Transaction Costs (Part 3): Why sharing economy firms will struggle as they go public.

Well, it’s that time of the blogging cycle for me again!

Transaction Costs part 1, 2, and now, 3, has been the longest running part series of this blog and is probably going to remain so for a long long time. I might almost be forgiven for writing so much on Transaction Costs because I genuinely might be trying to reawaken Buchanan’s (James M.) ghost. Buchanan’s work has been truly inspiring for me, and this is just my way of paying tribute to him.

Following up on transaction costs part 2, this post specifically looks at why the firms currently operating in the SE (sharing economy) space might struggle when/if they go public. Their struggles exaggerated not in-spite of lower transaction costs, but maybe because of them. Lower transaction cost, which include expenses incurred when buying or selling a good or service, might turn out to be a bane for sharing economy firms in the long run. Lower transaction costs allow firms to engage in providing services at cheap rates while making profits at the margin. The difficulty with doing this long term?- Low transaction costs are available to every single new entrant/competitor in the market. Which subsequently begs the question how do you gain a competitive advantage in a field where everyone enjoys the same benefits? The answer is, product differentiation. It’s the classic trope for most mid size firms looking to scale, but sharing economy firms can’t compete on differentiation for obvious reasons- They can’t/don’t own the IP rights to their product. Hence sharing economy firms fight each other not on the product, but rather on the price they charge their consumers. The difficulty with that strategy?- It requires an abundance of cheap venture capital (VC) and hence isn’t an efficient strategy in the long term. Your competitor can easily out price you the next week and take back the market share you had gained the previous week. Hence why lately you see firms price fix, or as in the case of Uber in China, get out of the market completely in exchange for ownership in your competitor

The other defining characteristic that differentiates a company from its competitor is, its assets, or for the benefit of specificity, its ownership of the assets under its control (not including tech sharing/joint venture). For most companies in the S&P 500, it’s either patents, supply chains, employees, data, or a combination of all them. The issue with SE firms?- They don’t own any of their assets. For example, if you thought for Uber its biggest asset was its drivers, think again. It’s neither the drivers nor the cars. Uber’s biggest asset, if it has one, is its ability to cheaply raise a shit ton of VC money and hence be able to survive while making a loss every quarter. This brings me back to what happens once these firms go public, as Lyft plans to later this year. The pressures attached to a public firm are much different to those of a private company. No longer are you allowed to get away with running a loss every quarter, because investors will demand a sizable return on investment (ROI) or they will pull money. For example, Lyft in its disclosures showed a loss of $911.3 million on $2.06 billion in revenue. Any public company worth its salt simply doesn’t survive the exodus/capital flight that follows such dismal numbers. The only companies that survive to fight another day are companies that have significant tangible assets that they can sell. *cough General Electric *cough. The other issue with the Lyft IPO disclosure is that it outlined no plan to achieve profitability. If one had to venture a guess it’d probably involve raising prices. The problem with raising prices? You lose your competitive advantage over taxis, public transportation, and other PRIVATE ride sharing companies. Which brings us back to square one- how do you gain a competitive advantage if you’re a sharing economy firm? Quite simply for the time being, You don’t! ..unless you’re willing to make some tradeoffs (changing worker classification to full-time, etc) The only sharing economy firm with some chance of surviving as a public company is probably Airbnb, simply because it doesn’t have an obvious competitor on the horizon, yet.

And just in case you thought I was done, the other issue with the sharing economy moving forward is that they offer jobs many of us find repugnant. The issue with repugnant jobs? While most of us do them because we’re forced to, we neither feel comfortable telling other people or engage in them for an extended period of time. Sharing economy jobs neither offer us the benefits we get from full time jobs nor the pay. This is why despite there being a monumental growth in the number of sharing economy firms in the last 10 years, the number of workers under alternative working arrangements, which includes independent contractors, freelancers, temp workers, only rose from 10.6 percent to 15.6 percent in the 10 years between 2005-2015. Workers in alternative work arrangement also earned less per week than regular employees with similar characteristics in similar occupations. (Katz, Krueger, 2018) They simply aren’t a good enough substitute for full time work now that the economy is back to being *somewhat normal again.

To summarize, if you’re an individual investor, specifically, yes you robinhood using college student aka individual investor- Your money really is better off under the mattress than investing in sharing economy firms just because your friends did so. Groupthink really is an epidemic.

*Somewhat is subject to market risks. Please read the offer document carefully before investing.

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