Why Restaurant Delivery is Great for Consumers but Bad for the Bottom Line
Want a Big Mac? What about a coffee from Starbucks? Or how about some A&W? With DoorDash, Uber Eats and Postmates you don’t need to leave your home to eat whatever you want when you want it. Similar to how Uber disrupted the transportation sector, delivery apps are changing our habits. In the U.S. between 2014 and 2019 restaurant delivery grew by 17% while restaurant visits remained flat.
At 3% of all restaurant orders in the U.S delivery is still a small segment but the industry growth is attracting both customers and new entrants. Kevin Johnson, CEO of Starbucks has said: "it is still early days for food and beverage delivery in the U.S." While we are not yet seeing Starbucks Delivers meaningfully contribute to our US business results, we believe that delivery is an important long-term growth opportunity."
The opportunity
Consumers between the ages of 18-34 are driving usage of food delivery apps with 23% of these consumers making an order using a meal delivery app at least once every week.
In 2020, it is forecasted that more than 44 million people in the U.S. will use food delivery apps and that number will jump to nearly 60 million people by 2023.
Meal delivery companies like DoorDash which is backed by SoftBank have raised millions of dollars in funding and are spending heavily to acquire customers as quickly as they can. In 2019 DoorDash came from behind to take the crown from Grubhub as the food delivery app with the highest market share in the U.S.
The profitability gap
Meal delivery is growing but at a cost. Delivery platforms take a 15% to 30% commission on each order. With these costs in mind Domino’s Pizza has decided to go it alone deciding not to partner with any of these apps. Speaking about its strategy Domino’s Pizza CEO Rich Allen said: “we’ve had a very strong and profitable delivery business for many years now.” “So unlike a lot of the other restaurant brands, we don’t have to decide to get in or not, or try to figure out which of these third-party aggregators is ultimately going to be the winner at the end of this shakeout.”
But Domino’s Pizza has conceded that: “aggressive marketing from third-party aggregators” has negatively impacted same store sales growth. Morgan Stanley estimates that third party delivery apps could erode Domino’s Pizza same-store sales by as much as 2%.
In an industry with razor thin margins the major concern for all restaurant owners is profitability. A survey of restaurant owners conducted by Restaurants Canada found that 55% of those surveyed believe that delivery apps are slightly profitable, 21% believe that delivery apps are not at all profitable and under 10% believe delivery apps are very profitable. With commissions of up to 30% incremental sales from the growth of a new segment doesn’t mean a panacea of incremental profits.
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Cannibalizing on premise sales is also concern. Nearly 37% of restaurant operators surveyed by Restaurants Canada said that third-party apps/websites have had a negative impact on dinner sales and 27% said delivery apps were hampering on premise lunch sales.
Starting in 2016 Paul Geffner, owner of Escape From New York Pizza, gave customers the option of ordering food using delivery apps. But what was a good thing for customers took a heavy toll on his business. As the New York Times reported, two of his restaurants which previously generated profits between $50,000 and $100,00 started to lose as much as $40,000 annually once customers shifted to delivery. Speaking about the decline of his business Geffner said: “we saw a direct correlation between the delivery services and the reduction of our income.” “It was like death by a thousand cuts.” Eventually he was forced to close those locations.
While restaurants complain about commissions, delivery platforms are also struggling. Speaking about the cost of delivery, David Albert, General Manager of food delivery company Foodora said: "it's what we have to charge to make our business work for us as well as the restaurant." "We're actually operating on very, very thin margins." Those concerns were echoed by GrubHub when it reported its 2019 third quarter results. In a letter to shareholders GrubHub wrote:
“In 2015, we added delivery capabilities to enable restaurants that didn’t have delivery to join our platform. We did this as a means to an end - we knew it would be valuable to have those restaurants on the platform. But, we didn’t then, and still don't believe now, that a company can generate significant profits on just the logistics component of the business. It is a commodity and there are significant variable costs that are hard to leverage even with technology and scale.
A common fallacy in this business is that an avalanche of volume, food or otherwise, will drive logistics costs down materially. Bottom line is that you need to pay someone enough money to drive to the restaurant, pick up food and drive it to a diner. That takes time and drivers need to be appropriately paid for their time or they will find another opportunity.”
In the third quarter of 2019 Grubhub’s net income decreased from $22.7 million in 2018 to $1 million. Some of the reasons Grubhub cites for its troubles, in addition to thin margins, is declining customer loyalty. With more and more delivery options new customers are making fewer orders than customers who have been with Grubhub for a longer period of time. Grubhub also believes its future lies in online advertising on its platform and delivery customers are just a way to create a large audience.
The future of meal delivery
As the meal delivery market grows it is spawning new businesses looking for the next wave of profits. One of these new businesses are ghost kitchens also known as cloud kitchens, virtual kitchens and dark kitchens.
A ghost kitchen is a kitchen that serves meal delivery orders. The facility has a commercial kitchen and is designed solely with delivery in mind. There is no seating or take out areas. The next time you make an order for spicy meatballs from Uber Eats the restaurant preparing it might not be a restaurant at all, at least not in the traditional sense. The ghost kitchen will prepare your order and it will be delivered by Uber Eats or whatever app you are using. Ghost kitchens are cheaper to run than a traditional restaurant. They require less real estate and lower overhead costs. The kitchen does not need to be located in the best part of town since the customer will never see it, reducing real estate costs.
These kitchens service existing restaurant’s delivery traffic as well as virtual restaurants created just for delivery. Chains like Halal Guys, Sweetgreen and Chick-fil-A have already partnered with ghost kitchens. Starbucks has opened several ghost kitchens in China inside of Alibaba’s Hema grocery stores. The partnership allows Starbucks to leverage Hema’s delivery capabilities to service Starbucks’ online orders quickly and efficiently. Commenting on this Starbucks CFO Pat Grismer said: “we’re learning from their experience to understand how we might bring a similar model to life in the U.S., particularly in large metro markets like New York.” Uber Co-Founder Travis Kalanick’s second act includes investing in CloudKitchens a ghost kitchen start up that has already raised $400 million.
While some are touting ghost kitchens as the next big thing, some of these kitchens have struggled to attain profitability forcing them to close down. For example, Alacarte, a virtual kitchen located in Miami closed after only one year in business. Ghost kitchens are a new and evolving model and companies are still trying to figure out how to make them a success.