If you listen in on any recent earnings calls for Uber (NYSE:UBER) or Lyft (NASDAQ:LYFT), you will inevitably notice a recurring theme: market rationalization.

"We are continuously optimizing our platform for growth and leverage, while also benefiting from an increasingly rational market," Lyft CFO Brian Roberts said last month. "This is resulting in reduced incentive spending and lower sales and marketing expenses overall." Just this week, Uber CEO Dara Khosrowshahi acknowledged, "We're not counting on rationalization near term in Q4, but we do think that all of these markets need to rationalize."

Man getting out of the backseat of a black SUV

Image source: Lyft.

That's a euphemism for the ridesharing industry's wake-up call as it nurses a hangover induced by years of binging on private capital. In the process, a massive industry -- legacy taxicabs -- was upended as the duo undercut incumbents by any means necessary in order to secure market share. Uber and Lyft have long been subsidizing both sides of the ride-hailing industry, offering incentives to drivers and riders alike, just to keep prices at unsustainably low levels.

If you read between the lines, all of the talk about market rationalization is also an implicit indictment of the ridesharing industry's irrational unit economics thus far.

Dollars and sense

Despite being among the most heavily hyped IPOs of 2019, Uber and Lyft have delivered lackluster performance since going public earlier in the year. Both companies are coping with investor skepticism over profitability, a problem fundamentally tied to ridesharing unit economics. Uber and Lyft have signaled to investors that they want to move away from competing exclusively on price, reducing promotional offers and other incentives.

This all bears out in the numbers as Uber and Lyft attempt to wean themselves off the addictive incentives. Some withdrawal can be expected.

Chart comparing sales and marketing as a percentage of revenue for Uber and Lyft

Data source: SEC filings. Chart by author.

Note that some driver incentives are classified as a reduction of revenue, so even this chart doesn't quite paint the full picture. Additionally, keep in mind that expenses jumped in early 2019 in connection with both companies' IPOs, which trigger the recognition of significant stock-based compensation expenses that have nothing to do with incentives.

"We think that we can improve our marketing spend and spend on incentives as a percentage of revenue as well," Khosrowshahi commented on the earnings call this week. "Both in terms of the market rationalizing, but our teams becoming much more effective in segmenting our consumer base, in using targeted marketing in order to reach the right person at the right time."

Uber and Lyft have now each laid out a timeline to profitability -- on an adjusted EBITDA basis -- with Lyft targeting Q4 2021 and Uber shooting for full-year 2021.

Money isn't the only cost

Beyond the dollars and cents, there are other very real human costs associated with ridesharing's irrationality. The most visible is that ride-hailing drivers often struggle to make ends meet, barely earning a living wage in some cases, particularly in markets that have a high cost of living. While drivers shoulder the brunt of performing the vast majority of the actual underlying work, Khosrowshahi brought home over $45 million in 2018, according to Uber's prospectus.

Uber app

Image source: Uber.

Ridesharing companies classify drivers as independent contractors, depriving them of many benefits like retirement plan matching, healthcare, and paid time off. Like many other strategic decisions, this was also done in order to lower prices. Uber and Lyft are facing legal challenges to that categorization, and company officials estimate that if the businesses are forced to recognize drivers as employees, fares could skyrocket by as much as 20% to 30%, depending on the market.

There are other layers of human costs. Thanks to lackluster security protocols, safety policies, and background checks, many drivers have been accused of sexual assaults and other crimes against riders. Seeking to minimize costs, Uber and Lyft have shortchanged rider safety, and those victims will now have to grapple with that trauma for the rest of their lives.

Countless rank-and-file employees have toiled for years, helping to build Uber's platform with the hopes of one day cashing in on a life-altering payday from equity-based compensation. Early employees at other tech companies transformed into millionaires overnight once those start-ups went public; why should Uber be any different? Any employee that joined Uber since mid- to late 2016 is likely staring at losses, Bloomberg's Shira Ovide notes.

Last and least (relative to these other stakeholders), public investors have also suffered losses. Many retail investors got caught up in the hype and could now be sitting on paper losses of 40% to 60% relative to each stock's respective highs. Compared to the other human costs, losing some money on a risky stock that just went public seems less consequential.

What goes down might not come back up

Do you remember when a decade ago book publishers threw a fit over Amazon.com selling e-books for just $10? The e-commerce giant utilizes a wholesale model instead of an agency model, buying books from suppliers (publishers) while setting its own price instead of letting publishers set the price and taking a cut. The underlying concern that publishers had was that Amazon would crush the perceived value among consumers of what a book should cost. They used to sell books for far more than $10, but Amazon changed the game.

Lyft app displayed on a smartphone

Image source: Lyft.

A similar situation is playing out in music streaming now, where record labels bemoan ad-supported services since they cement in consumers' minds that music is a free commodity as long as they're willing to suffer through a 30-second audio ad. Even as streaming services drive a renaissance in the music industry, record label execs fret about the deteriorating value perception.

That is precisely the problem that the ride-hailing industry now faces. After years of underpricing fares, consumers must now reset expectations around what a ride to the airport or a trip back from the bar is supposed to cost in the absence of venture capitalists subsidizing transportation in the pursuit of growth at all costs. That's a daunting task, as it's much easier to deliver perceived value through lower prices than higher ones.

To be clear, Uber and Lyft have no one to blame but themselves. This is a crisis of their own making, and deep-pocketed private investors are complicit in the predicament. As challenging as it is for consumers to adjust, it will be infinitely more difficult for ridesharing companies to justify to riders why prices need to keep creeping higher.

Where does ridesharing go from here?

This is the task that Uber, Lyft, and other ride-hailing companies around the world are faced with: strengthening the perceived value of transportation and bringing prices up to "rational" levels. Furthermore, there's a fine line between all companies in a sector recognizing the error of their ways and adjusting fares accordingly, and price fixing, which is an illegal form of market collusion.

Sure, you could argue that the traditional cab industry became overregulated over time, weighing on the industry's efficiency while imposing substantial costs of compliance that are ultimately passed on to consumers in the form of higher prices. But Uber and Lyft swung the pendulum way too far to the other side, and now we're all along for the ride.

Somewhere out there lies an economically sustainable middle ground. It's not clear how long it will take the ridesharing industry to get there, or how much we'll rack up in human costs along the way.