Sharing Economy 2.0: Can Innovation and Regulation Work Together?

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On a late October weekend, officers of the Philadelphia Parking Authority (PPA) conducted a sting operation on UberX cars in the city. Thus far, the agency has fined 10 drivers of the car service app $1,000 each and impounded their vehicles for violating the law. Uber was fined $1,000 per violation as well. The parking authority said Uber only has permission to operate a limousine fleet in Philadelphia, not a ride-sharing service, whose drivers may not have gone through background and other safety checks. PPA spokesman Martin O’Rourke called UberX a “renegade taxi operation.”

Meanwhile, New York City is cracking down on Airbnb lodging listings that authorities say violate zoning and other laws. Attorney General Eric Schneiderman said 72% of the listings are being run illegally. He has formed a joint task force with the City of New York to close down unlawful accommodations being rented out through the lodging-sharing site. “We must ensure that, as new online marketplaces revolutionize the way we live, laws designed to promote safety and quality-of-life are not forsaken under the pretext of innovation,” Schneiderman said in a statement.

But as regulators continue to crack the whip, there is little sign they will be able to stem the tide of popularity for these services. Indeed, an August report from PwC points to the rapid growth of the “sharing economy,” in which under-utilized assets are put to use for the benefit of both the owner and buyer. The report expects revenue from major sharing-economy sectors — peer-to-peer finance and lodging, online staffing, car sharing and music or video streaming — to increase 22-fold to $335 billion globally by 2025. Such sharing services could expand to other sectors such as energy, telecommunications and retailing, PwC said.

“Once the genie is out of the bottle, it’s hard to put it back,” says Gilles Duranton, a Wharton real estate professor. Consumers are attracted to the lower prices offered by these sharing-economy apps, as they pass on cost savings from not owning hard assets such as stores, cars or hotels. People also like the efficiency and better customer experience of these services, which usually offer cashless transactions, emailed receipts and online reviews. At Uber, rider demand for its car-hailing service has grown so rapidly in five years that it now operates in 45 countries, despite battles with regulators in many cities.

“Once the genie is out of the bottle, it’s hard to put it back.” –Gilles Duranton

Duranton notes that even in France — where there have been mass taxi protests against Uber and regulators have a long history of protecting unions — “this is moving forward.” Uber has ensured that in Paris, consumers can now get a taxi more easily if they need one, he says. Paris has historically had a limited number of taxis in circulation, which has kept prices up. “You’re sort of stuck since there’s no competition,” Duranton adds.

In Philadelphia, market forces seem to be siding with the sharing economy, at least for now. The Philadelphia Parking Authority had to postpone two auctions of taxi medallions at around the same time it was cracking down on UberX. The agency cited “lack of participation” on its website. Bidders were missing even though the city was auctioning off the previously sought-after medallions — which are required to operate a single cab in the city — for the first time in 15 years, and at a market discount. O’Rourke said the minimum auction bid was $475,000, but in private sales, a medallion has fetched as much as $525,000.

A New Era

Wharton management professor Ethan Mollick believes that these sharing services are entering into another phase of growth. “In my view, the next stage is about compromising and bargaining,” he says. Mollick thinks that “a lot of companies like Uber have very strong Libertarian streaks Twitter . They think the sole purpose of government regulations is to protect entrenched interests and restrict new entrants. Certainly, some of that is true.” As a result, a prevailing mindset seems to be that these regulations are “outdated and they don’t make any sense,” and tech companies then seek to overturn them, Mollick notes.

But Mollick argues that “efficiency isn’t always the goal of policy.” There are issues, such as fairness, that do not lend to the most efficient policy, but are virtues nonetheless. “Not all inefficiencies are bad,” he says. “Progressive taxation is not always bad. There are reasons why we don’t want pure economic efficiency.” For instance, child labor laws exist to protect the young, even though putting them to work after school would be more efficient for the economy. Mollick points out that sharing services are forcing governments to think about which regulations “really matter” as they learn to live with a new market reality. “At the same time, to say that all of this [legislation] is a waste is a bit disingenuous,” he adds.

