in a different world," he says. "There really needs, eventually, at some point, to be maybe like a third classification." The great unknown is what, even if there was the political will to create such a thing, that third category would look like.

Correction: The original version of this story misstated when Luxe announced a change in the employment status of its workers. It was July 30.

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