Part of the challenge facing regulators is that sharing-economy services found loopholes in the law that governments did not anticipate would be exploited, Mollick notes. The companies can lower their costs artificially by not providing worker protections, such as paying minimum wage and benefits like health insurance, or by operating outside the regulation and taxation systems that govern industries like traditional hotels or car services. “A lot of that regulation has to be updated to close loopholes we want closed — and allow more business models to enact change as long as they obey the law,” he says. Mollick predicts that these services will indeed change as they evolve from their initial phase in order to more fully follow the law.

Indeed, Uber’s black car service complies with applicable Philadelphia laws. “That’s fine. They follow the regulations,” O’Rourke said of that arm of the business. But UberX violates the law, city officials say, because it is a ride-sharing service in which it is not clear whether drivers are trained, insured or have had criminal background checks. However, Uber said on its blog that all UberX drivers go through a background check and their rides are insured for $1 million per incident. The company added that it also checks drivers against the National Sex Offender Registry.

In response to the New York Attorney General’s report, Airbnb did not dispute the findings, but a company spokesman told The New York Times that stakeholders need to “work together on some sensible rules that stop bad actors and protect regular people who simply want to share the home in which they live.”

Duranton agrees that sharing-economy businesses must comply with the law. For instance, he says it is just good practice for condominium owners posting spare rooms for rent on Airbnb to get the approval from building managers before accepting travelers. “If you organize your apartment as a hotel, your neighbors won’t be happy with that,” he points out. Drunken travelers stumbling noisily back to the apartment at 4 a.m. will incur the wrath of other residents, who do not have staff to deal with disturbances, unlike at a hotel where “you call the reception [desk] and the hotel will deal with it,” he adds.

“A lot of companies like Uber have very strong Libertarian streaks. They think the sole purpose of government regulations is to protect entrenched interests and restrict new entrants.” –Ethan Mollick

But it would be wrong to assume that technology enables more illegal activity, says Jeff Henretig, a founder of consulting firm East Fourth Partners who has worked in the sharing economy. He argues the opposite: “It’s making them more accountable by creating records of the transactions.” With Uber, every ride is recorded, including the identity of the driver and passengers. Taxis do not offer such tracking, he notes.

Henretig goes further to say that he thinks it is “actually much safer” to use apps like Uber because of warnings in online reviews and the ability to track identities because many users link their profiles to their Facebook accounts. Crimes happen in taxis and hotels as well, but with fewer ways to track perpetrators. Meanwhile, the presence of these services provides big benefits to the public by lowering prices, improving efficiencies and offering services that were previously unavailable. “Consumers are winning big time,” Henretig says.

Grassroots Lobbying

Consumer might love them, but regulators still need to be won over. That means sharing-economy companies will have to learn to play the regulatory game better. Gerald Faulhaber, Wharton professor emeritus of business economics and public policy, says one reason why these companies have not been more politically active is the way they see themselves. Airbnb, for example, is a matching service for homeowners and people who need a place to stay. It does not own hotels that need to comply with zoning and other laws. But once the company started to threaten old economy incumbents, those businesses started to lobby regulators to hobble the service. “That’s what economists call ‘rent-seeking,’” Faulhaber notes.

Faulhaber says these companies have to do a better job of rallying consumers for support. “You’ve got to get the public on your side,” he notes. There is evidence that grassroots lobbying works. Faulhaber points to the fight before the U.S. Federal Communications Commission about preserving net neutrality. Consumer groups and other politically savvy advocates got more than one million people to send emails to the commission. “They’re pretty well roused up,” he adds. The challenge for tech apps, he says, is: “How do you get a million people to tell regulators this is what you want?”

One way is to make sure to provide a more superior service than old economy competitors to get public support more easily. “Get people to …be your advocate and intervene on your behalf,” Faulhaber suggests. Making the argument that the service brings innovation to the city would have limited appeal to politicians. “They don’t care about it being more efficient. They care about whether they hear from constituents,” he says. Teachers’ unions, for instance, are famously influential. “If they don’t like what Time magazine puts on its cover [about teachers, the union will] tell people to write in and say ‘you’re insulting teachers,’” Faulhaber points out.

Sharing economy companies also should quickly address criticisms about their service and take corrective steps, Faulhaber says. The taxi industry has accused ride-sharing apps of compromising passenger safety because of questions about drivers’ backgrounds and insurance. Insurance is particularly crucial because personal auto insurance policies generally do not cover a car and its driver when it turns into a cab, wrote Samuel Marshall, president and CEO of the Insurance Federation of Pennsylvania in an August 1 column for the Pittsburgh Post-Gazette. Sharing apps must refute these accusations from deep-pocketed rivals. “They’re playing with the big boys here,” Faulhaber says.

“[Politicians] don’t care about it being more efficient. They care about whether they hear from constituents.” –Gerald Faulhaber

It is entirely possible that ride-sharing services like Uber will end up with a diminished presence as the companies adapt to the regulations of different cities. “I don’t know if Uber is going to survive in the taxi business, especially in Europe,” Faulhaber says. “They may not survive in New York City. It’s pretty highly regulated with very organized unions. But they could survive outside New York, in places like the suburbs, where the taxi business is very different from downtown New York and Philadelphia. There may be less political pressure.”

As for cities changing laws to cater to these sharing services, a strong case for it has not yet been made. “It isn’t clear that the cities need to change their regulations,” says Wharton management professor Peter Cappelli. “For example, with Uber, cities have rules that govern things like background checks on taxi drivers and the amount of insurance they carry. Should Uber be exempt from them? It’s not clear why.” Even if the sharing services say they are complying with the law, there has to be a system of checks and balances. “The reason we regulate some industries is because we don’t trust them to regulate themselves,” Cappelli adds. “We don’t want to take the word of restaurants that their kitchens are clean, because the consequences to the public if they are not [doing so] are big.”

Philadelphia Mayor Michael Nutter tweeted on October 27: “I strongly support having Uber/Lyft services in Philly,” despite opposition from the state-run parking authority. In September, the parking authority’s own website promoted a car-hailing app called “Way2Ride,” which summons any one of 1,400 Philadelphia taxicabs. It also supports “215 Get A Cab” and “Freedom Taxi” as e-hailing apps that abide by its “rigorous, yet necessary, safety regulations.”

At the same time, regulations should not exist to protect entrenched industries and shut out competition, experts say. “I think the line is pretty clear: We shouldn’t as a matter of public policy be interested in protecting industries from competition unless there are some pretty extraordinary reasons for doing so,” Cappelli notes. Incumbent companies have good reasons to grouse if new apps compete with them without having to abide by the same laws. “They are complaining that these companies are ducking regulations, and that is a reasonable concern. The reason they care about that, of course, is because they are losing business or feel they soon will,” he adds.

Sharing services may have an easier time disrupting the status quo in industries that do not have strong political backing and are more lightly regulated. For example, the music industry had to adapt or die when sales of individual songs in digital format began outselling entire albums. Apple’s iTunes was instrumental in upending the music industry by selling single tracks for 99 cents a decade ago— a model that itself has now been disrupted by streaming services. Record companies changed to survive while record stores went out of business. “That business has changed enormously,” Faulhaber notes.

But incumbent companies are not without tools to fight back, beyond lobbying politicians. “The more interesting challenge seems to be how the existing companies should adapt to these new ones. If riders are willing to pay a premium for rides on Uber because the cars are clean and the drivers show up quickly, what should the taxi and limo companies be doing to compete with that?” Cappelli asks. “Seems like there is a market there.”

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